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Wednesday, February 13, 2013

Independent Review Requirements in Equator Principles III

The requirement for "independent reviews" has been strengthened in the last draft of the EP III.  This means that Equator Principle Financial Institutions (EPFI) will need to be more cognizant of how they conduct such reviews and who they choose to do them.  The final draft of the EP III is set to be released in the first quarter of 2013.

EP III requires that, for Category A and (as appropriate) Category B projects, an “Independent Environmental and Social Consultant”, defined to mean a qualified independent firm or consultant not directly tied to the borrower) acceptable to the EPFI.  This is distinguished from an "Equator Principles Reviewer" who are defined to include EPFI employees responsible for reviewing the environmental and social aspects of loans subject to the Equator Principles.

What does an "independent review" entail?

External independent reviewers are required by Principle 7 to critically examine the environmental and social Assessment, management plan, management system and consultation process documents, to assist the EPFI's due diligence, assess EP compliance of the project and propose a suitable AP capable of bringing the project into compliance with the EP or to indicate if compliance is not possible. 

When is an independent review required under Principle 7 of the EP III?

For Project-Related Corporate Loans, an independent review is required for projects with high risk impacts, or at the discretion of the EPFI for other Category A or B Project-Related Corporate Loans. High risk impacts may arise from:
  • Adverse impacts on indigenous people,
  • Critical habitat impacts,
  • Significant cultural heritage impacts
  • Large scale resettlement.
In exercising this discretion, the EPFI may consider the due diligence performed by an “Official Agency” such as an Export Credit agency or multilateral development bank.

Internal EPFI Project Reviews

EPFI have diverse approaches to the management of Environmental and Social Risks and implementation of the EP. Some EPFI have a highly decentralized approach, where implementation of the EP is managed by lending officers, with support from centralized risk management teams for higher risk projects. At other EPFI, environmental and social risk management is more centralized. Centralized risk management teams may specialize only in environmental and social risk issues, or be staffed by generalist credit risk management personnel.

Some EPFI utilize advisory centres who provide technical support to front line business managers or lending officers who are ultimately responsible for EP compliance. In-house legal counsel may have dotted line oversight of this process, but are typically not heavily involved in this process.

Since management approaches may vary between EPFI, complications may arise where lending takes place through a syndicate, particularly if certain lenders are not EPFIs. The independent review process attempts to overcome such challenges for high risk Projects.

Independent reviews are designed to give “sober second thought” to the documents prepared as part of the implementation of the EP III.

Independent Environmental and Social Consultants

The “independent” reviewer should be independent from any ulterior (such as financial) motives that may undermine their independence or create the appearance of bias. The wording of Principle 7 in EP III is more clear than previous versions that an “independent reviewer” is distinct from an “internal review by the EPFI”.

As such, while it may have been ambigious in the EP II, in EP III it is quite clear that an independent review is not consistent with a review conducted by an internal department of the EPFI, even though they are arguably not “directly associated with the borrower”.

Independent Environmental and Social Consultants should be external and independent from both the borrower and EPFI. “Independent Environmental and Social Consultant” is also defined distinctly from “Equator Principles Reviewers” which is an internal EPFI role, implying that the former is not the equivalent of an internal reviewer.

What does "qualified" mean?

There are a plethora of consultants out there claiming qualification to conduct independent reviews.  In considering whether they are indeed qualified, it's useful to consider what it is that independent reviewers must do.  There are 14 references to "compliance" in the EP III.  "Compliance" means acting in accordance with environmental and social laws and regulations in all cases.  In some cases (based on the application of Principle 3), it may also mean complying with the requirements of the IFC Performance Standards in addition to legal compliance.  So, the task of EP III implementation is to ensure compliance with law and possibly the IFC Performance Standards.  Any external reviewer should therefore be competent and qualified to advise on questions of legal and regulatory compliance as well as the requirements of the IFC Performance Standards.

The US Treasury Department, in its comments on the 2012 version of the IFC Performance Standards, explicitly stated that environmental and social due diligence is an ideal opportunity to conduct anti-corruption and bribery reviews of a project.  As such, it is highly prudent for an EPFI to take the opportunity of an EP III review to examine anti-corruption measures and associated risks.  To do this effectively, an independent reviewer should also be competent to advise on applicable anti-corruption legal requirements.

The independent review process, and the ongoing monitoring that occurs for an EP III project, is critical to effectively manage the legal, reputational and financial risks of the project.  As such, selection of qualified independent advisors is an important decision that EPFI may need to rethink with the release of EP III.

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