When leading project finance banks signed up last year to an IFC-backed initiative for environmental and social responsibility in project lending (the Equator Principles) the move was greeted by many in the banking community as an environmentally friendly PR exercise.

And not without reason: some of the leading commercial banks involved were the focus of heavy NGO pressure which has since lessened; some of the signatories have privately claimed that the Principles are no more than they were doing already anyway; only one government-backed export credit agency has since joined, with the rest, like the banks, claiming that they are already fulfilling the Principles; and each bank dictates its own procedures and lending policies.

The Principles were always going to have a hard ride - to concede they are necessary is to concede they were not already being applied. And implicit in their acceptance is that financial institutions have at least some responsibility to police the practices of their borrowers - an aspect that banks are quick to dismiss.

Furthermore, even those that take a positive view of the Principles accept they grew out of some self-interest. Angst over the environmental and social impact of big-ticket projects, typically oil and gas pipelines and hydroelectric dams, combined with a lack of transparency and public guidelines was attracting the unwanted, and the banks claim unfair, attention of NGOs to project finance lenders and sponsors. In short, no-one wanted the sort of problems and publicity that Shell is attracting in the Niger Delta at the moment.

"The banks came to us and said 'we are starting to look at this as a very serious risk to our financing,'" says Peter Woicke, executive vice president of the IFC. "So we told the banks that by applying the safeguards we saw them not as an additional investment for the client, but really as a competitive tool," he says, stressing the business rationale for their adoption.

World Bank and IFC at odds

Despite uptake by 26 banks, a year on, the Principles are already coming under fire from the IFC's parent, the World Bank Group, as well as from some of the initiatives' commercial banking signatories.

In September, a leaked internal memo from the World Bank's legal department to senior management slammed the IFC for trying to dilute the World Bank Group's longstanding environmental and social assessments attached to its lending.

The memo said the proposed IFC approach of principles and guidelines rather than strictly enforced standards 'deviated from the clarity attached to the decade-long effort to distinguish mandatory from discretionary action.' It also said the IFC's proposals result in inconsistent policies being applied to the World Bank's public and private sector clients.

The criticism - which the IFC dismisses as being simply a part of normal peer review to any proposed policy changes - comes as the IFC is trying to update its environmental and social safeguards policy 'to make them more robust'. "We're revising the safeguards of the IFC because we have to stay at the forefront," says a resolute Woicke.

Despite the proposed changes the IFC's belief in the soundness of its basic safeguards remains essentially unshaken: the Equator Principles, says Woicke, are fast becoming the standard for project finance lending worldwide.

The Equator revisions

The proposed update will apply generally to the way the IFC carries out its business, but will also affect the Equator banks which have agreed to adopt IFC safeguards as the model for their lending practices. The Principles consist of guidelines that are meant to help a bank determine the level of risk a prospective project poses to the environment or local communities. Moreover, they seek to codify in one framework the existing best practices at international banks.

The IFC has started a consultation process on the updates to its safeguards that is expected to wrap up by next February, when the project finance industry should have a clearer idea of what the new policies will entail.

Broadly, the updates are said to include new provisions to extend protection to indigenous peoples, as well as natural resource dependent communities. "We're still sifting the new items to figure out what's new and what existed before," says one Equator banker. "The [Equator] banks haven't taken any position on the new policies yet. People are still absorbing this stuff."

Banks like Citigroup - which played a leading role in getting the principles of the ground - say they are have been making the projects they finance more accountable by including the Equator Principles in their evaluations of potential borrowers over the last year. "This ensures a better outcome and although it might lead to greater transaction costs it will ensure smooth and secure investments. It's more upfront work, but it speeds up projects overall by anticipating problems which could be costly to sponsors," says Chris Beale, managing director in Citigroup's structured corporate finance team, responsible for Equator Principles.

The Principles establish conditions that project sponsors must meet and these are incorporated into the loan covenants. The assessments only apply to projects of more than $50 million, which includes some of the largest and most contentious projects worldwide, such as the Baku-Ceyhan pipeline and the Camisea gas-pipeline project in Peru.

"It's not just that Sandy Weill (Citigroup CEO) got hit hard by the NGOs. I think there's a full understanding in Citibank, as in the other Equator banks, that this is good for the future of the business," says Woicke.

Banking scepticism

But off-the-record banking scepticism is rife - even among some of the Principles' signatories. !The Equator Principles are mostly a non-event," says the global head of project finance at a leading Equator bank. "It was just a signing ceremony with lots of hoopla over something that is really not that new," he says. "I'm hard pressed to think of any project finance loans we've made that have not been in conjunction with a multilateral or bilateral lender which is already largely enforcing such standards."

"I've heard banks say they did it for publicity, to say 'look, we're green'," he adds.

"The NGOs perceive there's more to this than is actually the case. In most deals banks are doing in emerging markets, they're generally working with a concessionary lender who is largely already taking into account the environmental considerations and applying Equator Principles without even knowing it. If it does improve upon existing industry practices it escapes me." So why did his bank sign on? "Well, it cost us nothing," he shrugs.

Further down the spectrum there are still a number of significant project finance banks that haven't bothered signing up to the initiative at all, two leading French banks - BNP Paribas and Société Generale - among them.

"Do I think managing your environmental risk is important? Yes. But we're doing all of those things, anyway," says a project financier at a leading investment bank that has yet to adopt the Principles.

"I take the view that we can manage our own position and guidelines. We don't need to be taught what to do by the IFC," says the banker. "At the end of the day this is just Citibank's way of spreading risk around. It's become a policy issue for them. We didn't see the need to come in behind Citibank on this. If we're prudent, we'll still win business."

The IFC says that one of the initiative's goals is to prevent companies from borrowing from banks with sloppy environmental policies. Yet, according to a leading Equator banker, there are several banks in the market pitching business precisely on the basis that they are not signatories to the Equator Principles.

And for a non-signatory, the point is all the more acute: "Some companies have said it's an impediment because of the rigidity it involves. Others just don't like the cartel aspect of that apparent unity [of banks]."

Woicke, however, is adamant: "I think these banks [non-signatories] are totally out of whack. Seriously. I would not think that would have happened. To be honest the business they are going after is not any business the Equator banks would want anyway."

Is full compliance possible in emerging markets?

The real test for Equator will be both policing and getting it both adopted in deals in emerging markets that have no multilateral support and therefore pure commercial governance. "How much compliance will occur then?" asks an Equator banker. "Where the principles should have bite are in the small percentage of cases where loans are being made in emerging markets where multilaterals are not involved," he says.

The Chinese market is likely to be a testing ground for big-ticket deals done without multilaterals - and possibly even without Equator banks. And there are a host of other smaller but semi-developed markets where multilateral or ECA support is often not necessary for smaller deals."It'll be interesting to see what happens when deals come along without multilaterals in the more advanced emerging markets. Smaller deals in these places are being done on a purely commercial bank basis - these are the test cases you want to watch out for," says the banker.

Most contentious among the small-ticket projects that might slip through the cracks are extractive industries deals. The IFC itself has received a large amount of negative coverage for its support of smaller mining operations, The IFC is reviewing its extractive industries safeguards, but against against a backdrop of rumblings from banks about flexibility and that any deal is better than no deal for emerging economies.

Peru's Camisea gas pipeline project last year was one of the first cases where the Equator Principles were put to the test. Because of its environmental impact the project is one of the most controversial in recent years - so much so that both US Ex-Im and Citibank pulled out of arranging and advisory roles respectively. At $818.5 million the project forms the largest part of a $1.25 billion field development, and consists of a 714km gas pipeline and a 540km liquids pipeline, transporting output provided by upstream producers.

Activists' focused their attention mostly on the institutions financing the pipeline. But the IDB forged ahead with the deal, bringing Andean development bank CAF on board, and closed finance at the end of last summer. The IDB claims the package complies to the fullest with World Bank Group social and environmental standards. In fact, it provided environmental assistance for the entire project, and not simply the section it financed. It also made a $5 million loan to the Peruvian government to monitor compliance.

So does Equator work without policing? As Woicke points out: "Information is more freely available today. Any project can be under the spotlight. But to be under the illusion that you can do a project today without being screened by stakeholders or NGOs I think is pretty naïve."

Conversely the critical World Bank memo points out, the Equator Principles lack an effective enforcement mechanism, although an ombudsman's office in Washington is meant to oversee banks' compliance. And Woicke concedes: "I think it will be very crucial going forward whether or not the banks are subject to audits. Eventually the banks will have to submit to some kind of audit."

Bringing in the local banks and ECAs

Local banks in emerging markets - a growing constituency of the project industry - are the next big frontier for the Equator Principles. In this group, the Brazilians have become cheerleaders for the initiative. After Unibanco signed up eagerly last year, Itau signed up this August, followed swiftly by Bradesco in September. The initiative has yet to pull in other large emerging market banks, although Woicke insists this is the next step.

The Principles are fast becoming the standard for all international project lending - a fact which causes some embarrassment to ECAs that have so far been unable to come up with meaningful common standards. EKN, the Danish agency, is so far the only ECA to have signed up to the Equator Principles.

"One of the frustrations and disappointments is that none of the ECAs, other than EKN, has signed on," says Woicke. "We've had lots of workshops with these ECAs and they've literally have told us they won't do it. There was a big fuss, the NGOs came to me and said 'you know, you should force them.' But of course I can't force the ECAs. But I did tell our board that we were very disappointed that the ECAs have not signed up. If all the facts are taken into consideration, why don't they sign up?" he asks.

Many suggest that their reluctance stems from a very simple premise: to adopt them would be to admit the deficiency of their existing practices - something which they argue is simply not the case and also something that most governments will not readily concede.

Just a beginning?

Despite what the leaked World Bank memo claimed was too little internal consultation, the IFC's new version of its safeguards is on its way to the Board for approval. Woicke, whose legacy may depend on the initiative's triumph, has only one thing to add: "The banks have adopted this with great success. I'm very proud of these Equator Principles."

And Woicke may yet have more reason to be. Current Equator signatories accounted for 75% of project finance lending in 2003 according to stats from Dealogic Projectware - in short, it's hard to do a major international deal without involving an Equator bank. Furthermore, with local banks beginning to sign up, the Principles will start to impact on smaller scale projects in some developing markets.

But the impact will be small in the short term. Despite the premise that some action is better than no action, with domestic lending in markets like Russia and China beyond the Equator reach, and no real means of policing the Principles, the biggest effect of Equator will likely be repackaged existing measures that, cynically or not, make for better banking PR.

If anything Equator's legacy will be long term. It is the first step to standardized and transparent international social and environmental investment rules. With flexible teeth, credibility and policing - it may yet work.

Equator signatories to date:

ABN Amro Banco Bradesco Banco Itaú

Banco Itaú BBA Bank of America Barclays

BBVA Calyon CIBC

Citigroup Credit Suisse Dexia

Dresdner Bank EKF HSBC

HVB ING KBC

MCC Mizuho Corporate Bank Rabobank

Royal Bank of Canada Standard Chartered Bank

Royal Bank of Scotland Unibanco

WestLB Westpac