mit freundlicher Unterstützung des Exzellenzclusters Normative Orders

The following essay focuses on a particular Corporate Social Responsibility (CSR) approach within the field of project finance which has the potential(!) – given that certain reform measures are adopted – to overcome the alleged trade-off between (corporate) self-interest and the common good. The approach is labeled as the Equator Principles (EPs) framework which celebrated its tenth anniversary and the formal launch of the third generation of the EPs (EP III) in June 2013.

The EPs are officially characterized as voluntary credit risk management framework for determining, assessing, and managing socio-environmental risk in project finance transactions. EP III applies globally to four financial products: project finance, project finance-related advisory services, project-related corporate loans and bridge loans. The project finance sector funds the design, construction and operation of large industrial and infrastructure projects in particular in emerging markets and developing countries. The EPs are based on the IFC Performance Standards on Environmental and Social Sustainability as well as on the World Bank Group’s Environmental, Health, and Safety Guidelines. As of today, 80 financial institutions from all over the world have adopted the EPs.

What makes the EPs attractive from a business ethics perspective is that they aim to balance socio-economic, environmental and ethical issues, or as the ‘triple P’-framework would say: people, planet and profit. As such, they aim to reconcile the potential trade-off between (corporate) self-interest and public interest. The following paragraph explains the reasons by taking a closer look at the economic and ethical adoption motives.
The EPs help financial institutions to pursue their economic rationales. The self-interested goals of a corporation include profit motives as well as the implementation of effective risk management strategies. The main economic motives for banks to adopt the EPs are the following ones:

1. Managing financial risks: By complying with CSR-standards as well as transnational and host country’s laws and regulations, the EPs are able to minimize various risk categories. For instance, they allow the involved financial institutions to better identify and manage financial and non-financial risks due to the fact that environmental and social impact assessment and due diligence processes have to be carried out. In ‘Equator banks’, CSR as well as socio-environmental and human rights due diligence processes become ideally a matter of general risk management existing next to other legal or financial due diligence processes. The EPs as a risk management tool are thus able to enhance better management practices of economic and socio-environmental risks of financed projects. By better assessing and managing economic and non-economic risks, the EPs make a project a more secure investment and a safer loan. This is because the EP-framework helps reducing information asymmetries between lenders and borrowers, and the risks inherent to incomplete contracting (i.e., adverse selection). In addition, the EPs require a close collaboration between Equator banks and their clients in terms of socio-environmental impact assessment, management systems, action plans, stakeholder engagement/dialogue, grievance mechanism, independent review, monitoring and reporting (all of which get formalized in the loan agreement).

2. Managing reputational risk: Non-CSR behavior might backfire in the sense that it causes public outcry and media-driven scandalization that directly and adversely affects the reputational capital and stock market value of a corporation. If the project developer – the client – performs in a socio-environmentally irresponsible manner, it may cause legal and other financial costs and reduce revenues due to NGO-pressure and reputational damage – leaving aside the costs that are involved when lawsuits are filed against a company. Reputational capital has direct impacts on banks’ ability to generate future revenue. Adopting and implementing CSR-guidelines and ethical codes of conduct, therefore, provides defense against customer boycott and NGO-criticism. It also helps to boost the credibility and reputation of a company.

3. Levelling the playing field: One of the biggest challenges in developing countries and emerging markets is that socio-environmental regulations are often inadequate and rather poor. In these cases, the EPs help establishing worldwide minimum socio-environmental standards for the project finance sector. Moreover, emerging markets and developing countries face the problem of ‘socio-environmental shopping’: Borrowers that are unconcerned with the socio-environmental impact of their projects can easily reduce their transaction costs by shopping the project around, until they find a credit lender with the lowest socio-environmental standards and requirements. As a direct consequence, socio-environmental standards might be circumvented and undermined. The EPs as an industry-wide standard, however, reduce the possibility of ‘socio-environmental shopping’ by creating a level playing field and preventing a race-to-the-bottom. The greater commonality and uniformity among financiers make it harder for project developing corporations to pit one financial institution against the other one and to negotiate or water down socio-environmental and human rights standards. Additionally, by creating minimum, industry-wide standards, prisoner’s dilemma situations can be overcome: a prisoner’s dilemma is a situation in which each financial institution would be better off by adopting the EPs (in terms of risk reduction), yet, each bank fears commercial disadvantages in term of limited lending opportunities and higher compliance costs from acting alone. Such a situation can only be overcome by establishing unified standards that apply industry-wide.

In sum, joining and adhering to the EPs is not an altruistic act; it is in the bank’s own best (financial) interest. It is a rational strategy for banks to minimize risks and to maximize profits. Therefore, a business case for adopting the EPs seems to exist. The benefits of signing up include reduced reputational risk, better reputation, positive impacts on financial risk profile, better market access, charging of premium prices and enhanced possibilities to recruit high-skilled employees. It also enables banks to follow a differentiation-based strategy which allows them to gain competitive advantages. Equator banks are private profit-seeking entities which try to minimize financial, legislative, political and reputational risks and enhance corporate profitability. Thus, a variety of interdependent strategic and self-interested motives for joining the ‘EP-club’ exist.

Beside these economic aspects, the EPs also contain explicit references to the common good. The protection of human rights – together with environmental protection and the fight against the climate crisis – is at the heart of EP III. Human rights are closely related and interlinked with the inclusion of project-affected communities, especially indigenous peoples, but also NGOs and civil society organizations into stakeholder dialogue processes. Equator banks and their clients commit themselves to comply with socio-environmental and human rights standards, indigenous rights and humane labor and working conditions. Moreover, EP III acknowledges John Ruggie’s Protect, Respect, and Remedy_-Framework, which forms the basis of the _UN-Guiding Principles on Business and Human Rights, the Universal Declaration of Human Rights, the International Covenants on Civil and Political Rights, and on Economic, Social and Cultural Rights, the core International Labor Organizations’ Conventions and the UN-Declaration on the Rights of Indigenous Peoples.

It is the main aim of the EPs as well as the IFC-Performance Standards to establish an ongoing and culturally appropriate stakeholder engagement and informed consultation and participation process. Project-affected communities and other stakeholder groups must have the rights to information, consultation and influence. Information has to be made readily and publicly available to the project-affected communities in their local languages. The disclosure of information should occur as early as possible in the assessment process – ideally within the planning stage and before construction commences – and on an ongoing basis. Moreover, project-affected communities must have the right to participate in decision-making. Their voices have to be heard, and the interests and needs of disadvantaged and vulnerable groups have to be taken into consideration. The whole stakeholder engagement process should be free from external manipulation, interference, coercion and intimidation. Projects with adverse impacts on indigenous peoples require their Free, Prior, and Informed Consent (FPIC).

The aspired stakeholder dialogue illustrates the close connection between (corporate) self-interest and the common good, and how both imperatives – the economic as well as the ethical one – can be (theoretically) reconciled: Respecting and protecting indigenous rights are not just ethical necessities; they are also a business imperative to reduce financial and non-financial risks such as reputational damage and negative publicity. Communities can delay or stop projects through blockades, legal actions or permit appeals. To prevent reputational pressure and operational delay due to social unrest and conflict, divestment campaigns, cleanup costs, legal challenges and compensation payments as well as the loss of social and/or legal licenses to operate, it makes good business sense to set up an effective stakeholder engagement system including community liaison and grievance officers, negotiations committees, community development plans and (legally binding) impact-benefit agreements in which benefit sharing and financial compensation schemes are recorded. Companies that proactively engage with their stakeholders and have developed a positive reputation from decisions made in the past of ethically responsible and sustainable business practices have a strategic advantage over their competitors. These companies are in the best position to create real business values for all stakeholders and thereby ensure that their own business plans and shareholder value goals are realized.

More specifically, the project finance sector builds on broad social acceptance and community support. Required is a social license to operate granted by project-affected communities and stakeholders. It can be obtained by relationship and trust-building processes, e.g., in the form of FPIC. Failure to establish and maintain good community relationships might result in a corporation losing its social license, even where the company possesses a legal license to operate. Obtaining a social license from local communities can reduce disruptions and delays to project construction and operation. Thus, the collective approval and social legitimacy of a project is crucial for the success of a project. It protects the reputational capital and financial viability of the project and the company. It allows a company to ‘cash in’ their social capital. Leaving the economic aspects aside, FPIC gives voice to vulnerable, marginalized and disadvantaged groups, such as indigenous peoples. It fundamentally helps protecting human rights and provides inclusion and participation in decision making activities which can be considered a common good.

Provided that the EPs are implemented properly (which is not yet the case), the EP-framework ideally contributes to overcome potential trade-offs: the trade-off between short-term and long-term interests, the one between economic, ecological and ethical sustainability and responsibility, the one between shareholder and stakeholder values, the one between people, planet and profit, and the one between (corporate) self-interest and the common good – all mentioned trade-offs can theoretically be alleviated in the field of project finance with the help of the EPs.

In practice, the EPs have to balance the following, partially conflicting, rights: the right to development; the right to economic growth; the right to poverty alleviation; the right to employment creation; the right to a clean environment/protection of biodiversity; the right to adequate working conditions; the right to public participation and consultation; property rights especially those of project-affected communities; protection against involuntary resettlement; and protection of cultural heritage.
Some of these rights are more crucial for developing countries and emerging markets, some of them affect developing and developed countries equally. The EPs relate to all of them; it is one of the main tasks and responsibilities of the Equator banks and their clients to find a balancing solution that takes the partially conflicting interests of the various stakeholder groups into account for each project and project-affected region.

Industrial and infrastructure projects financed ‘under the EPs’ foster some of the mentioned rights – especially, the ones named first (i.e., pursuit of economic growth through income generation and job creation) –, while at the same time conflicting with others (i.e., clean environment, protection of biodiversity, cultural heritage as well as protection against involuntary displacement). Project finance, in general, can have a substantially large ecological and socio-economic footprint; they impact on natural resources as well as local communities including vulnerable and disadvantaged ethnic minorities. The EPs try to mitigate and minimize these potential adverse socio-environmental impacts while at the same time not to lose track of economic rationales.

The EPs ideally help to balance economic growth and profit imperatives with socio-ecological responsibilities of corporations. The market-driven objectives of commercial banks have to be in line with the protection of socio-environmentally sensitive ecosystems, the fighting of global warming and human rights standards. The EPs show that financial and socio-environmental performance as well as CSR-behavior and profit maximization can coexist and that a linkage between financial performance and socio-environmental sustainability can exist. All three perspectives – ecology, economics and ethics – are ideally taken into consideration. As a consequence, the EPs have the potential to foster the (corporate) self-interest and to promote the common good, e.g., in the form of the protection of human rights.

It is still premature to state that a ‘love story of business and socio-environmental rationales’ (Haack et al.) exists, since the EPs still suffer from serious business-ethical shortcomings and since banks still engage in financing ‘dirty projects’ (for an overview, compare the website of the NGO BankTrack). However, the EP-framework has some potential in terms of bridging the gap between economics and ethics in the area of project finance – given that necessary reform measures are adopted.

What needs to be done to fully realize the compatibility between (corporate) self-interest and public interest of societies? The current version of the EPs suffers from a series of institutional shortcomings such as inadequate and ineffective monitoring, enforcement and sanctioning mechanisms. To further strengthen the EPs as a true benchmark for responsible investment and sustainable financing practices, the following necessary reform steps should be adopted (i.e., top 10 priorities towards EP IV):

1. Introduction of an anchoring and guiding principle solely devoted to human rights;

2. Extension of scope I: The ‘spirit of the EPs’ (Conley/Williams) should be applied to all banking activities – including investment banking – and not being restricted to project finance alone (i.e., ‘going beyond project finance’);

3. Extension of (regional) scope II: An outreach strategy to the BRICS-countries is required to guaranty world-wide application of the Eps;

4. Introduction of an ‘enforcement pyramid’ including automatic sanctions like delisting and exclusion of non-compliant EPFIs;

5. Introduction of absolute performance standards, that is, clear, verifiable metrics which are transparently and independently monitored;

6. Introduction of minimum entry requirements that have to be met prior becoming a member of the EPs (e.g., human rights due diligence; stakeholder dialogue; impact benefit agreements; grievance, complaint and remedy mechanisms);

7. Tiered membership structure within the EP-Association that allows bridging the gap between broadening and deepening;

8. Reform of the EP-Association including enhanced funding and staffing as well as creation of an EP-Forum, EP-Advisory Group and EP-Ombudsman office;

9. Third-party beneficiary rights for project-affected communities which enhance accountability by allowing non-signatories to a contract to enforce their human rights against the contracting parties (borrowers and lenders as promisors owe duties of performance to project-affected communities as local stakeholders, that, if breached are enforceable by the local communities. EPFIs and clients which violate the EPs could be sued: Project-affected communities would be able to assert their third-party beneficiary rights through breach of contract actions in courts;

10. Regulatory Pressure: Stronger government oversight (including binding/mandatory regulation) should be accompanied by increasing shareholder pressure (i.e., divestment from companies which violate social, environmental and human rights standards; shareholders filing lawsuits against CEOs and senior management) and market regulation pressure (i.e., denied market access by securities and exchange commissions; exclusion of companies from sustainability indexes).

The main question raised in this essay was: How can companies be both profitable and socio-environmentally responsible? Given that appropriate reform measures are adopted which improve EP’s monitoring, enforcement and sanctioning (governance) mechanisms, the EPs can be seen as a potential mediator between (corporate) self-interest and public interest; they help in balancing efficient finance economics on the one hand and socially conscious investment and lending practices aiming at long term socio-environmental sustainability on the other hand. The EPs can be seen as a starting point contributing to the emergence of an overarching normative order of sustainable finance. While the EPs have the potential to foster the self-interest of companies, they also can promote the common good in the form of socio-environmental and human rights protection. To fully exploit their potentials, the EPs require a fundamental overhaul, a substantial revision of EP III and a move towards EP IV. It remains to be seen whether the Equator banks and their association is willing to implement at least some of the suggested reform measures.