Bond issue sounds ethical alarm

By Megan Rowling

The ethics of investing are becoming harder to define

Environmental organisations have warned that major banks may be contravening their environmental and social policies by helping to finance controversial projects indirectly.

A growing number of financial institutions have developed guidelines that prevent them providing loans to projects that cause environmental damage or have a harmful impact on local people.

However, campaigners are now arguing that banks should extend those standards to all their business activities, including the underwriting of bond issues for clients with poor policies on the environment and human rights.

Dubious lending?

Recently, they sounded the alarm over a US$1 billion bond sold to international investors by the state-owned Export-Import Bank of China (China Exim), the world's third-largest export credit agency.

Like most bond issues, it was co-ordinated and underwritten by several global banks, including Merrill Lynch, HSBC, Citigroup, BNP Paribas and Goldman Sachs.

At the moment there is no way that the Principles can be extended beyond forms of project finance where the use of proceeds is known Francis Sullivan, environmental advisor to HSBC

Many major banks have already agreed a set of ethical principles in their own lending - but so far they have not applied them to bond underwriting.

In a report, the International Rivers Network (IRN) and Friends of the Earth highlighted China Exim's role in funding "socially and environmentally destructive projects in countries with bad human rights records", including Sudan and Burma.

They argued that, by arranging the bond issue, banks would "help finance projects which they could not finance directly under their own environmental policies".

Equator Principles

For example, China Exim is one of the funders of the US$1.8 billion Merowe/Hamadab Dam now under construction in northern Sudan.

During a visit to the country earlier this year, IRN ascertained that an environmental assessment prepared by project engineering firm Lahmeyer International had not been approved by the Sudanese government as required by law, nor made public.

Big business can end up displacing indigenous populations

According to IRN, it failed to address some potential negative environmental impacts of the dam, such as sedimentation of its reservoir.

In addition, there is concern that the 50,000 indigenous people who are being displaced by the dam are not receiving adequate compensation. IRN estimates that this project violates World Bank policies on environmental assessment, natural habitats and involuntary resettlement on some 60 counts.

These policies in fact form the basis for the Equator Principles, a voluntary initiative for financial institutions that lays out environmental and social guidelines for project financing.

Since its launch in 2003, 32 international banks have signed up to these principles, but so far they only apply to direct project lending.

'Difficult area'

However, the controversy over the China Exim bond raises the issue of whether banks should also apply these standards to their involvement in funding activities where the use of the proceeds is unclear.

If you create enough layers and assurances, it gives psychological comfort to the underwriters Michelle Chan-Fishel, Friends of the Earth

For Michelle Chan-Fishel, green investments programme manager at Friends of the Earth US, non-specific financing instruments like the China Exim bond give participating banks "a false sense of non-responsibility".

"If you create enough layers and assurances, it gives psychological comfort to the underwriters. But it's very clear that money is fungible, and if you help capitalise an institution, then that allows it to lend more of its other funds elsewhere," she argued.

Banks contacted by the BBC declined to comment on their involvement in the China Exim bond issue.

However, Pamela Flaherty, head of global community relations at Citigroup, which is an Equator member, said that the US bank has adopted a policy of constructive engagement with Chinese financial institutions: "China is a very important country and we're obviously interested in doing business with them.

"Our process is to engage and expose them to best practice in international capital markets."

Francis Sullivan, environmental advisor to HSBC, which adopted the Equator Principles in 2003, acknowledged that bond issuance is "a difficult area" because "at the moment there is no way that the Principles can be extended beyond forms of project finance where the use of proceeds is known."

Stricter guidelines

However, HSBC is making an effort to go beyond the Equator requirements by developing and applying stricter guidelines for its involvement in certain sectors, including freshwater infrastructure projects.

Large dams have forced millions of people from their lands

In general, Michelle Chan-Fishel emphasises that private-sector banks have made "very heartening" progress in improving their environmental and social performance over the last few years.

"When we first approached them, the focus was on basic issues like recycling. Now the terms of the debate have changed in the sense that it concerns their core business activities," she said.

According to Paul Watchman, a partner at law firm Freshfields Bruckhaus Deringer and author of a recent report on the impact of Equator, banks have had to push clients hard to comply with their standards and are still working out how to deal with the "aggressive negotiating style" of some project sponsors.

Thorny issues

Citigroup, HSBC and ABN Amro, which has also published guidelines for sectors including oil and defence, all say their policies have caused them to turn down unsuitable projects and even client relationships.

The challenge going forward is whether the banks want to apply the Equator Principles to other business instruments, including bond issuance Rachel Kyte, World Bank

They identify the next challenge as moving from mitigating negative project impacts to contributing to sustainable development.

"Now we look not only at environmental and social risks, but also at sustainability and other ethical issues that affect our core business. We aim to be more pro-active and solutions-oriented," said André Abadie, head of the sustainable business advisory team at ABN Amro.

Yet unless the Equator member banks address the thorny issue of indirect financing, raising the environmental and social standards of infrastructure projects across the board - particularly in developing countries - may prove elusive.

Rachel Kyte, director of the Environment and Social Development Department at the World Bank's International Finance Corporation, identifies this as a key issue: "The challenge going forward is whether the banks want to apply the Equator Principles to other business instruments, including bond issuance and capital market activities in general."

Reputations at risk

The IFC, which provides financing for private-sector projects in developing countries, is in the process of redrafting its environmental and social policies, on which Equator is based.

It plans to apply these to all its business lines, and Ms Kyte believes that banks will follow suit - a view supported by Friends of the Earth.

According to Ms Chan-Fishel, some banks are now starting to consider how to apply the Equator Principles to their underwriting activities:

"They understand that there is a risk to their reputation if they are linked with a heinous project in any way, so they are looking at the implications of different types of financing."