• Widening The Scope Of The Equator Principles - What Could This Mean For The Ship Finance Market?
  • October 31, 2011
  • Law Firm: Norton Rose Canada LLP - Montreal Office
  • The Equator Principles Association has launched a consultation to consider extending the Equator Principles beyond project financing to apply to corporate loans where fifty per cent or more of the proceeds of that loan are being used to finance a single asset thereby, clearly, bringing such principles into the ambit of shipping and asset finance

    Introduction
    The Equator Principles are a set of principles designed to ensure that projects are developed in a socially and environmentally responsible way. Financial institutions can voluntarily agree to adhere to the Equator Principles, and by doing so, agree to apply them to all new project financings with total project capital costs of US$10 million or more. Each financial institution which signs up to the Equator Principles (an EPFI) interprets and implements the Equator Principles differently (which has led to inconsistent application) and the EPFIs often then seek to pass on the risk of complying with the Equator Principles to the borrower in loan documentation. As the Equator Principles Association (EPA) is currently considering whether to widen the scope of the Equator Principles to apply to asset finance it is worth considering what this might mean in a shipping context.

    What does implementation of the Equator Principles involve?
    As part of an EPFI’s internal approval process, it will categorise potential loans based on their perceived level of environmental and social risk. Categorisation is based on the screening criteria of the International Finance Corporation (this is the commercial arm of the World Bank) and the categories include:

    • Category A - Projects with potential significant adverse social or environmental impacts which are diverse, irreversible or unprecedented;
    • Category B - Projects with potential limited adverse social or environmental impacts that are few in number, generally site-specific, largely reversible and readily addressed through mitigation measures; and
    • Category C - Projects with minimal or no social or environmental impacts.

    In order to obtain funding for Category A and B projects, a borrower (or external consultant) will need to have conducted a Social and Environmental Impact Assessment (SEIA) which will identify relevant impacts and risks. In addition, borrowers will need to prepare “Action Plans” which set out strategies to mitigate, monitor and manage the impacts and risks identified through the SEIA.

    The borrower or third party expert involved in Category A projects and some Category B projects will be required to consult with affected communities where the project is located in non high-income OECD countries. The borrower will need to show, to the satisfaction of the EPFI, that a project has adequately incorporated affected communities’ concerns.

    In which type of loans are the Equator Principles implemented now?
    The Equator Principles are stated to apply to all new project financings with total project capital costs of US$10 million or more. The EPA refers to the Basel II definition of project financing which is “a method of funding in which the lender looks primarily to the revenue generated by a single project, both as a source of repayment and as security for the exposure. This type of financing is usually for large, complex and expensive installations that might include, for example, power plants, chemical processing plants, mines, transportation infrastructure, environment and telecommunications infrastructure...”. Many EPFIs take the view that shipping loans fall into the category of “asset finance” and therefore they do not need to apply the Equator Principles in their assessment of the transaction.

    Changes to the application of the Equator Principles
    The EPA recently commissioned a strategic review which highlighted a number of issues and has resulted in certain recommendations. One of the key points is that the definition of “project finance” is interpreted differently across EPFIs. In some cases, the view is that project financings with challenging environmental and social risks are being disguised as corporate loans to avoid application of Equator Principles. The recommendation of the strategic review is to widen the scope of the Equator Principles to apply to corporate loans where fifty per cent or more of the proceeds of that loan are being used to finance a single asset. At present, it is not clear whether that financing would need to be for the construction of that asset or merely related to it.

    In response to these recommendations, the EPA has launched a consultation process to consider amendments to the Equator Principles. The key dates are summarised below:

    • Phase I - Focused EPA group work and internal discussion on key topics and thematic areas (July - September 2011);
    • Phase II - Consultation period with the EPA membership, preliminary scoping discussions with key stakeholders and initial drafting of a new Equator Principles framework (known as the EP III framework) (September - November 2011);
    • Phase III - Launch of the formal 60 day Stakeholder Consultation and Public Comment Process (December 2011 - February 2012). The EPA will be providing a more detailed timeline for this at a later date; and
    • Phase IV - Finalisation and launch of the EP III framework (target date March 2012).

    Any formal amendment to the Equator Principles will require a voting process by the entire EPA membership.

    What this could mean for borrowers and EPFIs
    If the Equator Principles apply to shipping loans, each EPFI will need to evaluate the transaction and assess the level of environmental and social risk involved. Depending on the categorisation of the loan, it may be that:

    • Further reports, Action Plans and consultations will be required by EPFIs. This could increase costs for the borrower and lengthen the time period for approvals or satisfaction of conditions precedent.
    • Borrowers are required to give representations, warranties, undertakings and conditions precedent in loan documentation in relation to compliance with SEIAs, Action Plans and environmental laws. There will also be a continuing obligation to provide details of compliance with Action Plans.
    • If an EPFI is planning to syndicate the loan, it will need to ensure that each of the potential syndicate banks agrees to its categorisation of the loan. If not, an EPFI could find that the loan cannot be syndicated without further amendment.

    In view of the regulation that already exists in the shipping industry it will be interesting to see whether industry players seek to try and limit the application of the Equator Principles to shipping finance transactions and seek to get involved in the consultation process to achieve this. However, with more than 70 financial institutions (representing in excess of 90% of the global project finance industry as at 2009) having signed up to the Equator Principles, and in view of the significant cross-over between shipping and project finance departments in banks involved with offshore shipping finance transactions it may be difficult for borrowers, and other industry players, to entirely avoid them.