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Challenging environmental and social issues may include involuntary resettlement, loss of biodiversity, impacts on indigenous communities, community and worker safety, pollution, contamination, and others. The life cycle of such projects generally includes several phases such as construction, operations, and decommissioning and typically extends over many years.

Many financial institutions that are involved in project finance transactions have subscribed to voluntary sustainability principles such as the Equator Principles, through which they commit themselves to apply international standards for managing environmental and social risks. The procedures and tools for conducting environmental and social due diligence for a project finance transaction are described in a financial institution’s Environmental and Social Management System and should include the following steps as part of a desktop review and a site visit:

  • Screening of the project against a list of excluded activities adopted by the financial institution;
  • Review of industry sector and environmental and social issues that are typically associated with this type of operation;
  • Review the project’s compliance with applicable national environmental and social regulations;
  • Review the project sponsors’ track record on environmental and social issues, in terms of potential non-compliance with national regulations or negative publicity;
  • Review the project’s compliance against international standards or industry best practice regarding environmental and social issues; and
  • Review of the proposed actions (if any) to mitigate potential environmental and social issues associated with the project throughout all phases of the life cycle.

The financial institution should document all findings from the due diligence, which will be considered during the decision-making process before proceeding with a transaction. In the event that environmental and social issues are identified and should be mitigated through corrective actions, the financial institution can stipulate these in the legal agreement with the project sponsor and monitor on-going progress toward completion.

For transactions that have been categorized as high risk, the financial institution may require the services of an external expert/consultant to conduct the environmental and social due diligence. To do so effectively, it is critical that the financial institution communicates to the external expert/consultant the environmental and social requirements that clients/investees are required to comply with. The financial institution also needs to ensure that the findings are reviewed and factored in to the decision-making process.

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