Translate Lex Sustineo

Wednesday, December 12, 2012

Growing Legal Implications for Banks as Private Regulators of Environmental and Social Standards – Need for a New Approach with More Legal Involvement

Many banks have historically treated Equator Principles (EP) implementation process as though it were “non-legal”. This has been due, in part, to a belief that the initially voluntary nature of the EP agreement makes it different from a legally imposed requirement. While entering into the EP agreement is, certainly, a voluntary decision, the reality of that decision is that it carries significant legal implications and even risks.
By holding themselves out publicly as private regulators of their clients' environmental and social performance, EPFI have taken on both reputational and legal risks beyond the inherent risks of the project. The business case for doing so is the bank's interest in mitigating the reputational, legal and financial risks associated with poor environmental and social performance of their clients. The challenge will be to ensure that the risks of acting as a private regulator are also effectively managed by banks taking on that commitment.

It remains an open legal question whether public commitments and contractual agreements to apply the EP give rise to direct third party beneficiary rights (such as in relation to Affected Communities) through tort or contract law. There is jurisprudence in the United States where third party beneficiary rights have been found from contracts containing terms that are for the benefit of third parties – which in the EP context could include commitments to maintain environmental and social standards that could impact Affected Communities. These risks can be mitigated with appropriate contractual language, which would expressly remove third party beneficiary rights that might otherwise arise from contractual commitments for the benefit of Affected Communities.

Operational control or oversight of a project by a shareholder/owner can increase the risks of regulatory liability for those parties, including in the environmental, health and safety and labour contexts. To the extent EP banks take on an increasing operational role, they will be exposed to greater regulatory risks. 

There may also be implications for investment treaty and international trade law in light of increasing recognition of “sustainable development” or “corporate social responsibility” in investment agreements. The EP and IFC Performance Standards are a likely reference point for the interpretation of these two legal concepts.

Also in the context of international trade law, Export Credit Agencies (ECA) in OECD countries are often legally obligated to apply environmental and social risk management standards in extending their export credit facilities in accordance with the OECD Common Approaches, which is a framework analogous to the EP and include application of the IFC Performance Standards. These international trade implications of the EP reinforce their legal relevance.

We can expect that such risks will only increase as the EP process matures and becomes the subject of future litigation. EPFI would be well advised to get ahead on these issues to avoid being the industry “test case”.

On a more practical level, the EP (including EP III) and new IFC Performance Standards require compliance with state laws (including laws implementing international legal obligations of host countries), regulations and permitting processes pertaining to environmental and social matters. In fact, state laws are applied as the applicable benchmark in High-Income OECD countries. The IFC Performance Standards (a non-State framework) is applied as a supplement to local laws in other countries, where such laws are less stringent than the comparable IFC Performance Standard. In either case, the implementation of the EP requires a regulatory compliance review that must take into consideration legal requirements and assess legal compliance. It is, therefore, not possible to implement the EP without conducting a legal and regulatory compliance review of a project. While sustainability certainly necessitates more than simply “compliance”, the first step on the sustainability journey is compliance with law and applicable non-state regulatory frameworks like the EP and IFC Performance Standards.

In light of the inter-relationship and overlap between EP and legal and regulatory requirements and risks, an integrated approach to EP implementation with environmental and social legal due diligence is likely to emerge as a best practice trend. This will be both more efficient and more reliable than the old (and out of date) approach of viewing EP implementation as a “non-legal” process. By recognizing early their role as “private regulator” and working with legal counsel, EPFI can adopt best practice in regulatory and legal strategy to make the EP process more efficient and less risky.

No comments: