How unmanaged E&S impacts can generate business risk

Case 1: An example of good E&S risk mitigation by a Bank

Background

• Client - medium sized fertilizer manufacturing company.

• Location – near a major international watercourse, upstream from a national park

• Financing request - long term loan facility for $10mn.

• Bank categorized the Client’s activities as high risk project and engaged an external consultant to assist with the E&S due diligence.

Findings and Outcome of the E&S Due Diligence

Findings• Lack of management commitment, systems and capacity to

address E&S impacts. • Actions to control and manage pollution and fix failings in

the effluent holding ponds and other site infrastructure had not been implemented.

• Management appeared to be underestimating the potential risks associated with poor effluent management.

Outcome• The Bank makes repairs of infrastructure a condition

precedent for disbursement of loan facility.

What went wrong ?• Shortly after signing - a flood• Heavy rains lead to large volumes of

effluent spilling into the river as holding ponds fail;

• Wildlife and livestock deaths over a 15km stretch of river;

• Tourism activities suspended; • Plant closed down by authorities.

• Fortunately for the bank - first disbursement was on hold pending implementation of condition precedent.

Lessons Learned

• The type of activity, size and location all have a bearing on likelihood and potential severity of E&S impacts.

• Assessing a Client‘s commitment, capacity and track record to manage E&S impact is a critical part of the due diligence process.

• The bank‘s ESMS correctly identified high risks associated with weaknesses in E&S management, in particular failure to address structural failures in effluent ponds.

• The bank correctly made risk mitigation actions as conditions precedent to disbursement in the loan agreement.

Case 2: Importance of taking local communities into account

Background

• Client: Medium sized company manufacturing activated carbon from coconut shells.

• Financing request: long term loan facility for $7mn to expand production facility by 2 ha.

• Findings: E&S due diligence undertaken by the bank involved a desk top study of information provided by the client. No site visit was made.

• Terms: A clause was included in the facility agreement requiring the company to comply with relevant local E&S legislation, but Client was not requested to submit documentation to demonstrate compliance with this clause.

What went wrong ?• Closure. Shortly after signing the facility,

the company is closed down by the local authorities. Bank learns of the news through the newspaper.

• Why? The trigger for closure was a community protest over expansion and concerns of worsening dust pollution.

• No good news. Further investigations revealed that the factory had been exceeding national emissions levels by a lot, for a long time. Information that had not been shared with the Bank.

• Facility is written off by the Bank.

Lessons Learned

• Do not rely on the client’s word.• Visit the site as often as possible, ideally with the help of a

specialist. • Talk to other stakeholders, in particular those directly affected

such as neighboring communities• Consider E&S issues as early in the process as possible to

avoid cutting corners with the E&S due diligence.• Ask yourself “Would you and your family like to live next to

the project you are financing?” If not, you can probably count on community activism.

Case 3: Assess E&S risks beyond your project and financing perimeter

Background

• Client: A chemical plant producing highly inflammable substances, using state of the art technology with all E&S related licenses of local authorities obtained, operating in the industrial zone.

• Financing request: multi-million dollar facility.

Finding of Bank’s E&S due diligence• The E&SDD noted many overlooked risks that could increase

the likelihood and severity of a potential accident, including: • Proximity of many informal vendors outside the company walls,

preparing food on open fires only metres from petroleum intake;• Highly congested neighbourhoods and poor road infrastructure

preventing an effective emergency response; • Inadequate emergency preparedness and response; no engagement

with neighbouring entities or communities whatsoever.• The Bank requested the Client to• Develop a joint emergency response plan with neighbouring

companies and vendors.• Move the vendors to a vacant space away from the perimeter wall.• Engage local authorities to improve the road infrastructure.

Lessons Learned• A full assessment of potential community health and safety risks should

have been undertaken before site selection by the Client’s ESIA.• Ventures located in congested urban environments have inherently high

community health and safety risks.• Banks must look beyond issues that are directly within their Client’s

control. • If it is difficult for the Client to influence a third party to mitigate risk, it

may be better not to proceed with the deal.

Lessons learnt from all the cases• Implementing E&S Management Systems

in FIs pays in terms of avoided financial losses.

• Banks must always ask Clients for demonstrable evidence of compliance.

• If in doubt, involve specialists. • Banks should always conduct their own

site visits.• E&S risk research must extend beyond

the direct boundaries of the venture being financed.

• Banks should be alert to poor management commitment and capacity.