On 13 August 2012 a draft of the updated Equator Principles (EP) was released for stakeholder consultation and public comment. This latest revision of the EP is a marked attempt to dramatically alter the role of financial institutions in emerging markets, from financiers to sustainability regulators.
By writing certain levels of environmental and social performance into Project Finance documentation, which go beyond the levels prescribed by national law, EP lenders (EPFIs) become obligated to monitor, verify and remedy borrower compliance with sustainability standards. This undermines economic growth and sustainable development by imposing a significant burden on borrowers and EPFIs, as well as obstructing the efficient allocation of capital and hampering the advancement of legitimate state institutions.
Under the EP, borrowers must dedicate resources to demonstrate EP compliance, whilst EPFIs must develop the capacity to monitor and verify performance. Such an obligation results in time delays and increased transaction costs in the evaluation of Project Finance transactions. The burden effectively constitutes a tax on legitimate foreign investment and economic growth in emerging markets.
By requiring capital to be allocated on the basis of social and environmental well-being the EP also prevent resources from being allocated to where they will be most productive and yield the highest returns. Such a normative risk management framework inherently ignores the fact that economic trade-offs are fundamental to the maximization of socio-economic welfare.
Furthermore, the EP’s contribution to corporate value remains elusive. A cross sectional study of leading financial institutions has found that EPFIs have lower profit margins and failed to add value for their shareholders over the medium term. This proves that the economic justification for values-based investment criteria is weak and that the EP constitute a poor business proposition.
Another important driver of sustainable development is the rule of law by way of legitimate national institutions. Such institutions are vital to establishing a level playing field for commercial entities and laying the foundations of a free and open market. If the development of state institutional capacity does not occur jointly with the development of the market, then it becomes more likely that the weaknesses of the former will jeopardise the latter.
The EP hamper the advancement of such institutions by supplanting the regulatory role of the state. This is a concern for both regulatory and development policy for two reasons. Firstly, bypassing the laws of a sovereign state effectively infringes upon a society’s right to govern itself. Thus, the EP governance model inherently lacks democratic legitimacy.
Secondly, the means in which society comes to adhere to a particular set of norms generates a social good that is distinguishable from the overall regulatory outcome. Accordingly, the EP undermine state institutional development by robbing them of the opportunity to learn how to govern.
Nonetheless, many multi-national banks have adopted the EP, on the basis that it constitutes good ‘corporate citizenship’ and that it acts as a protective eco-badge against the criticism of environmental non-government organizations (ENGO). In reality, both of these propositions have proven to be false.
The manner in which the EP obfuscates the efficient allocation of capital, as well as the heightened level of ENGO scrutiny that becomes afforded to EPFIs, undermine the maximization of shareholder wealth and enhance reputational risks. Thus, adopting the EP has actually undermined corporate value and also failed to quell the threat of negative ENGO campaigns.
Banks have falsely presumed that a reputation for enhancing ‘social justice’ through their business dealings actually increases company value. Such a notion is derived from modern elements of corporate social responsibility (CSR), which incorrectly perceive the role of business as promoting social and environmental progress; rather than to maximize profit and shareholder interests.
Accordingly, EPFIs should withdraw from the EP process, pursue high yielding investment opportunities in emerging markets and more actively defend their role in the global economy. Such initiative will maximize returns for EPFI shareholders and enhance economic growth and development in emerging markets; both of which constitute true ‘corporate citizenship’.
In the end, the EP’s negative impact on the free movement of capital and the rule of law, poses a much greater threat to sustainable economic development and the maximization of welfare than the environmental degradation that the EP supposedly seek to prevent.