Environmental and social risk to a financial institution (FI) stems from the environmental and social issues that are related to a client's/investee's operations.

A financial institution's transaction with a client/investee can represent a financial, legal and/or reputational risk to the financial institution. Because environmental and social issues are inherent in client/investee operations, almost all transactions are exposed to some degree of environmental and social risk.

Understanding E&S Risks

The environmental and social risks inherent in a transaction depend on several factors such as the specific issues associated with a client's/investee's operations, the industry sector and the geographic context. E&S issues typically include environmental pollution, hazards to human health, safety and securityimpacts on communities and threats to a region's biodiversity and cultural heritage. In most cases, a client/investee has control over the E&S issues associated with the operation and can take the necessary steps to mitigate these risks.

By implementing a Environmental and Social Management System, a financial institution can enhance its understanding of E&S risks associated with each transaction, which can be included in the decision-making process for proceeding with a transaction.

Site Visit

Financial institution staff can conduct a site visit to gain an impression of the environmental and social issues associated with the daily operations of a client's/investee's business. This provides insight into potential environmental and social risks.

Financial institution staff can conduct a site visit as part of the environmental and social due diligence process for a proposed transaction as well as during the monitoring process for an approved transaction.

The focus of the site visit is to identify potential environmental and social issues that may represent a risk to the client’s/investee’s business activities if left unmitigated and to review a client’s/investee’s compliance with the financial institution’s environmental and social requirements. If a transaction involves an industry sector with complex environmental and social issues, financial institution staff should solicit the opinion of a social or environmental expert.

Prior to a site visit, financial institution staff should be familiar with the environmental and social information provided by the client/investee or identified during a previous site visit as well as have a general understanding of the environmental and social issues that are typically associated with a particular industry sector. Financial institution staff can then ask more targeted questions, request any necessary documents and focus their observations on particular areas of a facility during their site visit. This helps reduce the amount of time needed to conduct the site visit, which can range from less than 1 hour to a full day or more depending on the size and complexity of the facility.

Financial institution staff should meet with site managers including health and safety officers and human resources officers as well as technical staff who are well-informed of the environmental and social implications of processes associated with the client’s/investee’s operations. Although the specific focus of a site visit will vary for each transaction as a function of the client’s/investee’s business operations, financial institution staff should gain general information about:

  • General characteristics of the site including age and use of facilities and buildings
  • Operations and processes performed on the site
  • Size of the workforce
  • Labor practices
  • Surrounding land use

The site visit should be conducted during hours of operation and should focus on key areas such as:

  • Processing/manufacturing lines
  • Installations for wastewater treatment
  • Sources of air emissions and filters
  • Storage areas for hazardous materials
  • Storage areas for waste and disposal processes
  • Worker facilities
  • Neighboring properties

Signs of possible environmental and social concerns include:

  • Leaking containers or pipes
  • Poorly maintained storage tanks/facilities
  • Unmarked tanks or areas with hazardous or flammable materials
  • Discoloration of ground and potential site contamination
  • Discoloration of nearby streams or drainage channels
  • Excessive gas or dust emissions
  • Excessive noise
  • Strong odors
  • Limited use of personal protective equipment by employees
  • Complaints by local residents
  • Proximity of surrounding communities

The financial institution can develop a checklist for conducting a site visit and facilitate identification of environmental and social issues.

During the site visit, financial institution staff should also observe if there are any environmental business opportunities in the client’s/investee’s operations and follow up with appropriate investment officers within the financial institution. Financial institution staff should record the environmental and social findings, observations and photographs, if necessary, to insert in the client/investee file.

In the event of environmental and social findings that require follow up by the client/investee, financial institution staff can develop a formal corrective action plan with a timeframe for the client/investee to implement appropriate mitigation measures. In many cases, environmental and social findings can be addressed and resolved by the client/investee in a short time and do not require a formal corrective action plan but should nonetheless be documented in the client/investee file.

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FI's Exposure to E&S Risk

A client's/investee's exposure to environmental and social risk involves the potential of an adverse event that may have implications for the client/investee and may jeopardize its financial and operational viability.

Client/investee activities may cause environmental impacts, present a hazard to human health, or could negatively affect the surrounding community as a result of improper planning or management.

Because these risks may present a credit, liability or reputational risk to financial institutions, they can take steps to identify and mitigate these risks. A financial institution exposure to these risks will vary depending on their business lines. Banking, microfinance, leasing and private equity organizations face different E&S risks.

The extent of environmental and social risk depends, among other things, on the industry sector, in particular if there are production processes or other activities that generate emissions and byproducts that are potentially harmful to the environment and communities. High environmental and social risk is generally associated with industry sectors such as agriculture, fisheries, extractive industries, infrastructure, construction and manufacturing.

The unexpected implications of environmental and social risk associated with a client’s/investee’s operations ultimately also impact the financial institution as a result of the transaction that links the client/investee to the financial institution. The unexpected implications for a client/investee may include:

  • Disruption of operations. A client’s/investee’s operations may be impacted directly due to changing social conditions, such as high staff turnover or changing environmental conditions, such as deterioration of resources on which the operation depends. This impacts the client’s/investee’s prospects for staying in business and represents a risk for the financial institution.
  • Legal issues. A country’s environmental and social regulations establish requirements for operating licenses, occupational health and safety standards, and emission/discharge permits. If a client/investee fails to comply with these requirements or exhibits on a continued basis negligence or non-compliance, this will result in fines and penalties or even indefinite suspension of operations as operating permit may be revoked by authorities. This impacts the client’s/investee’s financial and operational viability and represents a risk for the financial institution.
  • Loss of market share. Due to new environmental and social regulations and/or market demands for socially responsible or environmentally preferable products and services, a client/investee may lose market share if it cannot meet these requirements. This impacts the client’s/investee’s ability to sustain profits from existing operations and represents a risk for the financial institution.
  • Liabilities and market devaluation. Clients/investees may face environmental and social liabilities from contamination as well as damages or injuries to third parties. This includes any land and/or groundwater remediation actions required under environmental regulations which can be extremely costly, and any claims for payment for damages or compensation due to environmental and social damages caused by a client’s/investee’s operations. For the client/investee, this represents a significant financial burden and typically results in market devaluation of assets. For a financial institution, this results in devaluation of collateral as well as a potential liability.
  • Poor reputation. As community awareness of environmental and social issues is growing, a client’s/investee’s operations are increasingly subject to scrutiny to ensure good management and accountability. Poor environmental and social performance can result in community opposition to a client’s/investee’s presence in the community and potential delays or interruptions in client/investee operations. Negative public perception will damage a client’s/investee’s reputation, which can lead to a decreased demand for a client’s/investee’s product or services. This impacts the client’s/investee’s financial and operational viability and represents a risk for the financial institution.

Clients/Investees who do not consider or effectively manage the environmental and social risks associated with their operations run the risk of exposing themselves to credit and liability risks as well as reputational damage that can ultimately threaten the viability of their operations.

Managing environmental and social risks to comply with social and environmental regulations and international environmental and social standards as well as pursuing environmental business opportunities to enhance overall performance signals good corporate responsibility. This reduces the client’s/investee’s exposure to potential environmental and social risk as well as unexpected implications for operations and also improves reputation. For a financial institution, this increases a client’s/investee’s credibility and reflects long-term financial and operational viability.

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Banking Institution

A banking institution (also referred to as a universal or commercial bank) can range from a large financial institution with a highly visible brand name and an international presence to a small organization with a local presence.

A banking institution’s financing activities generally involve various types of lending, such as corporate finance, housing, project finance, retail, short-term finance, small-medium enterprises, trade, and others. Alternatively, the focus of a banking institution may be only on specific transactions with clients that meet certain requirements and within certain industry sectors. Banking institutions may also provide financial products with a focus on environmental business opportunities.

A banking institution’s exposure to environmental and social risks varies greatly as a function of the clients within its portfolio. Some banking institutions usually have highly visible brands in their markets or globally, and are particularly susceptible to reputational risk. Banking institutions are also driven to improve their environmental and social risk management capacity to reduce credit and liability risks arising from environmental and social issues. A number of banking institutions have publicly committed themselves to sustainable banking, and many have voluntarily adopted the principles established under various sustainability initiatives.

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Leasing Company

A leasing company provides a physical asset or service for use by a commercial client or individual for an established period of time in return for regular payments, known as financial leasing.

A leasing company provides a physical asset or service for use by a commercial client or individual for an established period of time (sometimes with provisions to purchase asset at the end of the contract) in return for regular payments, known as financial leasing. The lessee is the receiver of the assets or services under the lease contract and the lessor is the owner of the assets or provider of services. Leasing assets include passenger vehicles, light duty trucks, furniture, office equipment, appliances, and heavy equipment, such as earth movers, large machines, industrial equipment, ships, heavy duty trucks, and airplanes. In some cases, a leasing company both owns and services the leased physical asset and is responsible for installing and operating the asset, which is known as operational leasing.

A leasing company’s exposure to environmental and social risks will be more significant for transactions involving specialized or heavy equipment and machinery for use in certain industry sectors, where liability or reputational risk may be of concern. A leasing company that provides operational leases may be directly responsible for environmental and social impacts such as land contamination and worker safety arising from use of the physical asset.

The leasing company can manage these risks by integrating environmental and social risk management procedures into its overall risk management framework.

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Microfinance Institution

Microfinance institutions are organizations that provide loans to low-income clients, including micro-companies and the self-employed, who traditionally lack access to mainstream sources of finance from Banking Institutions.

The loans are typically for small amounts (as little as US$ 100 or even less) targeting borrowers in developing countries and usually for a short term (a year or less). The loans are not secured by collateral assets as would be the case for Banking Institutions and require repayment in weekly installments rather than on a monthly basis.

A microfinance institution’s exposure to environmental and social risks is typically low. Because social development is part of their mandate, microfinance institutions are concerned with the environmental and social risks of their transactions and are taking steps to manage these risks to reduce negative impacts in their communities.

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Private Equity Fund

Private equity funds make long-term equity investments in companies or projects (although sometimes other financial instruments may be used) with the goal of later selling the equity stake at a profit at the time of exit.

A private equity fund usually consists of a partnership with investors who are limited partners in the Fund, which is controlled by a general partner. Limited partners commit to provide funding when the general partner has identified an opportunity for investment, such as acquiring a controlling stake of a company. A Fund will typically make separate investments in several companies or projects over the life of the partnership. Investee companies or projects can encompass microfinance institutions, small and medium enterprises, and corporations and large-scale projects.

Because such transactions make the private equity fund a partial or full owner of an investee company, the Fund is directly exposed to, and thus also liable for, the environmental and social risks of the investee company. Potential environmental and social risks may reduce an investee company’s market value and affect the timing of the Fund’s exit from the company. A private equity fund’s ownership position in an investee company offers the Fund a unique position to promote sound environmental and social management of the investee company’s operations and also identify environmental business opportunities that would enhance an investee company’s financial viability and increase its market value. Unlike many other financial institutions, a private equity fund can directly profit from the upside potential of good environmental and social management. If the environmental and social risks of the investee companies are well managed and the opportunities deriving from sustainability are maximized, the Fund’s exit opportunities can be improved substantially.

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E&S Issues

Environmental and social issues may manifest in many different ways and affect the viability of a financial institution's client/investee operations.

Environmental issues may present themselves as temporary or permanent changes to the atmosphere, water, and land due to human activities, which can result in impacts that may be either reversible or irreversible. Social issues may emerge in the workplace of a client’s/investee’s operations and may also impact surrounding communities. A client’s/investee’s performance in the areas listed below can represent environmental and social risks to the operation:

The extent of environmental and social impacts potentially associated with a client’s/investee’s operations depends on the industry sector and is usually categorized into low, medium or high risk.

Air Emissions and Air Quality

Emissions of air pollutants can occur from a wide variety of activities during construction, operation and decommissioning of a client's/investee's operations.

Air emissions are typically associated with processes such as combustion, storage of materials or other industry-sector specific processes and can be:

  • Point sources: These are discrete, stationary, identifiable sources of emissions (such as a specific stack, vent or other discrete point of emission) that release pollutants to the atmosphere. They are typically located in manufacturing or production plants. Point sources are characterized by the release of air pollutants typically associated with the combustion of fossil fuels, such as nitrogen oxides (NOx), sulfur dioxide (SO2), carbon monoxide (CO), and particulate matter (PM), as well as other air pollutants including certain volatile organic compounds (VOCs) and metals that may also be associated with a wide range of industrial activities.
  • Fugitive sources: These are emissions that are distributed spatially over a wide area and originate in operations where exhausts are not captured and released through a stack. Fugitive emissions have the potential for much greater ground-level impacts than stationary source emissions, since they are discharged and dispersed close to the ground. The two main types of fugitive emissions are volatile organic compounds (VOCs) and particulate matter (PM). Other contaminants (NOx, SO2 and CO) are mainly associated with combustion processes designed to deliver electrical or mechanical power, steam and heat.
  • Mobile sources: These are emissions associated with vehicle use and include CO, NOx, SO2, PM and VOCs. Emissions can be reduced by implementing a regular vehicle maintenance and repair program, instructing drivers on better driving practices that reduce both the risk of accidents and fuel consumption, replacing older vehicles with newer, more fuel efficient alternatives, converting to cleaner fuels and installing emissions control devices such as catalytic converters.

A client/investee should estimate and monitor air emissions associated with operations through qualitative or quantitative assessments and atmospheric dispersion models to assess potential ground level concentrations and environmental impacts. At a facility level, air emissions should not result in pollutant concentrations that exceed the ambient air quality standards set by national authorities, which would result in fines and/or penalties if concentrations are in violation of national legislation. Pollutant concentrations can also be compared to international best practice and standards to identify any deviations, which would indicate poor performance of an operation. Air emissions of concern typically include:

  • Volatile Organic Compounds (VOCs): Emissions of VOCs are associated with industrial activities that produce, store and use VOC-containing liquids or gases in particular where the material is under pressure. Typical sources include equipment leaks (from valves, fittings and elbows), open vats and mixing tanks, storage tanks, unit operations in wastewater treatment systems and accidental releases. Emissions can be reduced by modifying equipment, regularly monitoring equipment to detect and repair leaks, using less volatile substances such as aqueous solvents and collecting vapors through air extractors.
  • Particulate Matter (PM): Dust or particulate matter (PM) is released during certain operations such as the combustion of fossil fuels, open storage of solid materials, and from exposed soil surfaces, including unpaved roads. Emissions can be reduced through dust control methods such as covers, water suppression, or increased moisture content for open materials storage piles, or controls (such as a baghouse or cyclone).
  • Ozone Depleting Substances (ODS): Ozone depleting substances (ODSs) include chemicals, which have been scheduled for phase-out under the Montreal Protocol on Substances that Deplete the Ozone Layer . Systems or processes using chlorofluorocarbons (CFCs), halons, 1,1,1-trichloroethane (methyl chloroform), carbon tetrachloride, hydrochlorofluorocarbons (HCFCs), hydrobromofluorocarbons (HBFCs), and methyl bromide should be gradually phased out or not used at all as determined by national regulations. These chemicals are typically used in a variety of applications including refrigeration, air conditioning, manufacturing foam products, solvent cleaning, aerosol propellants, fire protection systems and as crop fumigants.
  • Greenhouse Gases (GHGs): Greenhouse Gases (GHGs), as defined under the Kyoto Protocol to the United Nations Framework Convention on Climate Change, include carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride (SF6). GHGs can be generated by a facility’s production processes as well as from the production of power (on-site or off-site) for use by the facility. Emissions can be reduced through mechanisms such as carbon financing, energy efficiency, sustainable forms of agriculture and forestry, use of renewable forms of energy, carbon capture and storage technologies, recovery and use of methane in waste management and energy distribution.
  • Sulfur dioxide (SO2): Sulfur dioxide (SO2) is mainly produced by the combustion of fuels such as oil and coal and as a by-product from some chemical production or wastewater treatment processes. Emissions can be reduced through the use of alternate fuels such as low sulfur coal, light diesel or natural gas, emissions control technologies.
  • Toxics (mercury): Mercury exists as elemental mercury, inorganic mercury compounds (primarily mercuric chloride), and organic mercury compounds (primarily methyl mercury). All forms of mercury are toxic and each form exhibits different health effects. A major source of exposure to elemental mercury is through inhalation in the work place. Sources of inorganic mercury compounds are generally low as their use has mostly been banned but limited exposure can occur through the use of old cans of latex paint. Sources of methyl mercury include fungicide-treated grains and meat from animals fed with treated grain.

Where possible, a client’s/investee’s operations should avoid, minimize and control adverse impacts to human health, safety and the environment from emissions to air. The generation and release of air emissions can be managed through a combination of energy use efficiency, process modification, selection of fuels or other materials and application of emissions control techniques. A financial institution can help a client/investee to identify areas for reductions in air emissions and to identify environmental business opportunities.

Biodiversity and Natural Resources

Land use and conversion to support a client's/investee's operations not only results in increased erosion of the topsoil but can also impact biodiversity due to habitat loss and fragmentation.

Land use and conversion to support a client’s/investee’s operations not only results in increased erosion of the topsoil, which leads to sedimentation of streams and rivers and degrades water quality, but can also impact biodiversity due to habitat loss and fragmentation. A reduction in biodiversity diminishes the capacity of ecosystems to provide a stable and sustainable supply of essential goods and services such as clean air and water and also reduces genetic variability, which could potentially decrease the amount of natural resources available for future use.

Protecting and conserving biodiversity – the variety of life in all its forms, including genetic, species and ecosystem diversity – and its ability to change and evolve, is fundamental to sustainable development. The components of biodiversity, as defined in the Convention on Biological Diversity, include ecosystems and habitats, species and communities, and genes and genomes, all of which have social, economic, cultural and scientific importance. Clients/Investees need to avoid or mitigate threats to biodiversity arising from their operations as well as sustainably manage renewable natural resources as most national environmental legislations protect biodiversity and regulate the use of natural resources. Any violation of legislations can result in fines and/or penalties.

The destruction of habitat (natural and modified) is recognized as the major threat to the maintenance of biodiversity. Natural habitats consist of land and water areas where the biological communities are formed largely by native plant and animal species, and where human activity has not essentially modified the area’s primary ecological functions. Modified habitats are typically altered natural habitats, often with the introduction of alien species of plants and animals, such as agricultural areas. Both types of habitat can support important biodiversity at all levels, including endemic or threatened species.

Within both natural and modified habitats, there may be critical habitats that are required for the survival of critically endangered or endangered species or for endemic or restricted-range species and migratory species. The intentional or accidental introduction of alien, or non-native, species of flora and fauna into areas where they are not normally found can be a significant threat to biodiversity, since some alien species can become invasive, spreading rapidly and out-competing native species.

Typically, measures to protect biodiversity include:

  • Modified habitats. The client/investee needs to minimize any conversion or degradation of habitat and identify opportunities to enhance habitat and protect biodiversity as part of operations.
  • Natural habitats. The client/investee needs to ensure that habitat is not converted or degraded unless there are no other alternatives and the overall benefits of keeping operations in that locations outweigh impacts to the environment and biodiversity. In cases of any conversion or degradation, the client/investee needs to ensure that appropriate mitigation measures are implemented.
  • Legally protected areas. In cases where a client’s/investee’s operations are located within a legally protected area under national regulations, the client’s/investee’s operations need to comply with the requirements established in the protected area management plans and consult with protected area managers, local communities, and other key stakeholders.
  • Invasive alien species. The client/investee cannot introduce any new alien species unless this is appropriately managed within an existing regulatory framework or action plan to determine the potential for invasive behavior. The client/investee should prevent accidental or unintended introductions of any alien species with a high or known risk of invasive behavior.

If a client’s/investee’s operations involve the use of natural resources such as forests and aquatic species, these need to be managed in a sustainable manner, to meet the reasonably foreseeable needs of future generation. A client/investee can demonstrate the sustainable management of these resources through a management plan or certification by an independent system of standards. Both should be based on objective and measurable performance standards and developed through consultation with relevant stakeholders and consists of fair, transparent, and independent decision-making procedures that avoid conflicts of interest. The sustainable management of natural resources involves the following:

  • Natural and plantation forests. The client/investee should not cause any conversion or degradation of critical habitat and give preference to land that has already been converted. The exploitation of natural forests and plantations needs to be independently certified against internationally accepted principles and criteria for sustainable forest management.
  • Freshwater and marine systems. The client/investee needs to demonstrate that the production and harvesting of fish populations or other aquatic species is conducted in a sustainable manner. If available, this includes certification by an internationally accepted system of standards.

Community Health, Safety and Security

A client's/investee's operations can increase the potential for community exposure to risks and impacts arising from accidents, structural failures, and releases of hazardous materials

A client’s/investee’s operations often bring benefits to communities including employment, services, and opportunities for economic development. However, these operations can also increase the potential for community exposure to risks and impacts arising from accidents, structural failures, and releases of hazardous materials. Communities may also be affected by impacts on their natural resources, exposure to diseases, and the use of security personnel.

While acknowledging the public authorities’ role in promoting the health, safety and security of the public, it is also the client’s/investee’s responsibility to avoid or minimize these risks and impacts that may arise from operations. This includes implementing the following actions:

  • Consultation and grievance channels. Where appropriate, the client/investee should conduct consultations and establish a line of communication with the impacted community in order to understand and monitor potential impacts. An appropriate consultation and grievance mechanism can help manage and minimize potential risks, avoid reputational issues and reduce the risk of conflicts with the community.
  • Infrastructure and equipment safety. The client/investee needs to ensure that operations are conducted to prevent potential injury to the surrounding community, especially if aspects of the operations are accessible to the community. If the client’s/investee’s operations involve operation of moving equipment on public roads, the client/investee needs to ensure that the necessary safety measures are in place to prevent the occurrence of any incidents and accidents.
  • Hazardous materials safety. The client/investee needs to prevent or minimize the potential for community exposure to hazardous materials that may be released during operations. If there is a potential for life-threatening hazards, the client/investee needs to modify operations or substitute or eliminate substances causing the hazard. The client/investee also needs to control the safety of deliveries of raw materials and of transportation and disposal of wastes.
  • Environmental and natural resource issues. The client/investee needs to avoid or minimize the exacerbation of impacts caused by natural hazards, such as landslides or floods that could arise from land use changes due to operations. This also includes avoiding or minimizing adverse impacts due to operations on soil, water, and other natural resources used by the affected communities.
  • Community exposure to disease. The client/investee needs to prevent or minimize the potential for community exposure to water-borne or vector-borne disease, and other communicable diseases that could result from operations. This also includes preventing or minimizing the transmission of communicable diseases that may be associated with the influx of temporary or permanent labor associated with the client’s/investee’s operations.
  • Increase in traffic. Traffic, especially movement of heavy vehicles increases especially during construction phase. This can lead to possible accidents/incidents which need to be minimized. There is a need for traffic management plan and training of staff to manage and minimize accidents/incidents.
  • Emergency preparedness and response. The client/investee needs to inform surrounding communities of potential hazards associated with operations and collaborate with the community and local government agencies in preparing to respond effectively to emergency situations.
  • Use of security personnel. A client/investee may retain security personnel to safeguard its operations, which may pose risks to the surrounding community if not managed properly. This includes ensuring that security personnel have not been implicated in past abuses, have been adequately trained in the use of force (including firearms, if necessary) as well as in the conduct toward workers and the local community. The client/investee will also provide a mechanism to allow the surrounding community to express concerns about security personnel and will investigate any allegations of unlawful or abusive acts of security personnel to take the necessary action to prevent recurrence.

If the impacts of a client’s/investee’s operations on the surrounding community are not appropriately managed, this can create conflict and objections to the client’s/investee’s presence in the community. This represents a reputational risk to the client/investee at the local level, and if not addressed, may escalate to reputational risk at the regional and even international level.

Cultural Heritage

Cultural heritage encompasses properties and sites of archaeological, historical, cultural, artistic and religious significance as well as unique environmental features and cultural knowledge, and practices of communities protected for future generations.

Cultural heritage encompasses properties and sites of archaeological, historical, cultural, artistic and religious significance as well as unique environmental features and cultural knowledge, innovations and practices of communities embodying traditional lifestyles, which are protected for current and future generations. Consistent with the requirements of the Convention Concerning the Protection of the World Cultural and Natural Heritage, a client/investee is required to avoid significant damage to cultural heritage due to their business activities.

Impacts on cultural heritage typical involve the following:

  • Chance finds. During the construction of a client’s/investee’s facility(s), there may be physical impacts on previously unknown or undocumented resources that were fully or partially buried prior to the start of construction.
  • Community input. Where a project may affect cultural heritage, the client/investee will consult with affected communities who use, or have used, the cultural heritage for longstanding cultural purposes to identify cultural heritage of importance. A client/investee should incorporate the views of the affected communities on cultural heritage into the decision-making process.
  • Removal of cultural heritage. Most cultural heritage is best protected by preserving it in its place, since removal is likely to result in irreparable damage or destruction of the cultural heritage. Cultural heritage should only be removed if the client/investee can demonstrate that the overall benefits of operations at a particular site outweigh the anticipated loss of cultural heritage.
  • Legally protected cultural heritage areas. When a client’s/investee’s proposed operations are located within a legally protected area or a legally defined buffer zone, the client/investee is required to take additional measures to promote and enhance the conservation of the area.
  • Use of cultural heritage. If a client/investee makes commercial use of a community’s cultural heritage, such as embodiment of traditional lifestyles, the client/investee is required to enter into a good faith negotiation with the affected local communities and to provide fair and equitable sharing of benefits from the commercialization of their cultural heritage.

If a client’s/investee’s operations are initiated and conducted without consideration for cultural heritage, there are significant legal and reputational risks. A systematic approach to incorporating concern for cultural heritage issues throughout a client’s/investee’s operations, including additional investments in the enhancement of cultural heritage, can bring significant reputational advantage to a client/investee at both the local and international level.

Energy Use and Conservation

A client's/investee's operations consume energy to power processes such as heating and cooling; auxiliary systems such as motors, pumps and fans; generating compressed air; heating, ventilation and air conditioning systems (HVAC); lighting systems or other industry-sector specific processes.

Energy consumption at the facility level is typically associated with specific production processes and supporting utilities such as:

  • Process heating: This is vital to many manufacturing processes including heating for fluids, calcining, drying, heat treating, metal heating, melting, melting agglomeration, curing and forming. In many process heating systems, only a portion of the system’s energy input provides true process heating while energy losses are caused by excessive parasitic loads, distribution or conversion losses. Energy losses can be reduced by identifying opportunities for improvement in a facility’s process heating systems.
  • Process cooling: This is vital to many manufacturing processes and energy losses occur due to issues such as lack of insulation to reduce heat gains; overcooling; poor refrigeration system design; and refrigerant compressor and chiller efficiency. Energy losses can be reduced by identifying opportunities for improvement in a facility’s process cooling systems.
  • Compressed air: In many industry sectors, this is the most commonly found utility service, yet in many cases, the energy contained in compressed air for use by a facility is often 10 percent or less the energy used in compressing the air.

The production of energy for use by client/investee operations entails the use of renewable or non-renewable resources. Energy from renewable resources includes solar power, wind power, hydropower, biomass and nuclear fission and fusion. Non-renewable resources include crude oil, coal and natural gas, which are collectively called fossil fuels. Fossil fuels are considered non-renewable resources due to the long duration of formation and assimilation to the environment. The combustion of fossil fuels to produce energy generates different types of air pollution, including greenhouse gases (GHGs) that can harm global environmental systems and human health. Emissions of pollutants and GHGs can be reduced by using renewable forms of energy.

Where possible, a client’s/investee’s operations should reduce overall energy use at the facility level by managing the energy consumption associated with specific production processes and supporting utilities, which would result in cost savings. A financial institution can help a client/investee to identify areas for reductions in energy use and identify environmental business opportunities.

Hazardous Materials Use

A client's/investee's operations may require the use of materials that are hazardous. Hazardous materials are materials that represent a risk to human health, property, or the environment due to their physical or chemical characteristics.

These can be classified according to the hazard as explosives; compressed gases, including toxic or flammable gases; flammable liquids; flammable solids; oxidizing substances; toxic materials; radioactive material; and corrosive substances.

A client’s/investee’s operations may involve the production, handling, storage and use of large quantities of hazardous materials. This can result in uncontrolled releases of hazardous materials or accidents if the necessary measures to prevent accidents such as fire and explosions or leaks and spills are not in place or the client/investee does not have procedures to respond to emergencies. The client/investee needs to ensure that prevention and control measures are in place to ensure the protection of the workforce and surrounding communities from hazardous materials used at a facility. Typically, prevention and control measures of hazardous materials include:

  • Non-hazardous substitutes. Avoiding or minimizing the use of hazardous materials in processes by using nonhazardous alternatives. For example, there are non-hazardous materials that can be used as substitutes for asbestos in building materials, PCBs in electrical equipment, persistent organic pollutants (POPs) in pesticides formulations, and ozone depleting substances in refrigeration systems.
  • Release prevention and control planning. When handling hazardous materials, a client/investee needs to develop procedures and practices for quick and efficient responses to accidents. Where there is risk of a spill of hazardous materials, facilities should prepare a spill control, prevention, and countermeasure plan, which would include training and drills of key staff on release prevention, inspection programs, and secondary containment structures.
  • Hazard communication and training programs. Workers should be able to recognize and respond to workplace chemical hazards and have a clear understanding of hazard identification and safe operating and materials handling procedures. This also requires the need for suitable personal protection equipment (PPE includes footwear, masks, protective clothing and goggles), emergency eyewash and shower stations, ventilation systems and sanitary facilities.
  • Hazardous materials transfer. Uncontrolled releases of hazardous materials may result from small cumulative events or from significant equipment failure associated with events such as manual or mechanical transfer between storage systems or process equipment. Hazardous material releases from processes can be prevented through the use of dedicated fittings, pipes, and hoses, regular inspection and maintenance of fittings, pipes, and hoses, and the use of secondary containment.
  • Overfill protection. The overfilling of vessels and tanks is among the most common cause of spills resulting in soil and water contamination, and can easily be prevented.
  • Reaction, fire, and explosion prevention. Reactive, flammable, and explosive materials should be managed to avoid uncontrolled reactions or conditions resulting in fire or explosion. Incompatible materials (acids, bases, flammables, oxidizers, reactive chemicals) should be stored in separate areas, and with containment facilities separating material storage areas.
  • Secondary containment. The use of secondary containment is a critical aspect for controlling accidental releases of liquid hazardous materials during storage and transfer. Appropriate secondary containment structures consist of berms, dikes, or walls, made of impervious, chemically resistant material, capable of containing the larger of 110 percent of the largest tank or 25% percent of the combined tank volumes in areas with above-ground storage tanks (ASTs) with a total storage volume equal or greater than 1,000 liters.
  • Underground Storage Tanks (USTs). Although there are many environmental and safety advantages of underground storage of hazardous materials, including reduced risk of fire or explosion, and lower vapor losses into the atmosphere, leaks of hazardous materials can go undetected for long periods of time with potential for soil and groundwater contamination. The risk of leaks can be reduced by installing impermeable liners or structures such as concrete vaults under and around tanks, reconciling tank contents by measuring the volume and comparing it against the expected volume, regular testing of the integrity of the tank, and monitoring down-gradient groundwater quality for potential contamination.
  • Pesticide use. When pest management activities include the use of pesticides, pesticides that are low in human toxicity and have minimal effects on non-target species and the environment should be used. Selected pesticides should be packaged in safe containers, clearly labeled for safe and proper use, and manufactured by a licensed entity. Pesticide should be handled, stored, applied, and disposed of in accordance with best international practice (Food and Agriculture Organization’s International Code of Conduct on the Distribution and Use of Pesticides). Pesticides that are categorized as extremely hazardous, highly hazardous, and moderately hazardous by the World Health Organization Recommended Classification of Pesticides should not be used.

Where possible, a client’s/investee’s operations should reduce the use and/or potential spills and releases of hazardous materials at the facility. A financial institution can help a client/investee to identify environmental business opportunities.

Indigenous Peoples

Indigenous Peoples (IPs) are recognized as social groups with identities that are distinct from dominant groups in national societies and are often among vulnerable segments of the population.

Indigenous Peoples may be referred to in different countries by such terms as “Indigenous ethnic minorities”, “aboriginals”, “hill tribes”, “minority nationalities”, “scheduled tribes”, “first nations”, or “tribal groups”.

IPs typically self-identify as members of a distinct indigenous cultural group and are recognized as such by others; have a collective attachment to geographically distinct habitats or ancestral territories, making use of natural resources in these habitats and territories; have customary cultural, economic, social, or political institutions that are separate from those of the dominant society or culture; and communicate in an indigenous language, often different from the official language of the country or region.

Indigenous Peoples are often closely tied to their traditional or customary lands and the natural resources on these lands. While these lands may not be under their legal ownership as defined under national law, the use of these lands by communities of IPs for their livelihoods or for cultural purposes is often recognized under customary law. However, the economic, social and legal status of Indigenous Peoples often limits their capacity to defend their interests and rights to lands and natural and cultural resources. Indigenous Peoples are particularly vulnerable if their lands and resources are transformed, encroached upon by outsiders, or significantly degraded. Their languages, cultures, religions, spiritual beliefs, and institutions may also be under threat. These characteristics expose Indigenous Peoples to different types of risks and severity of impacts, including loss of identity, culture, and natural resource-based livelihoods, as well as exposure to impoverishment and disease.

A client/investee should ensure that during the course of operations, the identity, culture and natural resource-based livelihoods of Indigenous Peoples are respected and exposure to impoverishment and disease is prevented. This includes implementing the following actions:

  • Avoid or minimize adverse impacts. When a client/investee cannot completely avoid impacts on Indigenous Peoples, the client/investee needs to mitigate or compensate for these impacts in a culturally appropriate manner and with the informed participation of affected Indigenous Peoples.
  • Consultation. The client/investee needs to establish an ongoing relationship with the affected communities of Indigenous Peoples, which should be culturally appropriate. If there are adverse impacts, the consultation process needs to ensure the free, prior, and informed consultation of the Indigenous Peoples and facilitate their informed participation with respect to proposed mitigation measures and sharing development benefits.
  • Sharing development benefits. The client/investee needs to identify opportunities for development benefits for affected Indigenous Peoples. This should aim at improving their standard of living and livelihoods in a culturally appropriate manner, including the long-term sustainability of the natural resource on which they depend.
  • Impacts on traditional or customary lands. If a client’s/investee’s operations are located within traditional or customary lands or involve the commercial use of natural resources located on these lands, this will generate adverse impacts on the livelihoods or cultural identity of the community of Indigenous Peoples. The client/investee needs to inform affected communities of their rights under national laws, including the recognition of customary rights; make efforts to avoid or at least minimize the size of the impacted land; and offer land-based compensation as well as culturally appropriate development opportunities to affected communities.
  • Relocation of Indigenous Peoples. The client/investee should avoid the relocation of Indigenous Peoples from their traditional lands. If relocation is unavoidable, the client/investee needs to enter into a good faith negotiation with the affected communities and ensure that any relocation complies with best international standards.

If a client’s/investee’s operations are initiated and conducted without the involvement of Indigenous Peoples, this can lead to misunderstanding and conflict. Given worldwide concern for the well-being of Indigenous Peoples, there are significant reputational risks for a client/investee if Indigenous Peoples issues are not managed appropriately.

Labor and Working Conditions

The pursuit of economic growth through employment creation and income generation should be balanced with protection for basic rights of workers.

For any business, the workforce is a valuable asset, and a sound worker-management relationship is a key ingredient to the long-term sustainability of the enterprise. Failure to establish and foster a sound worker-management relationship can undermine worker commitment and retention, result in labor strikes, and can jeopardize a client’s/investee’s operations. Conversely, through a constructive worker-management relationship, and by treating the workers fairly and providing them with safe and healthy working conditions, clients/investees may create tangible benefits, such as enhancement of the efficiency and productivity of their operations.

A client’s/investee’s commitment to establishing a sound worker-management relationship encompasses the following aspects:

  • Human resources policy. A client/investee should adopt a policy appropriate to its size and workforce, which sets out its approach to managing employees. The policy provides information regarding their rights under national labor and employment law, including their rights related to wages and benefits.
  • Working conditions and terms of employment. A client/investee should document and communicate to all employees and workers (including contract workers) their working conditions and terms of employment. These include their entitlement to wages and benefits, hours of work, overtime arrangements and overtime compensation, and leave for illness, maternity, vacation or holiday, that at a minimum comply with national law. This includes respecting a collective bargaining agreement with a workers’ organization if there is such an agreement.
  • Workers’ organizations. Where permitted by law, employees should be granted the right to associate freely and to bargain collectively, by forming and joining workers’ organizations or through alternative means. A client/investee should not discourage workers from forming or joining workers’ organizations and should not discriminate or retaliate against workers who participate in such organizations and bargain collectively.
  • Non-discrimination and equal opportunity. A client/investee should not make employment decisions on the basis of personal characteristics unrelated to inherent job requirements but rather on the principle of equal opportunity and fair treatment.
  • Retrenchment. If a client/investee anticipates the elimination of a significant number of jobs or a layoff of a significant number of employees, it should develop a plan for managing the adverse impacts on employees.
  • Grievance mechanism. A client/investee should provide all employees with a mechanism to raise reasonable workplace concerns, confidentially or anonymously if needed, so that concerns can be addressed promptly at the management-level without any retribution.
  • Child labor and forced labor. A client/investee cannot employ children in a manner that is economically exploitative, or is likely to be harmful to the child or to interfere with the child’s education. A client/investee cannot employ forced labor, which consists of any work or service not voluntarily performed by an individual but executed under threat of force or penalty.
  • Supply chain. A client/investee should pay attention to unfair labor practices of its suppliers, especially in instances where low labor cost is a factor in the competitiveness of supplies, and ensure that this is not due to harmful labor practices.

Respecting international standards with regard to labor and working conditions benefits a client’s/investee’s operations by encouraging positive worker-management relationships that lead to more productive and stable operations, including a reduced likelihood of strikes, and provides a reputational advantage that comes from enhanced public recognition that good international standards are being followed.

Land Acquisition and Resettlement

Involuntary resettlement refers both to physical displacement and to economic displacement due to land acquisition associated with a client's/investee's operations.

Involuntary resettlement refers both to physical displacement (relocation or loss of shelter) and to economic displacement (access to resources for income generation or means of livelihood) due to land acquisition (including rights-of-way) associated with a client’s/investee’s operations. Resettlement is considered involuntary when affected individuals or communities do not have the right to refuse displacement. This occurs in cases of: i) lawful expropriation or restrictions on land use based on eminent domain; and ii) negotiated settlements in which the buyer can resort to expropriation or impose legal restrictions on land use if negotiations with the seller fail.

Displaced persons may be classified as persons who:

  1. have formal legal rights to the land they occupy;
  2. do not have formal legal rights to land, but have a claim to land that is recognized or recognizable under the national laws; or
  3. have no recognizable legal right or claim to the land they occupy.

Unless properly managed, involuntary resettlement may result in long-term hardship and impoverishment for affected persons and communities, as well as environmental damage and social stress in areas to which they have been displaced. For these reasons, involuntary resettlement should be avoided or at least minimized. However, where it is unavoidable, appropriate measures to mitigate adverse impacts on displaced persons and host communities should be carefully planned and implemented with appropriate disclosure of information, consultation, and the informed participation of affected persons. This includes implementing the following actions:

  • Compensation and benefits for displaced persons. When displacement cannot be avoided, the client/investee will offer displaced persons and communities compensation for loss of assets at full replacement cost and other assistance to help them improve or at least restore their standards of living or livelihoods.
  • Grievance mechanism. The client/investee needs to ensure that a grievance mechanism is in place to receive and address specific concerns about compensation and relocation that are raised by displaced persons or members of host communities.
  • Social impact assessment, resettlement planning and implementation. Where involuntary resettlement is unavoidable, the client/investee will conduct a census to identify the persons who will be displaced by the project, understand the likely impacts on the affected persons and community, develop entitlement framework and determine who will be eligible for compensation.
  • Physical displacement. If people living on the site of a client’s/investee’s operations must move to another location, the client/investee will: i) offer displaced persons choices among feasible resettlement options, including adequate replacement housing or cash compensation; and ii) provide relocation assistance suited to the needs of each group of displaced persons, with particular attention paid to the needs of the poor and the vulnerable. New resettlement sites built for displaced persons will offer improved living conditions.
  • Economic displacement. If land acquisition for the client’s/investee’s operations causes loss of income or livelihood, the client/investee will promptly compensate these persons, for example by compensating affected business owners for the cost of reestablishing commercial activities elsewhere, for lost net income during the period of transition, and for the costs of the transfer and reinstallation of their business operations.
  • Government-managed resettlement. Where land acquisition and resettlement are the responsibility of the government, the client/investee needs to collaborate with the responsible government agency to the extent permitted by the agency to achieve outcomes that are consistent with best international practice.

If a client’s/investee’s operations involve land acquisition and resettlement, this should be carefully managed to prevent the likelihood of hardship and impoverishment for affected persons and communities. Given that a displaced community will not be entirely satisfied with its new situation unless there is noticeable improvement in standards of living or livelihoods, this will remain a reputational risk for the client/investee.

Land Contamination

Land can become contaminated due to releases of hazardous materials, wastes, or oil, including naturally occurring substances.

Releases of these materials may be the result of historic or current site activities, including accidents during their handling and storage, or due to poor management or disposal. Land is considered contaminated when it contains hazardous materials concentrations, including oil, above baseline and/or naturally occurring levels.

Contaminated lands may involve topsoils or subsurface soils that, through leaching and transport, may affect groundwater, surface water, and adjacent sites. Where subsurface contaminant sources include volatile substances, soil vapor may also create potential for contamination through infiltration of indoor air spaces of buildings.

Land contamination is a concern when hazardous materials, waste, or oil are present in any environment at potentially hazardous concentrations and the potential for contact with humans, wildlife, plants, and other living organisms exists. This may occur when a contaminant migrates from its point of release (e.g., leaching into potable groundwater) and humans or other living organisms are exposed to it (e.g., through ingestion or skin absorption). This has potential risks to human health(e.g., risk of cancer) and ecology and represents a liability to the polluter/business owners (e.g., cost of remediation, damage of business reputation and/or business-community relations) or affected parties (e.g., workers at the site and nearby property owners).

Land contamination should be avoided by preventing or controlling the release of hazardous materials, hazardous wastes, or oil to the environment. When contamination of land is suspected or confirmed during any project phase, the cause of the uncontrolled release should be identified and corrected to avoid further releases and associated adverse impacts. Contaminated lands should be managed to avoid the risk to human health and ecological receptors. This requires cleanup to reduce the level of contamination at the site while preventing human exposure.

In cases of land contamination representing an immediate risk to human health and the environment, appropriate risk reduction should be implemented as soon as practicable to remove the imminent hazard. Risk mitigation strategies should be developed based on site-specific conditions and target contaminant source reduction, taking into consideration technical and financial feasibility. To protect human health, access to a contaminated site should be limited or prevented, for example through signage, fencing, or site security. This may also require capping contaminated soil with clean soil to prevent human contact, introducing certain plants into contaminated soils or paving them over as an temporary measure to prevent direct contact.

A client’s/investee’s operations should implement the necessary measures to prevent releases of hazardous materials, waste, or oil to the ground. A financial institution can help a client/investee to identify environmental business opportunities.

Occupational Health and Safety

Providing workers with a safe and healthy work environment, free from physical, chemical, biological, and radiological hazards inherent in a particular industry sector, is essential for ensuring the long-term sustainability of a client's/investee's operations.

A client/investee is required to implement all reasonable precautions to prevent accidents, injury, and illness of workers in the course of performing their duties. This includes following industry-specific worker’s safety standards and implementing preventive and protective measures to:

  • Eliminate hazards by removing an activity from the work process (such as substitution with less hazardous chemicals or use of different manufacturing processes);
  • Control the hazard at its source through use of engineering controls (such as local exhaust ventilation, isolation rooms, machine guards, and acoustic insulation);
  • Minimize the hazard through design of safe work systems and procedural control measures (such as job rotation, training safe work procedures, lock-out and tag-out, workplace monitoring, and limiting exposure or work duration); and
  • Provide appropriate personal protective equipment (PPE) in conjunction with training, use and maintenance of the PPE. PPE provides additional protection to workers exposed to workplace hazards in conjunction with other facility controls and safety systems.

A client’s/investee’s efforts to protect the health and safety of workers in the design and operation of facilities encompass the following aspects:

  • Integrity of workplace structures. Facilities should be structurally safe and floors/surfaces should be free of accumulated material.
  • Severe weather and facility shutdown. Facilities should be designed and constructed to withstand the expected elements for the region and have an area designated for safe refuge of workers.
  • Workspace and exit. The workspace provided for each worker should be adequate for safe execution of all activities and passages to emergency exits should be unobstructed at all times.
  • Fire precautions. The workplace should be designed to prevent the start of fires and the facility should be equipped with fire detectors, alarm systems, and fire-fighting equipment.
  • Lavatories and showers. Adequate lavatory facilities (toilets and washing areas, including hot and cold running water, soap, and hand drying devices) should be provided for the number of people expected to work in the facility and segregated by gender, if necessary.
  • Potable water supply. Adequate supplies of potable drinking water (meeting drinking water quality standards) should be provided and supplied to areas of food preparation or for the purpose of personal hygiene (washing or bathing).
  • Clean eating area. A clean eating area needs to be designated within the facility, where workers are not exposed to hazardous or noxious substances.
  • Lighting. Workplaces should receive natural light and be supplemented with sufficient artificial illumination to promote workers’ safety and health, and enable safe equipment operation.
  • Safe access. Passageways around the facility should be segregated for pedestrians and vehicles; hand, knee and foot railings should be installed on stairs, fixed ladders, and platforms; floor openings should be covered; covers to protect against falling items should be installed; and measures to prevent unauthorized access to dangerous areas should be in place.
  • First aid. Appropriately equipped first-aid stations should be easily accessible throughout the place of work, including Eye-wash stations and/or emergency showers.
  • Air supply. Sufficient fresh air should be supplied for indoor and confined work spaces, through appropriate air distribution systems, including heating, ventilation and air conditioning (HVAC).
  • Work environment temperature. During hours of operation, the temperature in work, rest rooms and other welfare facilities should be maintained at an appropriate level.

Physical hazards in the workplace represent potential risks of accidents, injury or illness due to repetitive exposure to mechanical action or work activity. This may result in a wide range of injuries, from minor and medical aid only, to disabling, catastrophic, and/or fatal. Multiple exposures over prolonged periods can result in disabling injuries of comparable significance and consequence. Physical hazards in a client’s/investee’s operations stem from the following:

  • Rotating and moving equipment. Injury or death can occur from being trapped, entangled, or struck by machinery parts due to unexpected starting of equipment or unexpected movement during operations.
  • Noise. No employee should be exposed to a noise level greater than 85 dB(A) for a duration of more than 8 hours per day without hearing protection.
  • Vibration. Exposure to hand-arm vibration from equipment such as hand and power tools, or whole-body vibrations from surfaces on which the worker stands or sits, should be controlled through choice of equipment, installation of vibration dampening pads or devices, and limiting the duration of exposure.
  • Electrical. Exposed or faulty electrical devices, such as circuit breakers, panels, cables, cords and hand tools, can pose a serious risk to workers. Overhead wires can be struck by metal devices, such as poles or ladders, and by vehicles with metal booms. Vehicles or grounded metal objects brought into close proximity with overhead wires can result in arcing between the wires and the object, without actual contact.
  • Eye hazards. Solid particles from a wide variety of industrial operations, or a liquid chemical spray, may strike a worker in the eye causing an eye injury or permanent blindness.
  • Welding/hot work. Welding creates an extremely bright and intense light that may seriously injury a worker’s eyesight. In extreme cases, blindness may result. Additionally, welding may produce noxious fumes to which prolonged exposure can cause serious chronic diseases.
  • Industrial vehicle driving and site traffic. Poorly trained or inexperienced industrial vehicle drivers have increased risk of accident with other vehicles, pedestrians, and equipment. Industrial vehicles and delivery vehicles, as well as private vehicles on-site, also represent potential collision scenarios.
  • Working environment temperature. Exposure to hot or cold working conditions in indoor or outdoor environments can result temperature stress-related injury or death. Use of Personal Protective Equipment (PPE) to protect against other occupational hazards can accentuate and aggravate heat-related illnesses. Extreme temperatures in permanent work environments should be avoided through implementation of cooling and ventilation.
  • Ergonomics, repetitive motion, manual handling. Injuries due to ergonomic factors, such as repetitive motion, overexertion, and manual handling, take prolonged and repeated exposures to develop, and typically require periods of weeks to months for recovery.
  • Working at heights. Fall prevention and protection measures should be implemented whenever a worker is exposed to the hazard of falling more than two meters.
  • Illumination. Work area light intensity should be adequate for the general purpose of the location and type of activity, and should be supplemented with dedicated work station illumination, as needed.

Chemical hazards in the workplace represent potential risks for illness or injury due to single acute exposure or chronic repetitive exposure to toxic, corrosive, sensitizing or oxidative substances. They also represent a risk of uncontrolled reaction, including the risk of fire and explosion, if incompatible chemicals are inadvertently mixed. Chemical hazards in a client’s/investee’s operations stem from the following:

  • Air quality. Poor air quality due to the release of contaminants into the work place can result in possible respiratory irritation, discomfort, or illness to workers.
  • Fire and explosions. Fires and or explosions resulting from ignition of flammable materials or gases can lead to loss of property as well as possible injury or fatalities to project workers.
  • Corrosive, oxidizing, and reactive chemicals. Corrosive, oxidizing, and reactive chemicals present similar hazards as flammable materials. An additional hazard of these chemicals is that inadvertent mixing or intermixing may cause serious adverse reactions, which can lead to the release of flammable or toxic materials and gases, and may lead directly to fires and explosions. These types of substances have the additional hazard of causing significant personal injury upon direct contact, regardless of any mixing issues.
  • Asbestos containing materials. The use of asbestos containing materials should be avoided in new buildings or as a new material in remodeling or renovation activities. If asbestos containing materials are present, particularly friable asbestos representing the potential to release fibers, the repair or removal and disposal should be performed according to internationally recognized procedures to prevent worker exposure.

Biological agents represent potential for illness or injury due to single acute exposure or chronic repetitive exposure. The use of any harmful biological agents should be avoided and replaced with an agent that, under normal conditions of use, is not dangerous or less dangerous to workers. If use of harmful agents can not be avoided, precautions should be taken to keep the risk of exposure as low as possible and maintained below internationally established and recognized exposure limits.

Radiation exposure can lead to potential discomfort, injury or serious illness to workers. Workplaces involving occupational and/or natural exposure to ionizing radiation should be operated in accordance with recognized international safety standards and guidelines. Exposure to non-ionizing radiation (including static magnetic fields, sub-radio frequency magnetic fields, static electric fields, radio frequency and microwave radiation, light and near-infrared radiation, and ultraviolet radiation) should be controlled according to international standards.

Additional precautions are required for workers in special hazard environments such as a confined space or an isolated workspace. A confined space is a wholly or partially enclosed space, which is not designed or intended for human occupancy and in which a hazardous atmosphere could develop as a result of the contents, location or construction of the confined space or due to work done in or around the confined space. Serious injury or fatality can result from inadequate preparation to enter a confined space or in attempting a rescue from a confined space. A worker in an isolated space is out of verbal communication and line of sight with a supervisor, other workers, or other persons capable of providing aid and assistance, for continuous periods (exceeding one hour). This puts a worker at increased risk should an accident or injury occur.

A client/investee should establish procedures and systems for monitoring and recording occupational accidents and diseases as well as dangerous occurrences and incidents, to verify the effectiveness of prevention and control strategies in their operations and monitor employee productivity against lost time injury. If a client/investee does not adequately protect the health and safety of workers in the course of operations, leading to severe injuries, illnesses, and even fatalities, this represents a significant reputational risk and financial liability to the client/investee.

Wastes

A client's/investee's operations may generate, store, or handle any quantity of hazardous or non-hazardous waste across a range of industry sectors.

Waste can be solid, liquid, or contain gaseous material that is discarded by disposal, recycling, burning or incineration. It can be a by-product of a manufacturing process or an obsolete commercial product that can no longer be used for its intended purpose and requires disposal. Inappropriate waste disposal practices can lead to contamination of ground water or potential fines and/or penalties as stipulated in national regulations.

Solid (non-hazardous) waste generally includes domestic trash, inert construction/demolition materials, metal scrap and empty containers (except those previously used to contain hazardous materials, which should be managed as a hazardous waste), and residual waste from industrial operations.

Hazardous waste shares the properties of a hazardous material (such as ignitability, corrosivity, reactivity, or toxicity), or other physical, chemical, or biological characteristics that may pose a potential risk to human health or the environment if improperly managed. When a hazardous material is no longer usable for its original purpose and is intended for disposal, but still has hazardous properties, it is considered a hazardous waste. Typically, hazardous wastes include solvents, fuels, asbestos in building materials, PCB oils in electrical equipment, most pesticides, and ozone depleting substances in refrigeration systems. Wastes may also be defined as “hazardous” by local regulations or international conventions, based on the origin of the waste and its inclusion on hazardous waste lists or based on its characteristics. Hazardous wastes should always be segregated from nonhazardous wastes.

Facilities that generate and store wastes need to consider issues linked to waste minimization, generation, transport, and disposal. Typically, approaches to waste management include:

  • Waste management planning. Facilities that generate waste should characterize their waste according to composition, source, types of wastes produced, generation rates, or according to local regulatory requirements. This information can be used to identify opportunities for pollution prevention, such as source reduction, reuse, and recycling.
  • Waste prevention. Processes can be designed and operated to prevent, or minimize, the quantities of wastes generated and hazards associated with the wastes generated. This can be accomplished by substituting raw materials or inputs with less hazardous or toxic materials, or with those where processing generates lower waste volumes, and improving manufacturing processes to convert materials more efficiently.
  • Recycling and reuse. The total amount of waste can be significantly reduced through the implementation of recycling and reuse plans. This entails identifying and recycling products that can be reintroduced into the manufacturing process or industry activity at a site or in industrial processing operations located at other facilities. It also includes identifying materials that can be reused, saving both costs and disposal needs.
  • Treatment and disposal. If waste materials are still generated after the implementation of feasible waste prevention, reduction, reuse, recovery and recycling measures, waste materials should be treated and disposed of while considering all measures to avoid potential impacts to human health and the environment. Typical treatment and disposal methods include on-site or off-site biological, chemical, or physical treatment of the waste material to render it non-hazardous prior to final disposal; and treatment or disposal at permitted facilities specially designed to receive the waste.
  • Hazardous waste storage. Hazardous waste should be stored so as to prevent or control accidental releases to air, soil, and water resources. This requires the need for storage in closed containers away from direct sunlight, wind and rain; secondary containments; and the provision of adequate ventilation where volatile wastes are stored.
  • Hazardous waste transportation. On-site and off-site transportation of waste should be conducted using appropriate protocols to prevent or minimize spills, releases, and exposures to employees and the public. All waste containers designated for off-site shipment should be secured and labeled with the contents and associated hazards, and be properly loaded on the transport vehicles before leaving the site.
  • Hazardous treatment and disposal. In the absence of qualified commercial or government-owned waste vendors, facilities generating waste should have the technical capability to manage the hazardous waste or install on-site waste treatment or recycling processes in a manner that reduces immediate and future impacts to the environment. This may also require the need for applicable permits, certifications, and approvals.
  • Small quantities of hazardous waste. Hazardous waste materials are frequently generated in small quantities by many projects through a variety of activities such as equipment and building maintenance activities. Waste storage collection and storage areas should be visually inspected on a regular basis for evidence of accidental releases and to verify that wastes are properly labeled and stored. These types of wastes include spent solvents and oily rags, empty paint cans, chemical containers; used lubricating oil; used batteries (such as nickel-cadmium or lead acid); and lighting equipment, such as lamps or lamp ballasts.

Where possible, a client’s/investee’s operations should implement sound waste management practices at the facility. A financial institution can help a client/investee to identify environmental business opportunities

Wastewater and Water Quality

A client's/investee's operations generate wastewater, which is treated on site and/or discharged either to the municipal sewage system for treatment or directly to the environment (surface water) without prior treatment.

Wastewater includes process wastewater, wastewater from utility operations, stormwater and sanitary wastewater. Wastewater will vary in quality and quantity by industry sector and typically includes:

  • Process wastewater: Pollutants may include acids, bases, and many others. These include soluble organic chemicals, suspended solids, nutrients (phosphorus and nitrogen), heavy metals (such as cadmium, chromium, copper, lead, mercury, nickel and zinc), cyanide, toxic organic chemicals, oily materials and volatile materials. The costs of treating process wastewater can be significant.
  • Wastewater from utilities operations: Utility operations such as cooling towers and demineralization systems may result in high rates of water consumption, as well as the potential release of high temperature water containing high dissolved solids, residues of biocides and residues of other cooling system anti-fouling agents.
  • Stormwater: Stormwater includes any surface runoff and flows from process and materials staging areas resulting from precipitation or drainage. Typically stormwater runoff contains suspended sediments, metals, petroleum hydrocarbons, Polycyclic Aromatic Hydrocarbons (PAHs) and coliform. Rapid runoff, even of uncontaminated stormwater, also degrades the quality of the receiving water by eroding stream beds and river banks.
  • Sanitary wastewater: This may include effluents from domestic sewage, food service and laundry facilities serving site employees and can also include other sources such as from laboratories, medical infirmaries, equipment maintenance shops and water softening.

A client/investee should monitor the quality, quantity, sources and discharge points of liquid effluents by type (process, utilities operations, stormwater and sanitary). At a facility level, discharges of wastewater should not result in contaminant concentrations in excess of the effluent discharge quality standards of national regulations to avoid liability for fines and/or penalties. Discharge quality can also be compared to international best practice and standards to identify any deviations, which would indicate poor performance of an operation. The generation and discharge of wastewater should be managed to reduce the volume of water requiring specialized treatment by improving water use efficiency, modifying production processes (including the use of hazardous materials that contaminate water), and treating wastewater on-site prior to discharge in order to reduce the load of contaminants.

Where possible, a client’s/investee’s operations should avoid, minimize and control adverse impacts to human health, safety and the environment from wastewater generation through wastewater management, water conservation and reuse. A financial institution can help a client/investee to identify opportunities for preventing or reducing wastewater generation through water conservation and recycling/reusing within operations and to identify environmental business opportunities.

Water Use and Conservation

A client's/investee operations use water in various production processes, which vary by industry sector. Typically, water use at the facility level is associated with processes such as described here.

  • Process water: Processes that typically use large quantities of water include washing machines, rinsing, water jets or sprays to keep conveyors clean or to cool product, and the use of tanks, which are refilled to control losses. Opportunities for reducing water use exist through water reuse, improved equipment maintenance and better process design.
  • Building facility operations: Consumption of building and sanitary water is typically less than that of industrial processes. Areas for reducing water use include repairing leakages and installing water-saving devices.
  • Cooling systems: Once-through cooling systems with cooling towers use large quantities of water and can be replaced by closed circuit cooling systems. Fresh water use can also be reduced by replacing it with treated water.
  • Heating systems: Closed heating systems based on the circulation of low or medium pressure hot water may consume large quantities of water if they leak and are poorly maintained. In some cases, large quantities of water may be used by steam systems but water use can be reduced through steam recovery systems and improved systems operations.

Where possible, a client’s/investee’s operations should reduce overall water use at the facility level by managing the water consumption associated with specific production processes to avoid excess costs. A financial institution can help a client/investee to identify areas for reductions in water use and new environmental business opportunities

E&S Risk for Financial Institutions

The operations of a financial institution do not generate significant environmental and social impacts, but the way their clients/investees manage impacts of their operations may pose risks to a financial institution.

Client/investee operations may also represent opportunities for additional financing and growth. All financial institutions are exposed to some level of environmental and social risk through their clients/investees. If left unmanaged, these risks can lead to a decline in the financial institution’s reputational image, costly litigation, or loss of revenue.

E&S Risk for Financial Institutions
E&S Risk for Financial Institutions

The type, quantity and severity of environmental and social issues that present a risk to a financial institution for any given transaction depend on a variety of factors, including geographic context, industry sector, and the type of transaction: corporate, housing, insurance, leasing, microfinance, project finance, retail, short-term finance, small and medium enterprise, and trade.

  • Liability risk. By virtue of taking possession of collateral assets, a financial institution is exposed to liability risk stemming from a client’s/investee’s legal obligations. This includes fines, penalties, and costs for addressing third-party claims for damages due to negligence in managing environmental and social risks in a client’s/investee’s operations and clean-up of contamination. If the financial institution is a principal shareholder of a client’s/investee’s operations, it may also be directly liable for all environmental and social risks associated with a client’s/investee’s operations.
  • Financial risk. A financial institution is exposed to financial risk stemming from potential disruption of client’s/investee’s operations as a result of environmental and social problems. If not managed properly, these problems can affect a client’s/investee’s ability to meet its financial obligations to the financial institution and/ or can drive down the value of a client’s/investee’s collateral in the context of a transaction. A client’s/investee’s failure to effectively address environmental and social considerations can jeopardize its business operations as well as the financial institution that is supporting the transaction. The financial institution will also face liquidity risks from environmental and social problems associated with collateral.

    For example, the financial institution will have to use up internal resources to meet government clean-up requirements or to clean the site up before it can be sold if collateral is contaminated.

  • Reputational risk. A financial institution is exposed to reputational risk due to potentially negative publicity associated with a client’s/investee’s poor environmental and social practices. This harms a financial institution’s brand value and image in the media, with the public, with the business and financial community, and even with its own staff. For example, if a client/investee faces strong public opposition against its operations, the financial institution’s reputation may be tarnished through its association with this particular client/investee.
  • Credit risk. A financial institution is exposed to credit risk when a client/investee is unwilling and/or unable to fulfill the contractual obligations associated with a transaction as a result of environmental and social issues. For example, if a client/investee faces increased capital or operating costs of complying with environmental and social standards or if operating and emission/discharge permits are absent or expired resulting in regulatory fines or penalties, there is a risk that the client/investee cannot meet its financial obligations to the financial institution.
  • Market risk. A financial institution is exposed to market risk stemming from a reduction in the value of collateral associated with a transaction due to environmental and social problems. For example, if a production site becomes contaminated, the market value of the underlying collateral will fall.

A financial institution’s environmental and social risks are those of their clients/investees and are inherent in the nature of a client’s/investee’s operations. Environmental and social risks can be mitigated through compliance with environmental and social regulations and international environmental and social standards. These risks are not static, but rather are dynamic over time and subject to change.

Some potential environmental and social risks may not seem significant or relevant at the time of approval of a financial transaction, but may become so during execution, for instance as a result of higher regulatory standards and increased levels of enforcement. In other cases, environmental and social risks, such as spills or explosions, may seem unlikely to occur, but when they do, the environmental and social impact is potentially extremely high.

To reduce exposure to risk arising from the environmental and social risks of its clients/investees, financial institutions need to ensure that their clients’/investees’ financial and operational sustainability is not undermined by adverse impacts on the environment and surrounding communities. Financial institutions need to have a clear understanding of potential environmental and social risks and implications for a client’s/investee’s operations prior to being linked to the client/investee in the context of a transaction.

This requires proactive identification, assessment, and management of environmental and social risks before they become significant or result in an adverse outcome on the client/investee. A financial institution can best achieve this by developing and implementing a Environmental and Social Management System (ESMS), to systematically assess the environmental and social risks and opportunities arising from their clients’/investees’ operations and manage its exposure to risk.

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Risk in Corporate Finance

Corporate transactions typically consist of loans to, or investments in, commercial operations of different sizes and operating in a variety of industry sectors.

Loans (debt) can be used by the commercial operation to finance a specific aspect of the operation, such as the purchase of equipment, or for renovation/expansion of the operation. Equity investments in a commercial operation provide operating capital for an operation in exchange for shares (equity) in the company/project.

The environmental and social risks associated with a corporate transaction will vary greatly and can be significant as a function of the operation’s industry sector, size, location, and company commitment and capacity to managing environmental and social risks. Environmental and social risks will be more significant for medium and high-risk industry sectors and large-scale operations such as mining, oil and gas, and heavy manufacturing, which may result in loss of life, health impacts, and water contamination, among others, if not managed properly. For low-risk industry sectors such as retail operations and other services, the environmental and social risks will usually be low and mainly related to labor standards and life and fire safety, which can readily be addressed. Regardless of the industry sector, there may also be environmental and social risks, especially related to labor and working conditions, in the supply chain of raw materials and goods.

Environmental and social issues may threaten the financial and operational viability of a commercial operation. For a commercial operation, the source of repayment of a loan or payment of dividends on an investment is from the operation itself, backed by its entire balance sheet, rather than a specific asset. A corporate transaction exposes a financial institution to the entire commercial operation of the investee company, which presents a liability, reputational, and credit risk. When a loan is backed by a specific asset as collateral, the liability risk for the financial institution may be increased if there are associated environmental and social issues.

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Risk in Housing

This type of financing generally involves providing mortgage loans directly to consumers for the specific purpose of financing the purchase of a home.

In this type of transaction, the financial institution becomes the legal owner of the property during the repayment duration of the mortgage.

Environmental and social risks associated with housing finance may include inappropriate development location, poor building design (including ability to withstand natural disasters) and inadequate construction as well as unresolved land tenure issues. Some of these risks can result in damage or loss of the property or in some cases injury and safety concerns for residents.

Environmental and social risks that may result in property damage and legal issues affect the financial standing of borrowers and their ability to repay the mortgage loan. For financial institutions focusing on housing finance, this represents a credit risk. There are also legal and reputational risks for the financial institution arising from ownership of properties in cases of land contamination or other environmental and social liabilities.

Risk in Insurance

Many financial institutions sell insurance policies to clients, which involves agreeing to cover the potential costs associated with an event that meets pre-established requirements in exchange for the regular payment of a premium to the financial institution.

Claims can be made under health, life, and accident insurance policies, which are generally considered to have minimal or no environmental and social risk. Property insurance carries some environmental and social risks, usually associated with natural disasters or construction quality and design. Risk insurance can also be provided to companies or projects with a significant exposure to potential environmental and social risks, which are inherent in the nature of their operations, such as maritime transportation, construction, large scale agribusiness, extractive industries, manufacturing, and infrastructure development. These activities may be associated with involuntary resettlement, community and occupational health and safety, loss of biodiversity, and land and water contamination. Through surety or performance bonds, a financial institution may guarantee completion of projects (in particular infrastructure) such as roads, dams, and mining operations, which have potentially high environmental and social impacts.

The environmental and social risks to financial institutions that underwrite insurance originate in their potential exposure to claims that are related to environmental and social issues, such as damages resulting from industrial accidents, or health and safety related incidents, or natural disasters. These risks are typically factored into the cost of the insurance policy and financial institutions often work with their clients to minimize them. Financial institutions may also receive public disapproval due to their association with high-risk projects, particularly in case of infrastructure.

Risk in Leasing

In a leasing transaction, the use of a fixed asset or service is provided in return for regular payment by the user (the lessee) under the lease contract.

Fixed assets that can be leased typically include light equipment (such as passenger cars, light duty trucks, office equipment, furniture, and appliances,) or heavy equipment (such as earth movers, large machines, industrial equipment, cargo vessels, heavy duty trucks, and airplanes). In some cases, Leasing Companies can own, maintain and operate the leased physical assets, known as operational leasing. In other cases, Leasing Companies simply provide the necessary financing to lessees, known as financial leasing.

The environmental and social risks associated with leasing activities are generally minimal for most transactions but will be more significant if the fixed asset involves the use of heavy equipment and as a function of the industry sector. Improper operation or maintenance of the equipment may impact community or worker safety and result in potential environmental contamination and pollution.

For financial leasing, Leasing Companies have limited exposure to the lessee’s environmental and social performance and also limited leverage over the lessee’s use of the fixed asset. However, the leasing company may be impacted by legal issues, disruption of lessee operations, and reputational concerns. Through operational leasing, a leasing company is linked to the operation of the leased asset and can be directly responsible for any environmental and social impacts.

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Risk in Microfinance

Microfinance institutions provide financial services, such as loans, to low-income clients, including micro-companies and the self-employed, who traditionally lack access to finance.

These transactions are typically of smaller amounts and shorter tenure than corporate loans and target small business owners or commercial clients whose operations are generally small.

The environmental and social risks associated with microfinance are typically low partly due to the small size of the operation and the industry sector. However, in some cases clients may be involved with handling dangerous substances such as pesticides that can pose health or environmental risks, but frequently they lack the necessary environmental and social management capacity to do so safely.

Although at the individual transaction level the environmental and social risks associated with microfinance are low, given the smaller size and shorter tenure of transactions, there are credit or liability risks for the microfinance institution in cases where environmental and social issues, such as an accident, affect a micro-entrepreneur’s ability to repay a loan. Microfinance institutions often consider the environmental and social impacts associated with their transactions in the context of the developmental role they play in their communities and are therefore concerned with reputational risks. In addition, many see the promotion of good environmental and social practices as part of their role in the community.

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Risk in Project Finance

Project finance transactions typically involve the direct financing of infrastructure and industrial projects.

The financing is usually secured by the project assets such that the financial institution providing the funds will assume control of the project if the sponsor has difficulties complying with the terms of the transaction.

Project finance is generally used for large, complex and sizable operations, such as roads, oil and gas explorations, dams, and power plants. Due to their complexity, size, and location, these projects often have challenging environmental and social issues, which may include involuntary resettlement, loss of biodiversity, impacts on indigenous and/or local communities, and worker safety, pollution, contamination, and others. Because these projects generally face high scrutiny from regulators, civil society, and financiers, the project’s sponsoring companies allocate more resources to managing environmental and social risks.

If not managed properly, the environmental and social risks can result in disrupting or halting project operations and lead to legal complications and reputational impacts that threaten the overall success of the project. Because anticipated project cash flows typically generate the necessary resources to repay the loan, any disruption to the project itself, regardless of the financial standing of the sponsoring companies involved, poses a direct financial risk to the financial institution.

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Risk in Retail

Retail transactions include financial services such as deposits (checking and savings accounts) and credit cards as well as personal loans such as mortgage and vehicle finance.

Environmental and social issues associated with retail transactions that target individuals are generally non-existent, although there may be concerns associated with mortgage finance and potentially certain investment options that may involve controversial or high-risk projects/companies.

There is usually no credit, liability or reputational risks due to environmental and social issues for financial institutions involved in retail banking. However, in some cases, there may be concerns with corporate accounts that are linked to companies or individuals whose activities are viewed as harmful, such as arms manufacturing, money laundering, and terrorism, which may represent a legal and reputational risk to the financial institution.

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Risk in Short-Term Finance

Short-term finance involves providing loans with a term of a few months or less, but no longer than a year.

Short-term finance, such as trade finance, often involves collateral such as accounts payable or inventories. A company will pledge or sell its receivables to the creditor in exchange for immediate cash (also called factoring). While certain corporate loans and types of project finance usually target a specific purpose such as construction or purchase of equipment, short-term loans such as working capital loans, are usually for general purposes and support the general business operations of a company.

The environmental and social issues related to a short-term finance transaction range from minimal to complex and vary according to size,industry sector, location, and company commitment to managing environmental and social risks. Because a working capital loan provides general support to a company as opposed to being targeted for equipment purchase or expansion, the financial institution is exposed to the borrower’s overall risk including potential environmental and social issues.

Reputational risk is the main concern for short-term finance, especially if borrowers have pending environmental and social issues that are highly visible and scrutinized by the public. Due to the short-term nature of the transaction and the use of collateral, the credit risk to a financial institution is limited. However, given that assets are used as collateral there may be liability risks, for example in the case of land contamination. Due to the short tenure of short-term finance, a financial institution will have limited leverage in managing environmental and social risks.

Risk in Small and Medium Enterprises

Although less complex than for large corporate and project investments, the environmental and social issues associated with small and medium enterprises can be significant and are primarily related to worker health and safety and pollution.

Investments in small and medium enterprises focus on a particular set of clients, usually defined by annual sales but also by loan amount. Small and medium enterprises have specific funding needs in terms of their business growth. The monetary cut-off for classifying a company as a small and medium enterprise generally varies greatly by country, by market, and by financial institution.

Although less complex than for large corporate and project investments, the environmental and social issues associated with small and medium enterprises can be quite significant and are primarily related to worker health and safety and pollution. These environmental and social issues may not be closely monitored and the risks will vary depending on company size and its capacity to manage environmental and social risks, as well as by industry sector, and location.

Financial institutions that lend or invest in small and medium enterprises generally try to develop long-term relationships, which may further expose lenders/investors to environmental and social issues associated with the enterprise, posing financial and liability risks. Due to the visibility of small and medium enterprises in a community, reputational risk is also a factor.

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Risk in Trade

Trade financing involves providing financial products to enable importers and exporters to trade across national borders and is generally done through banks, credit agencies, insurers, forfeiters or other institutions.

The environmental and social risks of trade finance are associated with the production of those goods being traded and vary by industry sectorand location. Companies selling to foreign markets are required to comply with local and international social and environmental regulations and in many cases also face public scrutiny. Importing and exporting companies are therefore exposed to some level of reputational risk.

Given the short-term nature of trade finance, a financial institution will have limited leverage to manage environmental and social risks once it has approved a transaction. However, a financial institution can have simple transaction screening procedures to avoid supporting the trade of products and substances that are subject to bans and international phase-outs.

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E&S Risk by Industry Sector

Clients/investees operate in a variety of industry sectors with a range of environmental and social risks. A preliminary risk assessment can be conducted based on the sector of operation.

Industry-specific environmental and social guidelines have been developed to assist both clients/investees and financial institutions to better understand and manage environmental and social risks in their operations.

The IFC/World Bank Environmental, Health, and Safety Guidelines provide guidance to environmental and social management in a wide variety of industry sectors, including:

  • Agribusiness/Food Production
  • Chemicals
  • Forestry
  • General Manufacturing
  • Infrastructure
  • Mining
  • Oil and Gas
  • Power
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