‘Green' risks in project financing

In the last decade or so, a number of companies or projects in India have either been shut down temporarily or permanently, or have been heavily penalised as a result of adverse environmental and social impacts.

Some of the projects highlighted in the news recently include Lavasa Housing, Vedanta Aluminium, Dhamra Port, Posco Steel and Jindal Power.

While this has been the subject of much discourse in the media — ranging from speculations about the Environment Minister being the target of a Cabinet reshuffle to environmental issues becoming a potential bottleneck to India's double-digit growth — very little has been said about the role of financial institutions in the entire process.

While the environmental impact of financial institutions may be indirect compared with the impact of industries, they are still increasingly being held responsible for the undesirable environmental impact resulting from projects or activities they have financed.

Financial institutions that invest in such projects face a multitude of risks that include credit and collateral, as well as legal, regulatory and reputational risks.

Since the long-term success and sustainability of banks depend on their client's performance, the integration of environmental and social risk assessment in their business can have a widespread influence on industries, sectors and communities.

Appropriate environmental and social due diligence can reduce the chances of non-performing assets, increase the reliability of securing collateral of the right value and create new business opportunities.

Clean technology, eco-tourism, waste recycling, and low-income housing are examples of such emerging sectors. While Indian banks have become adept at identifying such eco-friendly business opportunities, they are yet to take significant action on managing environmental risk.

In India the environmental aspects of project finance deals are governed primarily by legislation — project developers are required by regulation to undertake an Environment Impact Assessment (EIA) in order to obtain the Environmental Clearance, which is a major prerequisite for starting projects and is, thus, demanded by banks in all project finance deals.

Environment clearance

Although the process appears sound, there are loopholes in its implementation. In many cases, the EIA reports are not authentic, the public consultation does not take place as per the Act, and the EIA reports are so voluminous and technical that the project's impact on local communities and the surrounding environment remains unclear.

Corruption and poor monitoring, on the one hand, and strict actions against the polluters, on the other, make the system even more inefficient.

The involvement of banks in this entire process is minimal and they are not required to spend any resources on investigating environmental and social issues, since different state agencies are responsible for the initial risk assessment and compliance.

As these issues affect the banks later, they do, however, need to adopt internal guidelines in order to ensure that they manage their environmental and social risks effectively.

Internationally, there are several initiatives to create a common protocol to manage environmental concerns, among which the United Nations Environment Program Finance Initiative (UNEPFI) and the Equator Principles are the most notable.

The UNEPFI is a global partnership between the UNEP and the private financial sector. It is associated with over 160 financial institutions worldwide to develop and promote linkages between the environment, sustainability and financial performance.

The Principles of Responsible Investment (PRI) and the Global Reporting Initiative (GRI) are some of its major contributions in this area.

The Equator Principles (EP) are a set of voluntary guidelines for the categorisation, assessment and management of social and environmental risks in project finance. The EPs, announced in 2003, were drafted by 10 leading banks, in consultation with the IFC.

Equator Principles

Till date, 68 institutions, including 16 from the emerging markets, have voluntarily adopted the Principles. Financial institutions commit to applying extensive environmental and social due diligence to all project loans exceeding $10 million.

Indian banks might choose to sign on to one of the international protocols such as the Equator Principles, the UNEP-FI or, alternatively, another set of guidelines can be prepared, that would be more specific to the Indian context.

It is imperative to understand the need for such sustainable practices, to access the present systems and practices and then decide what could be a more acceptable and feasible set of guidelines for Indian banks.

In December 2007 the Reserve Bank of India (RBI) issued a circular citing the importance for banks to act responsibly and to contribute to sustainable development.

The circular referred banks to the Equator Principles and suggested that there is a need for Indian banks to evolve institutional mechanisms to enshrine sustainability.

With a number of ongoing projects being dragged to court, clearances and EIAs being challenged and reviewed by the Ministry, project developers and companies facing protests from communities and NGOs, it is imperative that Indian financial institutions recognise the need to act now.

(The author heads the Environmentally Sustainable Finance group at the Centre for Development Finance, IFMR, Chennai. >blfeedback@thehindu.co.in )

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