Just two decades ago, commercial banks paid little attention to the environmental and social risks of lending in emerging markets. When it came to financing projects, bankers focused on financial risks and returns. That’s the way it had always been.
But throughout the 1990s and early 2000s—as environmental awareness grew and protests led to disruptions of major mining and oil pipeline projects in developing countries—banks became vulnerable to criticism that their lending might be doing more harm than good. As the situation escalated, some banks determined that their reputations were at risk. That carried financial consequences.
Bank officials understood that they needed new ways to align their investments with modern social values.
The Equator Principles—a global benchmark for sustainable project finance—were created 15 years ago for this new era. They’ve made it possible for “real bankers to talk both profits and social benefits,” says Graham Sinclair, Principal at Sustainable Investment Consulting LLC. The consequences, he believes, have transformed the one-time status quo: “The Equator Principles have altered the way the business of global project finance is conducted in emerging markets… now, the Equator Principles are a de facto best practice that place environmental, social, and governance issues inside every deal.”
Convincing a Skeptical Audience
As the Equator Principles have become the most tested and applied global benchmark for sustainable project finance, they continue to influence the growth of responsible business standards across the globe. But in 2002, when discussions began, few were convinced that this new approach would catch on.
“Initially there were doubts that all these highly competitive banks would work together to establish common environmental and social principles or hold themselves to account for meeting them,” according to Jane Nelson, Director of the Corporate Responsibility Initiative at Harvard’s Kennedy School of Government. “But they did, and the Equator Principles became a pioneering model for other industry coalitions in developing and spreading responsible business standards.”
In fact, groups are now drawing on the experience of the Equator Principles to create similar standards for stock markets and capital markets. Sinclair notes that a new transparency initiative to fight corruption in the infrastructure sector is also modeled on the Equator Principles.
“Initially there were doubts that all these highly competitive banks would work together to establish common environmental and social principles or hold themselves to account for meeting them, but they did, and the Equator Principles became a pioneering model.”
— Jane Nelson, Director, Corporate Responsibility Initiative,
Harvard Kennedy School of Government
As for the original target—project financing—94 banks in 37 countries now adhere to the Equator Principles. This covers over 80 percent of project-finance transactions in emerging markets. In many of these markets, the Equator Principles set the bar above local requirements and standards.
A New Approach to Lending for a New Era
Today, the Equator Principles are considered a rare example of financial market self-regulation and the financial sector’s power to influence the trajectory of sustainable development. But the original idea was more modest in scope.
In the early 2000s, pressure was mounting against the lending practices of major banks. IFC had begun to build the business case for sustainability—demonstrating that companies in emerging markets could actually boost their financial results by taking steps to improve environmental, social, and corporate governance processes.
An IFC report featuring firms that had benefited from adopting environmentally friendly measures was launched at the Rio+10 Summit in 2002, sparking “a whole set of different conversations between IFC and clients around the area of sustainability,” recalls Bernie Sheahan, IFC’s then-Director of Strategy.
One of these conversations was with ABN AMRO. Civil society groups were criticizing the Dutch bank for not doing enough to manage social and environmental risks, and the bank approached IFC for help.
After those discussions, the bank ruled out the option of adopting principles on its own—among other things, it would put ABN AMRO at a disadvantage among its peers—and instead chose to try to convince other banks to follow the same policies.
Sheahan says ABN AMRO played the lead role in bringing together a group that originally included Citibank and Barclays. IFC provided advice to the group so it could create a new industrywide framework to manage environmental and social risks in project lending. This common approach—originally, a “lighter” version of IFC’s Safeguard Policies from 1998—could help reduce important risks related to deal structuring, project completion, credit, and reputational risks.
This was a welcome but unexpected game-changer, says Sheahan, who met with banks’ teams over a period of nine months. “The big surprise was that, in the last month, we were able to bring the banks to a completely different position: that they would adopt IFC’s policies, not some ‘light’ version as they had intended to do. The key argument that won them over was that they would consistently be arbitraged by NGOs against IFC’s standards so that a ‘light’ position was untenable.”
“The big surprise was that, in the last month, we were able to bring the banks to a completely different position: that they would adopt IFC’s policies, not some ‘light’ version as they had intended to do.”
— Bernie Sheahan, former Director of Strategy, IFC
Negotiations wrapped up in June 2003, when 10 banks announced that they were adopting the Equator Principles. The name they chose reflected the initiative’s global perspective.
The news that financial institutions were taking steps to safeguard the environment made headlines because financial institutions were doing something unheard of—taking a leadership role on global environmental and social issues.
A New Global Standard
By Candido Bracher, Chief Executive Officer, Itaú Unibanco Holding S.A.
The Equator Principles have changed the way major projects around the world are funded. They have become the global standard for project finance, while successfully addressing regional differences and managing cross-border complexities. Such an achievement was only possible because the Principles are consistently evolving to absorb changing market practices and stakeholders’ demands.
Itaú was one of the first emerging-market banks to adopt this new global framework, in 2004. The commitment was consistent with our international expansion strategy and our persistent engagement with sustainable development and social responsibility.
“The Equator Principles have changed the way major projects around the world are funded… Such an achievement was only possible because the Principles are consistently evolving to absorb changing market practices and stakeholders’ demands.”
— Candido Bracher, Chief Executive Officer, Itaú Unibanco Holding S.A.
Besides knowledge-sharing, membership has brought Itaú benefits in many areas: It has directly enhanced our risk approach and enabled us to access foreign funding and investors who increasingly value what the Equator Principles stand for. Moreover, with more than 90 members—including major European, American, and Asian banks—the framework has set a level playing field for sustainable financial institutions with overseas operations.
By leading the way in sustainable finance, IFC continues to push to improve and enhance the Principles. The fact that one-third of the signatories now come from emerging markets is mostly thanks to IFC. The IFC Performance Standards are at the heart of the Equator Principles, forming the technical framework on which the Principles were built. They provide valuable guidance on how to address sensitive topics such as indigenous communities, filling gaps left by environmental and social laws.
The Principles’ future lies in widening their scope and outreach by covering a comprehensive spectrum of project-finance instruments, and addressing important trends, such as climate change.