The Equator Principles: An Industry Approach to Managing Environmental and Social Risks
Posted: 11 Jul 2005
SUBJECT AREAS: project finance, business ethics, sustainable development, environmental and social risk, bank lending, regulation
On June 4, 2003, ten leading banks announced a new voluntary framework to guide project finance lending decisions called the Equator Principles. In the years leading up to the announcement, non-governmental organizations (NGOs) and other civil society organizations (CSOs) had begun targeting sponsoring firms and, more recently, private commercial banks in high-profile campaigns. NGOs wanted the financiers of large projects to take legal and moral responsibility for the social and environmental damage caused by projects they financed. While the banks presented the Equator Principles as a major step toward sustainable development, they were quickly attacked by many NGOs which argued the Principles were incomplete, if not flawed. Given the criticism, the Equator banks had to decide what to do: should they encourage other banks and export credit agencies (ECAs) to adopt the Principles, focus on implementation, or respond to the criticism directly?
Although this case was written for a course on project finance, it is appropriate for a variety of courses including business ethics, general management, risk management, financial institutions, and environmental economics. Depending on the nature of the course, instructors can tailor this teaching plan to meet the following pedagogical objectives. First, the case illustrates a private-sector attempt to promote sustainable development. Students must assess whether the Equator Principles will help mitigate environmental and, to a lesser extent, social risks in project-financed deals. Relatedly, the case highlights the challenges of being a pioneer in setting standards. Second, the case examines a set of voluntary standards for environmental and social accountability. Students must decide how effective the Principles are likely to be, and what can be done to make them more effective (i.e., how much and what kind of disclosure is needed for the standards to work? what kinds of enforcement mechanisms, if any, are needed? etc.) Third, the case highlights the importance of uniformity and consistency when establishing industry-based regulations. Failure to ensure widespread adoption could result in a race to the bottom among financial institutions in their willingness to finance environmentally harmful deals. Finally, students assume the role of bankers and analyze the likely effectiveness of a financing strategy designed to minimize reputation and termination risks. Will the Principles reduce the probability that a blocking coalition of stakeholders (e.g., NGOs, political opponents, CSOs, etc.) will delay or stop a project? Beyond these immediate issues looms the much larger issue of how history will judge the actions taken by the Equator Banks. Will the Principles be seen as a bold step towards achieving sustainable development, a negligible step with little long-term impact, or simply a public relations stunt?
In addition to the case, there is a technical note entitled, An Overview of Project Finance - 2004 Update, that provides background information on project finance and describes some of the institutional details of this rapidly growing field of finance.
JEL Classification: G21, G31, M14
Suggested Citation: Suggested Citation