The Equator Principles and the IFC Performance Standards

The Equator Principles and the IFC Performance Standards Itaú Case Study in Energy Project Financing By Rafael Mol* 2015

Introduction Performance Standard 1 Assessment and Management of Environmental and Social Risks and Impacts Performance Standard 2 Labor and Working Conditions Performance Standard 3 Resource Efficiency and Pollution Prevention Performance Standard 4 Community Health, Safety and Security Performance Standard 5 Land Acquisition and Involuntary Resettlement Performance Standard 6 Biodiversity Conservation and Sustainable Management of Living Natural Resources Performance Standard 7 Indigenous Peoples Performance Standard 8 Cultural Heritage Conclusion

Aligned with its Sustainability and Environmental and Social Responsibility strategy, Itaú Unibanco believes that the adherence to voluntary commitments reinforces the way we address the topic and guides our practices in the business fronts. Therefore, since 2004, Itaú Unibanco has voluntarily adopted the Equator Principles (EP): a set of guidelines and criteria for identifying and assessing the environmental and social impacts and risks in Project Finance deals whose investment amount is equal or above US$ 10 million. Since we adopted the Equator Principles, we have financed over R$ 6 billion in projects, representing a capital investment of nearly R$ 60 billion. The Equator Principles have been adopted by 80 financial institutions, including the major European, American and Brazilian banks. The first revision of the document occurred in 2013. The current and third version was released more recently, in 2013. The Equator Principles III show the continuous improvement of the environmental and social risk management in project financing. The scope of application of EP III, for example, was extended. Formerly, compliance with the criteria prescribed by the Equator Principles was only required for long-term financing. Currently, the client must be compliant with such criteria in an earlier stage, when the bridge loan is granted. Thus, in seeking long-term financing for its project, the client will already be more prepared to meet the related requirements, avoiding rework and long negotiations. However, the new version of the Equator Principles maintained as primary technical criteria of analysis the International Finance Corporation (IFC) Performance Standards, which are parameters internationally recognized as best industry practices that should be adopted in projects to avoid, minimize or mitigate adverse impacts caused by their activities.

From the perspective of the Equator Principles, the analysis of the project is done not only before closing the deal, but also periodically during the tenor of the deal. The adoption by the client of measures designed to mitigate possible environmental and social impacts and risks in its project is monitored on a regular basis by the bank through an action plan that is an integral part of the contracting instrument. The criteria the client commits to meet includes the establishment of a communication channel with the stakeholders and communities impacted, which includes necessarily the implementation of a mechanism to receive and handle complaints on the part of the affected parties, in such a way that the projectcommunity relationship is always based on transparency. In addition to adopting this commitment, Itaú was also the first bank from an emerging market to be a member of the EP Steering Committee and occupy the position of Chair of the Steering Committee (2008-2010). Considering that Itau finances project in different sectors, we selected the main environmental and social challenges and dilemmas faced by our teams. Please note that the Performance Standards are based on topics and not all standards apply to all projects. Each of these guidelines should be applied to an extent and depth that is proportionate to the impact and risk posed by the respective project. The examples provided here represent higher risk projects that necessarily require these standards to be applied in a more in-depth manner.

Performance Standard 1 Assessment and Management of Environmental and Social Risks and Impacts This standard is said to be applicable to 100% of the projects, since it does not address a specific technical matter, but the structure that is necessary for a project to be able to identify, mitigate and monitor its environmental and social risks and impacts, thus moving forward in the adherence of the remaining standards. This requirement works like an umbrella for the other standards. By structuring an effective and continuous environmental and social management system, the project is required to promote a solid and sustainable performance, providing better financial, social and environmental results. To achieve this, the project should continually and systematically: i) identify and assess all risks and impacts on environment, workers or other communities affected; ii) adopt a mitigation hierarchy to firstly anticipate and avoid these impacts and, only when this is not possible, avoid, minimize or, ultimately, remedy / neutralize; and iii) ensure the engagement and absorb complaints of projectaffected people Itaú s experience shows that many of the conditions under this standard are already required by the Brazilian legislation. However, the Brazilian legislation does not require the performance of a systemic and continuous assessment to improve this management system. That is, the legal requirement to assess environmental impacts can be sufficiently fulfilled by means a single report which is submitted to the proper agency as a condition to obtain environmental permits for a project. In financing a large hydropower plant in Brazil, under the Equator Principles criteria, Itaú required the implementation of a procedure whereby the environmental impacts of the project could be reassessed on a semi-annual basis, since unexpected circumstances may arise during the development of such a large-sized project. New impacts, which have not been previously identified in the planning phase, may arise as works progress. The adoption of this dynamic and continuous assessment has enabled the early identification and mitigation of the impacts that would be caused by an erosion process that has spread across an area larger than that originally identified as affected. This avoided putting the life of several families living in the region at risk. Moreover, the process of resettlement of these families was conducted in a very orderly manner, resulting in better quality of life, as people were granted access to electric power and drinkable water in their new homes.

Many projects end up limiting their environmental and social management process to the mere fulfillment of the requirements upon which obtaining environmental permits is contingent, which is not necessarily sufficient to manage all their risks under the criteria prescribed by the Equator Principles. We had several experiences with clients in which we could notice that the adoption of the best industry practices is extremely important to avoid possible delays, unexpected events and additional costs in the project development. Due to our requirements, our clients, in most of the cases, need to reinforce their environmental and social teams not only to meet minimum legal requirements, but also to develop more sophisticated actions, implementation and verification of compliance with policies and procedures. We had a case where the client, before initiating its relationship with Itaú, used to treat environmental and social issues as secondary. When Itaú financed its first projects, we requested the Executive Board to prepare periodic reports on the achievement of environmental and social management goals and that such Board made strategic decisions on environmental and social matters based on the performance results attained. Due to concrete improvement results obtained from this strategy, the client made of IFC Performance Standards its policy at an institutional level. In addition, the client, since the beginning of a new project, structures the social and environmental teams considering the IFC Performance Standards, based on the criteria set forth by IFC.

Performance Standard 2 Labor and Working Conditions Inspired by several international conventions and instruments, including the International Labour Organization (ILO), this standard focuses on the protection of workers basic rights. Therefore, its objective is to provide safe and healthy working conditions to this important project-affected group, in such a way to ensure that: i) the local legislation is strictly complied with; ii) there is no unequal treatment; and iii) an improvement in the relations between workers and managers is promoted, especially workers belonging to more vulnerable groups. Chile, a country where Itaú finances a hydropower project, has very politically engaged communities. Protests and strikes are, however, common. To avoid that shutdowns can adversely affect the schedule of this project, Itaú requested the creation of a In financing a large hydropower plant in Brazil, Itaú has identified that, after some long strikes and shutdowns on the part of workers, the client should establish collective bargaining agreements in advance to be able to address complaints that might give rise to new strikes. We then began to work in conjunction with the client to specific communication channel so that their complaints may be addressed in a more agile and efficient manner. The main result obtained was a reduction in the number of working days lost to strikes, which remained at levels lower than that of the country s average. Moreover, this project had another peculiarity, since the client opted to engage various specialized construction firms, rather than a large construction firm that concentrated all the other subcontractors. Due to this diversity of contractors and subcontractors involved in the project, we requested the client to reinforce its management under its supplier chain and also to extend labor benefits policies to all workers in the supplier chain. In addition, incentives, such as bonuses, for these firms to improve their performance in health and occupational safety were created. This resulted, among others, in the continuous improvement of the labor accident levels. anticipate the negotiations that would result from the renewal of the next collective bargaining agreements for the civil construction workers. This way, we managed to reduce the number of strikes and shutdowns.

Performance Standard 3 Resource Efficiency and Pollution Prevention While acknowledging that environmental resources are scarce, this standard promotes the efficient use of them as well as the prevention and control of pollution, including that derived from the effect of greenhouse gas emission To achieve this, Performance Standard 3 suggests the adoption of feasible technologies and good international industry practices in an effort to avoid and minimize adverse impacts on human health and environment. A case that illustrates this standard is Itaú s experience in financing a large-sized transmission line in Brazil. The client was required to prepare a specific study to show that the technology adopted, if compared to the conventional ones, would generate energy efficiency gains as transmission losses would be reduced. The use of such technology resulted in annual savings of more than 2000 GWh. This standard has also been applied in the scope of a project financing for the construction of a gas thermoelectricity plant in Northeast Brazil. Since the air emission standards required by the Brazilian environmental and social legislation are less restrictive than the international ones, adopted by the IFC, the client ended up using a technology more efficient than that originally planned to be able to obtain our financing. Therefore, in meeting the requirements of the good international industry practices, the client mitigated the effects caused by air emissions

Performance Standard 4 Community Health, Safety and Security This standard addresses new impacts or worsening of existing impacts of the project on surrounding communities. In addition, its objective is to help the project, its employees and structures to anticipate and avoid adverse impacts on the project surrounding communities. Its objective is to help the project, its employees and structures to anticipate and avoid adverse impacts on the health, safety and security of the affected population throughout the project operation and development, whether these impacts have been anticipated or are unexpected, whether they are direct or indirect. In Itaú s view, the social issues are more challenging as they are more subjective and sensitive when compared to others. For this reason, we have even refused to finance a hydroelectricity project in a needy region in Northern Brazil. We understood that the impacts that would be caused to local populations would not be mitigated due to the mismatch between the social investment and works schedules submitted by the client. The region s social scenario, which already was not favorable, could become even worse, and social claims might arise, affecting the progress of the project works. In contrast, we had a case involving the financing of a hydropower plant that was set up in a malariaendemic area in North Regional of Brazil. The most significant risk would be the hydropower plant s reservoir making the situation worse, since the accumulated water could make for the proliferation of the malariacarrying mosquitoes. Instead of neglecting this possibility, the project seized the opportunity and developed a program to combat malaria, obtained financing

from the World Bank, and was granted awards. As a result of this action, the local health scenario was significantly improved. We had also a successful experience with a hydropower plant in the Andes region where water is a scarce and disputed resource. Although the project retains all water use rights required, and technical studies have shown that the availability of water for use by local people would not be affected, the population expected the hydropower plant to interfere in their right to use water and in water quality. Based on the best international industry practices, the company then conduct additional studies which analyzed scenarios and also considered the effects of climate change on the shortage of water in the region. In addition, the client adopted the concept of participative monitoring under which the population was invited to engage in campaigns to monitor the quantity and quality of this water. Feeling part of the process, the community was led to take responsibilities over their activities and disclose the results to other families in the region.

Performance Standard 5 Land Acquisition and Involuntary Resettlement This standard is based on the assumption that an involuntary resettlement process, if poorly conducted, may be disastrous both to the affected population and environmental resources involved. Involuntary resettlement refers both to physical displacement (relocation of people, even though they are not formal owners) and economic displacement (loss of assets or access to assets that leads to loss of income sources or means of livelihood). For this reason, the first significant recommendation is that involuntary resettlement should be avoided, either by finding alternative sites for the project or by means of a negotiation process seeking an friendly settlement. When involuntary resettlement is unavoidable, the project should implement to the stakeholders a sufficient process that includes disclosure, consultation and informed participation. A fair negotiation is also necessary to offset loss of assets and services. The long-term objective of this process should be the enhancement, restoration or even the improvement of the standards of living of the displaced persons. A lesson learned in applying this standard is that, in some cases, the socioeconomic registry of the affected population which should be the first step to start the resettlement process should not be something static. In a gas pipeline projected we analyzed in Colombia, for example, was identified that this registry was completed within a very short range of time. Given FARC's strong presence in Colombia until recently, many people were in the process of returning to their land, so such registry should be continuously extended in order to track this social process. We then requested the client to extend the registry process to ensure that all returning families are also included. A population that deserves special attention during the resettlement process is that of rural workers, since they are more sensitive to changes in their means of livelihood and production. Itau s experience in this context comes from the financing of a hydropower plant in Northern Brazil, in which Itau identified that the resettled people needed not only a fair compensation but also technical support to help them reorganize their activities. It was also agreed, that this technical support must continue until clear triggers of efficiency improvement and economic returns was reached.

Performance Standard 6 Biodiversity Conservation and Sustainable Management of Living Natural Resources The requirements set out in this standard were guided by the UN Convention on Biological Diversity (CBD). It defines how a project should manage, throughout its execution and operation, the protection and conservation of biodiversity at all its levels, maintain the benefits from ecosystem services (benefits that people and companies obtain from ecosystems) and promote the sustainable management of living natural resources. A case that illustrates the application of this principle is the financing of a hydropower plant in the Andes region. Because the project was close to a conservation unit, the use of explosives to drill the necessary tunnels was restricted and a drilling technology that kept disturbance to the local fauna and flora to a minimum was employed. Another example is how two hydropower plants in Brazil managed the risk associated with their impacts on biodiversity, specifically fishes. The construction of damns could represent a threat to the continuity of important species of long-distance migratory fishes, since this would fragment their habitat. Therefore, both projects conducted genetic studies of these populations of fishes to identify their behaviors. These studies revealed that, prior to the construction of dams, they were already naturally segregated in their habitat, and were divided into genetic subgroups. In practice, the challenges related to this topic are enormous when the project is located in or close to a protected area, such as conservation units or areas with fauna and flora species in danger of extinction. Long-term monitoring actions (30 years) were planned to verify, by means of indicators, if there would be numeric variation of the individuals of these species during the project life cycle, and no relevant changes have been identified so far. In addition, several fish transposition approaches were tested and an alternative considered less invasive to species was elected. Finally, an artificial reproduction center was also proposed to ensure that these species, if in danger based on the figures obtained by the indicators, can be reproduced in laboratory. Please note that the first three actions have so far shown sufficient for the indicators to remain at adequate levels, without the need to implement the fourth action.

Performance Standard 7 Indigenous Peoples This standard is based on the assumption that traditional peoples, including indigenous, represent a vulnerable segment of the population, especially when a project impacts directly or indirectly their material and non-material resources. It also provides recommendations of actions that should be adopted for these peoples to benefit from the impacts generated by the project.. Especially in Brazil, the indigenous issue is very complex and still an important insecurity factor in the development of infrastructure projects. In this regard, we have adopted a very conservative approach as we have required these projects to implement alternative actions and make decisions to avoid impacts on these populations. An example of this approach was when Itaú, in financing The objective of this standard is to respect the unique characteristics of these peoples, obtaining their free, prior and informed consent in relation to the proposed actions and establishing a continuous and culturally adequate communication channel. the construction of a large transmission line, required the client to adopt an alternative design that did not affect directly indigenous land, even though the route was longer. Projects should always be designed to generate benefits to these populations, like in the case of one of the hydropower plants we financed in Northern Brazil, and whose entrepreneur, even after indepth studies that revealed that the project would not impact indigenous land, adopted measures to benefit communities in the region that lived in poor conditions. Firstly, the project contracted etymologic studies which, besides helping government agencies to rescue the cultural origins of that community, allowed to identify that that population was in danger, mainly due to problems related to land security (for example, invasion of illegal miners and woodcutters) and diseases caused by lack of access to basic sanitation resources. As a result of this study, a program requiring the adoption of surveillance measures in the territorial boundaries of these communities and the provision of basic sanitation infrastructure was created.

Performance Standard 8 Cultural Heritage The last standard provides recommendations to protect the cultural heritage that may be affected by the project and, in some cases, promote the equitable sharing of benefits from the use of such cultural heritage. To achieve this, all works must be monitored by an archeologist, and the involved workers must be properly trained to identify archeological remains and keep them in safe until its rescue. To meet this standard, our experience also shows that engaging local archeologists and sociologists, or at least having a vast local knowledge, to conduct an appropriate analysis of the characteristics of this heritage and recommend proper handling and isolation actions. For example, at the above-mentioned hydropower plant in Chile, the existence of Inca Empire heritage was identified in the area impacted by the project. Such historic heritage, known as Inka Trail, is hardly identified by archeologists who are not from that region or who are not at least researchers of the Incan civilization. However, as the choice was to engage local professionals, the correct identification of the area and its characteristics enabled the adoption of the due care during the explosion activities, for example, in a way not to impact such an important Mankind Cultural Heritage.

Conclusion The cases outlined here reflect Itaú Unibanco s experiences in requiring, as part of the conditions precedent for granting credit, the adoption of measures to manage environmental and social risks and impacts, according to the IFC Performance Standards. Real-life solutions and lessons learned from some of the biggest challenges we faced over more than 10 years as signatories of the Equator Principles and as an institution financing infrastructure projects in the energy industry were presented.. We hope the lessons learned and presented here may go beyond the mere disclosure but reinforce the transparency approach valued by our environmental and social risk management guidelines. We believe that the demystification of the difficulties to fully implement the Equator Principles encourages the adoption of such criteria by other financial institutions besides being meaningful to other stakeholders. We are confident that this initiative will inspire a better alignment of these practices in the global financial services industry, in addition to significantly increase the breadth of positive effects while seeking sustainable development. To talk to Itaú Unibanco about the Equator Principles, contact us by email: sustentabilidade@itau-unibanco.com.br Rafael Mol is a senior environmental and social risk analyst in the wholesale segment of Itaú bank, so-called Itaú BBA. Specialist in risks related to the implementation, development and operation of projects in the energy and oil & gas sectors, Mol also provides climate change advisory services. Holder of a bachelor s degree in Environmental Engineering from the University of São Paulo (USP), Mol has also completed postgraduate studies on Environmental Management and Businesses in the Energy Sector and on Health and Safety Engineering at USP.

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