Equator Principles and COVID-19: Compliance challenges
Friday, August 28, 2020 @ 8:26 AM | By Alison Babbitt, Kellie Johnston and Josh Smith
COVID-19 reaches ESG risk management in project finance
In response to COVID-19, the Equator Principles Association recently published guidance on how borrowers and lenders in large project financings should modify their practices to implement the Equator Principles (EPs) — a risk management framework adopted by financial institutions — during the pandemic. Yet, even if they do make changes to the way they operate, lenders and borrowers may still find themselves unable to fulfil core EP requirements. As well, parties to such financings may need to reconsider how project-related COVID-19 health risks themselves could trigger additional human rights risk assessment and mitigation obligations.
COVID-19 complicates the fulfillment of ESG diligence obligations required in EP-qualifying project financings, such as site visits by EP financial institutions (EPFIs), which are currently hindered by both international and local in-country travel and health restrictions. Out-of-country EPFI representatives may not be able to drive or fly to project host country sites, and local consultants may be limited in their ability to inspect or consult on behalf of EPFIs or borrowers. Some substitutes or alternatives to on-site visits include:
• Delaying the site visit, which is appropriate for monitoring mature or steady-state projects;
• Making combined use of videoconference, drones, photography/time-lapse photography, orbital satellite imagery, etc. for virtual site visits;
• Hiring local consultants and providing remote oversight, in conjunction with virtual site visit methods, and;
• Increasing the frequency of communications between EPFIs, their advisers and borrowers.
However, COVID-related restrictions on physical site visits may limit the possibility of complying comprehensively with the EPs in the manner typically adopted by the EPFIs, even if the above measures are deployed. It may not be possible to: (i) complete a robust diligence process; or (ii) complete all material assessments and planning activities necessary to meet the EPs. To address this, companies may want to consider more comprehensive covenants in the loan agreement and other financing documents to address COVID-19-related risks and diligence-related uncertainties.
Alternatively, transaction parties can address such issues by agreeing that a site visit be conducted as a condition to close or through a covenant requiring one or more supplementary on-site visits at a later date. However, this could lead to a situation where construction or operations get underway even though environmental and social risks have not been fully assessed. In such a case, if the project’s environmental and social risk management was found to be inconsistent with the EP standards, then solutions to address ESG risks would be solely retroactive and the impacts may not be adequately managed.
Further, there are other scenarios where closing without site visits may present practical obstacles to compliance. For example, compliance could be undermined if procurement for construction services has been completed prior to the execution of closing documents without contractual provisions to address COVID-19 risks themselves. Or when a project’s local workforce is available and mobilizes before the EPFI is able to visit the site, the EPFI may not be able to assess and adapt the ESG measures to address potential changes in COVID-19-related risks posed to the workforce, or impacted communities, as a result of the movement of such workers.
EPFIs will need to seriously consider whether the combination of alternative visitation methods, or a condition precedent for a site visit at a future date, satisfies their “robust” and “material” diligence requirements. EPFIs should also consider whether such modified practices provide sufficient comfort that environmental and social risks are adequately determined and mitigated. Additionally, both EPFIs and borrowers should consider that they are taking on environmental and social compliance risk insofar as they agree to such alternative arrangements. In some cases, lenders may prefer to delay financial close until the circumstances return to normal, but given fluctuating local and international public health directives related to COVID-19, it may be some time before this occurs.
Community and stakeholder engagement
COVID-19 may also hinder the ability of borrowers and EPFIs to meaningfully engage with stakeholders and communities affected by projects that have the greatest potential environmental and social impacts. The EPs require such engagement, which includes coordinating informed consultation and allowing for affected communities to meaningfully participate in the environmental and social risk assessment and management process. However, in light of COVID-19, it may be difficult to have open houses, meetings and other gatherings to engage fulsomely and effectively with potentially affected communities. As such, during COVID-19, EPFIs and borrowers should look to enhance or adapt their communication efforts to facilitate community involvement. However, this may prove difficult in some project scenarios where, for example, technology is not available to support virtual engagement.
Accordingly, EPFIs and borrowers should very carefully consider the extent to which they rely on adapted diligence or community engagement protocols to fulfil their respective EP obligations.
COVID-19-related health risks as a human rights issue
COVID-19 itself could trigger new ESG issues for lenders and borrowers in EP-scale project financings. This is because the incoming fourth version of the EP, which comes into effect on Oct. 1, newly requires an assessment of potential adverse human rights impacts of a project in line with the United Nations Guiding Principles (UNGPs). The UNGPs generally state that businesses have the responsibility to: a) avoid causing or contributing to adverse human rights impacts through their own activities and address such impacts when they occur; and b) seek to prevent or mitigate adverse human rights impacts that are directly linked to their operations, products or services by their business relationships, even if they have not contributed to those impacts.
The EP association guidance specifically references World Health Organization policy as a heightened best practice above and beyond the health and safety standards set out in EP4 (the Action Plan). If EPFIs fail to adequately consider and mitigate the additional COVID-19-specific health risks to workers and communities during the pandemic, they may be found not be compliant with the elevated human rights risk management obligations contained in EP4. This situation could create serious negative perceptions of the respective project, especially if the project appears to, or actually, increases COVID-19 risks in a community.
With ESG risk management and sustainability playing an increasingly prominent role in the financial and public support for large-scale project investments, and large infrastructure and industrial developments likely playing a critical role in many countries’ post-COVID-19 economic stabilization plans, it is critically important for parties involved in such transactions to understand the novel environmental and social compliance and associated human rights risks that COVID-19 creates.
Alison Babbitt is a project finance partner at Norton Rose Fulbright in Ottawa, whose practice is centered on the mining, renewables and clean technology sectors. Of Counsel Kellie Johnston, who works out of the firm’s Calgary office, is a member of the global risk advisory practice and she advises clients in a variety of sectors, with a particular focus on risks and opportunities relating to sustainability. Ottawa-based Josh Smith is a corporate and commercial lawyer in Ottawa with experience in project development and regulatory law.
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