Beyond Risk (2003)

BEYOND RISK ➜ In developed markets, the concept that environmental risk can critically affect the viability of investments is well understood. But in emerging markets, the appearance of a new set of global stakeholders presents both risks and opportunities for financiers.

INTERNATIONAL FINANCE CORPORATION A Member of the World Bank Group

JAPAN/IFC COMPREHENSIVE TECHNICAL ASSISTANCE TRUST FUND

➜

➜

S U S TA I N A B I L I T Y A N D T H E E M E R G I N G M A R K E T S F I N A N C I A L S E C TO R

FOREWORD ➜ With support from the Japan/IFC Comprehensive Technical Assistance Trust Fund, IFC has developed a pioneering program designed to help its financial sector clients in emerging markets integrate environmental management techniques into their operating practice. Drawing on the lessons of experience of these clients, the objective of this casebook is to examine emerging risks for the financial sector, outlining examples of strategic responses that have the potential to transform this risk into opportunity and documenting experience in implementing these initiatives successfully. Letitia F. Lowe

ACKNOWLEDGEMENTS This casebook has been prepared by Leo Johnson, Consultant, on behalf of the Environment and Social Development Department of the International Finance Corporation (IFC). The project was made possible by the generous financial support of the Japan/IFC Comprehensive Technical Assistance Trust Fund. The task manager for the project was Letitia Lowe. Many people within IFC provided valuable guidance, input and support including: Glen Armstrong, Martyn Riddle, Imoni Akpofure, Dan Siddy, Todd Hanson, Clive Mason, Maria Gallegos, Vanessa Manuel, Sevaun Palvetzian, Debra Sequeira, James Beck, Zenaida Chavez, Sarah Ruck, Richard Caines, Bernie Sheahan, Karin Strydom, Batsuren Eenjin and Stuart Turnbull.

Table of Contents 1 INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5 2 THE NEW GEOGRAPHY OF RISK . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 3 THE EMERGING MARKET RESPONSE . . . . . . . . . . . . . . . . . . . . . . . .25 4 LESSONS FROM THE FIELD: SUSTAINABILITY IN ACTION . . . . . . . . .45 5 CONCLUSIONS AND RECOMMENDATIONS . . . . . . . . . . . . . . . . . . .57

Thanks also go to: Andre Abadie, Charity Agorsor, Vera Assad, Trevor Bowden, Ferdinando Buffoni, Cesare Calari, Michael Campbell, James Casey, Paul Clements-Hunt, Josefina Doumbia, Roberto Esmeraldi, Warren Evans, John Ganzi, Maureen Gilbert, Iris Gold, Caroline Goldie, Bregje Hamelynck, Harvey Himberg, Hilary Hoagland-Grey, Mark Hughes, Madeleine Jacobs, Kaj Jensen, Stanley Johnson, Mark King, Rachel Kyte, Julian Lampietti, Dana Lane, Arthur Levi, Tina Mack, Jacob Malthouse, Arvind Mathur, Shawn Miller, Mario Monzoni, Herman Mulder, Taies Nezam, Joe O’Keefe, Michael O’Neill, Niamh O’Sullivan, Harry Pastuzek, Vipul Prakash, Bruce Purdue, Gladis Ribeiro, Helen Sahi, Robin Sandenburgh, Alke Schmidt, Corrie Shanahan, Mangala Suresh, Felice Tambussi, A.J. Teixeira, Yogesh Vyas, Udayan Wagle, Flavio Weizenmann, Christina Wood, Prakash Yardi, Caroline Zuniga. Special thanks go to: Vijay Joshi and the management of IL&FS, Roberto Dumas Damas, and Maria Estela Ferraz de Campos of BBA, Ziad Oueslati of Tuninvest, Gaspar Millhaiffy, Laszlo Szabo and Attila Bogdan of Raiffeisen Bank and all of the participants in the CEA workshops.

ANNEXES A) LIST OF BOXES, FIGURES AND TABLES

. . . . . . . . . . . . . . . . . . . . .65

B) SURVEY, METHODOLOGY, QUESTIONNAIRE PRO-FORMA, UPTAKE OF ENVIRONMENT INITIATIVES . . . . . . . . . C) LIST OF SITE VISITS

. . . . . . . . . . .69

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79

D) CEA WORKSHOPS AND PARTICIPANTS

. . . . . . . . . . . . . . . . . . . .83

E) REFERENCES, LINKS AND FURTHER INFORMATION SOURCES

. . . . . . . .93

4

1. INTRODUCTION

ACRONYMS ISO

International Organization for Standardization

AFDB African Development Bank

MOF

Ministry of Finance

CEA

Competitive Environmental Advantage

NGO

Non-Governmental Organization

CDC

Commonwealth Development Corporation

NPL

Non-Performing Loan

ADB

Asian Development Bank

EBRD European Bank for Reconstruction and Development

OECD Organization of Economic Cooperation and Development

EIB

European Investment Bank

SME

Small and Medium-sized Enterprise

EMAS Eco-Management and Audit Scheme

SRI

Socially Responsible Investment

EMS

UNEP United Nations Environment Program

Environmental Management System

ESMG Environment and Social Management Group

USAID United States Agency for International Development

EU

European Union

WB

World Bank

FI

Financial Intermediary

WBG

World Bank Group

IFC

International Finance Corporation

WCED World Commission on Environment and Development

IFI

International Financial Institution

WTO

IPO

Initial Public Offering

WWF World Wide Fund for Nature

World Trade Organization

“A successful bank can no longer just look at the commercial performance of a customer. It has to consider its broader performance in environmental and social issues.” Roberto Dumas Damas Banco BBA Creditanstalt, Brazil

➜

Introduction 7

➜ Since mid-1997, as part of a two-phased program funded by the Japan/IFC Comprehensive Technical Assistance Trust Fund, IFC has collaborated with

Under the second phase of the program IFC set out to complete three tasks: ■

regional, multilateral and bilateral development

➜

banks in running the Competitive Environmental

■

Advantage (CEA) workshop program. The workshops,

■

part of a program designed to build environmental SINCE 1997, OVER 375 MANAGERS FROM 275 FINANCIAL INSTITUTIONS AND 45 NATIONS HAVE PARTICIPATED IN THE COMPETITIVE ENVIRONMENTAL ADVANTAGE WORKSHOP SERIES

appraisal capacity in private financial institutions from developing and transitional economies, aim to equip participants to complete three tasks: 1. Assess the strategic rationale for environmental management for their financial institutions 2. Perform cost-effective environmental risk management of investments 3. Implement value-adding environmental techniques institution-wide Since 1997, over 375 managers from 275 financial institutions and 45 nations have participated in the workshops, with institution types including commercial banking, project finance, leasing and private equity. Annex D provides details of the workshops held to date, together with a list of the participant institutions & partner development banks.

a website on environmental management for the financial sector development of a Trainer’s Manual publication of a casebook on environmental management in the emerging markets financial sector.

OBJECTIVES This casebook, the first of its kind to focus exclusively on the emerging markets financial sector, aims to capture the lessons of experience of IFC’s participating institutions: Chapter 1 provides background and summarizes objectives. Chapter 2 summarizes major sustainability-related business drivers for the financial sector. Chapter 3 provides illustrative examples of leading financial institutions that have responded strategically to these business drivers, including examples from commercial banking, leasing, private equity and project financing institutions. Chapter 4 examines good practice in implementing a cost-effective management system to respond to these risks and opportunities. Chapter 5 presents summary conclusions and a series of recommendations.

8 Beyond Risk

METHODOLOGY For this casebook IFC used a three-part approach designed to capture the experiences and expertise of the workshop participants: ■

■

■

IFC conducted a series of in-depth interviews with senior management participants of the CEA workshops. IFC conducted a detailed questionnaire survey of a representative sample of 60 institutions from different regions. In addition, IFC reviewed current best practice among institutions in the international financial sector.

Annex B presents a more detailed review of the methodology.

2. THE NEW GEOGRAPHY OF RISK What is the relevance of sustainability to the emerging markets financial sector?

➜

Beyond Risk

The New Geography of Risk 11

FIGURE 2.1 COMPETITIVE THREATS TO THE FINANCIAL SECTO R

➜ WHAT IS THE RELEVANCE ECONOMIC INTEGRATION TECHNOLOGICAL CHANGE ■ ■

➜

■

THE SIGNIFICANCE OF ENVIRONMENTAL AND SOCIAL ISSUES FOR FINANCIAL INSTITUTIONS HAS, IN GENERAL, BEEN CONSIDERED LIMITED

■

Internet Electronic Banking ATM Virtual Banks

■ ■ ■ ■ ■

GATT/NAFTA/WTO Reduced Tariffs Currencies linked Global Capital flows Diversification

DECLINE OF COMMUNISM MATURATION OF DEVELOPED COUNTRY MARKETS ■ ■ ■

■ ■ ■

Privatization Corporate Growth Global Private Capital Flows

Slower Growth Aggressive Exporters Deregulation

What is the relevance of environmental and social factors to the performance of a financial institution?

➜

➜

➜

➜

FINANCIAL SECTOR COMPETITIVE THREAT Source: Furrer, “Increasing a Company’s Value Through Environmental Management

B OX 2 . 1 SUMMARY OF FORMS OF DIRECT LIABILITY FOR FINANCIAL INSTITUTIONS

■

■

■

■

OF ENVIRONMENT TO BANKS? The emerging markets financial sector faces a growing number of competitive pressures; from economic integration to the rise of technology-enabled banks and non-bank competition (See Figure 2.1, left).

Liability for the clean up of any contaminated collateral (for example, asbestos, heavy metals, polychlorinated bi-phenols). Liability for misrepresentation of environmental risks (e.g. to co-financiers). Liability for negligence in any failure to assess actual and potential environmental risks. Direct liability if the financial institution is a principal, general partner or owner.

The significance of environmental and social issues for financial institutions has, in general, been considered limited. In a number of developed countries, where banks have been held directly liable for the clean up of contaminated collateral, environmental due diligence has begun to form a routine part of the due diligence process. Direct Legal Liabilities Between 1986 and 1996, a number of court rulings and well-publicized cases on environmental damage widened the focus of lenders: not only towards concern for pre-existing conditions on properties on which they foreclosed, but also onto their capacity to exercise influence on the daily operations of the company concerned. Box 2.1, left, summarizes a range of direct liabilities for financial institutions.

FIGURE 2.4

SIGNIFIC ANT SOURCES OF ENVIRONMENTAL RISKS for clients identified by all financing institutions

INFRASTRUCTURE

The most significant long-term sources of environmental social risks as identified by infrastructure institutions Government (e.g. shutdown, fines) Export market regulators

Community

38%

Financiers

36%

Customers

40%

70%

FIGURE 2.5

EXPORT-ORIENTED INDUSTRIES

DOMESTIC GENERAL MANUFACTURING

75%

80%

Other

Employees

Insurers

Financiers

68%

70% 50%

50%

60% 46%

46%

59%

50% 29%

41%

40% 25%

32%

32%

30% 13%

20%

35%

17%

16%

20% 4%

10%

24%

4%

0%

11%

10%

8%

5%

Other

60%

International NGOs

Insurers

Supply & distr. chain

Customers

Financiers

Community

Media

Export market

Other

Employees

International NGOs

Customers

Financiers

Community

Media

Export market regulators

Government

0% Government

70%

67%

Employees

80%

Primary sources of risk were found to vary according to the type of financial institution surveyed. Figures 2.3–2.7, pgs. 12–14, present the results for institutions that are financing sectors which subdivided into the following categories: a) export-oriented industries, b) infrastructure, c) domestic general manufacturing, d) hightech industries and e) extractive industries. Summary of findings: A Range of Risk Drivers Overall, the enforcement of national and export market regulations was the most frequently identified source of environmental and social risk for client organizations. Risk drivers were found to vary significantly according to the client base. For those institutions financing exportoriented industries the key risk driver to clients was identified as the loss of markets. Other major risks identified included the following: shutdown/fines, reputational risk, protests over critical resources and, loss of financing.

The most significant long-term sources of environmental social risks as identified by domestic general manufacturers

30% As an example, in the past 5 years, the imposition of environmental standards requirements has been widely perceived as the major driver in a number of Asian export-dependent markets, particularly consumer electronic related. This appears to have been one of the main reasons for the rapid uptake of industry environmental management systems certified to the internationally recognized ISO14001 standard.

60%

FIGURE 2.3

40%

1

50%

International NGOs

30%

Supply & distr. chain partners

20%

Customers

0%

5%

0% Community

8% 10%

11%

10%

10%

Other

16%

16%

20%

Media

12%

32%

30%

Export market regulators

International NGOs

58% 37%

Government

12%

53%

40%

20%

Insurers

63% 53%

50%

28%

Supply and distribution chain partners

68%

60%

40%

Employees

The survey showed that all the respondents in the four groups identified the existence of significant risk drivers for their emerging market clients. While government is identified still as the key risk driver, new stakeholders have emerged. In particular, 58% of respondents cited the influence of export market regulators as a key risk driver for their customer base1.

70%

56%

Media (reputational risk, negative publicity)

Survey Results: New Stakeholders Figure 2.2, right, summarizes the most significant sources of environmental risk that institutions identified for their clients

80%

60%

Insurers

The Emergence of Indirect Liabilities Are these legal liabilities also the prime risk drivers for emerging markets? To address the topic, IFC’s survey requested 60 emerging market institutions to identity what they considered to be the most significant sources of environmental risk, both for their clients and for their own institutions directly. The results suggest evidence of a significantly different risk profile for emerging markets.

The New Geography of Risk 13

FIGURE 2.2

Supply & distr. chain partners

12 Beyond Risk

Risk of shutdown/fines was also identified as a key risk for infrastructure clients and domestic general manufacturing along with reputational risk, protests over critical resources and loss of market.

14 Beyond Risk

For general manufacturing, the primary risk driver was identified as export market regulation. After government and export market regulators: the risk of community action, the potential for adverse publicity in the media and possible action from financiers ranged among the top five overall risk drivers.

FIGURE 2.6

FIGURE 2.8

HIGH-TECH INDUSTRIES

PRESENTS CONNECTIVITY IN 1991

The most significant long-term sources of environmental social risks as identified by high-tech industries

IBRD 32423

78%

80% 70%

The New Geography of Risk 15

67%

The two Figures 2.8 and 2.9, left, show changes in international connectivity between 1991–1997

56%

60% 50%

33%

33%

40%

33% 22%

30%

INTERNATIONAL CONNECTIVITY

Connectivity New technology has enabled the rapid international flow of communications, and in the process has begun to empower previously disenfranchised individuals and their spokespersons. In particular three changes have occurred:

Version 2 - 9/91

20%

Internet

11% 0%

0%

Other

Employees

International NGOs

Insurers

Supply & distr. chain

Customers

Financiers

Community

Media

Export market

Government

0%

Bitnet but not Internet EMail Only (UUCP, Fido Net) No Connectivity No Data Source: Larry Landweber and the Internet Society.

■

FIGURE 2.7

FIGURE 2.9 FIGURE 2.9

EXTRACTIVE INDUSTRIES

PRESENTS PRESENTS CONNECTIVITY IN 1997

The most significant long-term sources of environmental social risks as identified by extractive industries

IBRD 32424

70% 60%

50%

50% 40% 30%

■

■

Stakeholders can readily acquire information about the impact on environmental resources. Stakeholders have a low-risk means of preparing a coordinated international response to these impacts. Finally, they have a cost-effective means to implement these campaigns.

75%

80%

25%

25%

25%

25%

25%

INTERNATIONAL CONNECTIVITY Version 2 - 9/91

20%

Internet

10%

0%

0%

0%

0% Other

Employees

International NGOs

Insurers

Supply & distr. chain partners

Customers

Financiers

Community

Media

0% Export market regulators

BEYOND COMPLIANCE A more complex reality appears to be emerging. A decade ago, information was accessible by only parts of the international community. Distance separated a company with a poor environmental track record, or a proposed project with potentially significant environmental impacts, from key national and international stakeholders. But changes in information

10%

Government

THE CHANGING GEOGRAPHY OF RISK Several conclusions can be drawn from these results. Conventional wisdom suggests that environmental risk derives from the enforcement of national legislation with resultant civil and criminal penalties. Government, therefore, is held to be the key risk driver and where local or national government does not have the resources to enforce environmental regulation, there is thought to be no risk.

11%

technology, including the growth in internet and fixed and cell phone usage appear to have lessened that distance.

Bitnet but not Internet EMail Only (UUCP, Fido Net) No Connectivity No Data Source: Larry Landweber and the Internet Society.

Driven by this reduction of distance, a trend is emerging. A networked economy is developing in which governmental and non-government regulators can pose risks to a company’s operations at a number of stages in the business cycle, translating value reduction at the individual level into value reduction at the level of the firm.

16 Beyond Risk

The New Geography of Risk 17

FIGURE 2.10

FIGURE 2.11

DRIVERS OF ENVIRONMENTAL RISK ACROSS THE CORPORATE VALUE CHAIN

ENVIRONMENTAL RISKS FOR FINANCIAL INSTITUTIONS

These risks are presented in Figure 2.10, right. In this networked economy, corporate performance depends not solely on regulatory compliance, but on the ability to understand and satisfy the expectations of a wide range of stakeholder interest groups. RISKS FOR THE EMERGING MARKETS fiNANCIAL SECTOR Having explored the changing demands on companies, drivers for these changes and the potential for company operations to be affected by the scrutiny from stakeholders, the survey asked participants to identify major sources of environmental risk for their financial institution. Figure 2.11, pg. 17, presents an overview of the responses.

CONCLUSIONS: EMERGING MARKETS ENVIRONMENTAL RISK CONSUMER BOYCOTT ■

SALES AND DISTRIBUTION

■ ■

Devalued collateral

46%

Reputational risk/Negative publicity

46%

Loss of IFI funding

42% 35%

Liability for cleanup of contaminated collateral LABOR RECRUITMENT, RETENTION ■ ■

MANUFACTURING

■ ■ ■ ■

Productivity Strikes or sabotage Shut-down Fines, penalties Compensation for health Operating liabilities

AVAILABILITY OF WATER SUPPLY MATERIALS ACQUISITION

■ ■

Raw materials access Raw materials price Permit rejection

PERMITTING DELAY OR REJECTION ■ ■

START- UP

■ ■ ■ ■ ■

Insurance access or cost Construction delay Contract lost Labor supply Contract terms Infrastructure obligation Cost of capital, access

The survey results suggest that the same change in the geography of risk that has affected their industrial client base is also beginning to affect the financial sector. Stakeholders that have the potential to affect the performance of financial institutions are beginning to emerge, adding environmental risk to the range of identified business risks, from interest rate risk, currency risk, and legal risk to operational risk.

58%

Reduced access to private/international capital

■

Overall, the prime risk was identified as non-performing assets. A number of other issues were also identified as significant, again varying by institutional type. Key risks identified include the following: devalued collateral, reputational risk and loss of international financial institution funding.

Entry of substitute product Product liabilities Product replacement

Non-performing loans/leases/investments

23%

Civil or criminal liability for negligence

13%

Increased central bank/MOF regulation

10%

Loss of depositors

4%

Other 0%

6% 10%

20%

30%

40%

50%

60%

70%

Traditionally, where the primary environmental risk drivers for financial institutions have been restricted to the threat of direct legal risks, these new stakeholders, active in developed and emerging markets alike, are posing a wider range of indirect risks. If a bank borrower violates labor laws, that borrower can be penalized in ways that cause it to close down its operations. The borrower then goes into default and the bank is left with a nonperforming loan. If an industry faces a sector-wide boycott or regulation, multiple companies in that industry can default on their loans, creating large losses for individual banks and the banking system. Allegations of poor corporate governance can undermine the reputational assets of the institution.

18 Beyond Risk

Indirect environmental and social risks, then, can affect a financial institution’s performance at three levels: at the level of the single non-performing loan, at the level of multiple non-performing loans, and at the level of operating license, driven by reputational risk. LEVEL 1: SINGLE NON-PERFORMING LOAN (NPL) At the level of the single non-performing loan, the operations of these diverse stakeholders have the potential to cause loan defaults across the manufacturing cycle of portfolio companies. Clearly, these impacts on portfolio companies may pose a risk of increased costs for a financial institution. However, the probability of these risks occurring during the lifetime of a short-term loan is relatively small. In addition a number of factors may lower the risk of default: The company may have insurance. ■ Debt service coverage ratios may be unaffected and payments may proceed on time. ■ The financial institution may have collateral that is unaffected by environmental stigma. More significant for the financial institution though is the potential for multiple non-performing loans.

The New Geography of Risk 19

B OX 2 . 2

FIGURE 2.12

FINANCIAL COSTS OF ENVIRONMENTAL NON-PERFORMANCE

RISK TO THE EMERGING MARKETS FINANCIAL SECTO R

LEVEL 2: MULTIPLE NON-PERFORMING LOANS ■

Decreased quality of assets

■

Increased need for provisioning

■

Reduced capital adequacy

■

Increased cost of funds

■

Reduced liquidity

■

Reduced profitability

■

Reduced rating

New stakeholders have the potential to cause not just single NPLs but multiple NPLs within a bank’s portfolio. A growing trend is for an industry sector to become the target of a coordinated campaign involving NGOs, consumers and the media. When these stakeholders act, they can affect numerous companies within the sector at once. These campaigns have the potential to result in a pattern of defaults, horizontally across the portfolio. Key drivers of multiple NPL include the following:

LEVEL 1: Single non-performing loan

LEVEL 2: Multiple non-performing loan

LEVEL 3: Reputational risk

■

Government regulators may respond by invoking a change to regulations that can lead to a virtual closure of the sector, or the alternative of incurring prohibitive switching costs

■

Export market regulators may impose restrictions. NGOs may lead national or international product boycotts. Consumers may lead product or corporate boycotts, or enter into sectorfocused class action lawsuits. In addition, NGOs, local communities and employees may adopt a project by project strategy that has the same effect of reducing the operating viability of multiple projects within a sector

FIGURE 2.13 THE RISK MANAGEMENT GAP

Unmanaged Risk

■

■ Low

Reputational Risk ■ Multiple Regional NPL

Current Risk Assessment Capacity

Multiple Sector NPL ■ Single NPL

COVERED

High Low

High Potential Losses

FIGURE 2.14

PERFORMANCE SIGNALS

SUSTAINABILITY OPPORTUNITIES

Reputational risk as a whole was ranked the third most important risk after non-

Resource-based conflict can cause multiple defaults within multiple sectors, impacting wholesale, retail and individual accounts.

Accessing international funding HIGH QUALITY BRAND SIGNAL

LEVEL 3: REPUTATIONAL RISK For deposit-taking financial institutions, reputation and brand image are of critical importance. In particular, a deposit-taking commercial bank’s operations are built on a borrow-short, lend-long strategy that depends on three elements:

■

■ ■ ■ ■ ■ ■

Depositor belief that the bank has a critical mass of deposits to smooth over potential asset-liability mismatches Mass trust among consumer base Mass branding as trustable

26%

Providing risk-management services to high-risk industries

21%

Attracting improved terms of insurance

15%

Attracting new depositors

9%

Other 0%

9% 10% 20%

B OX 2 . 4

FIGURE 2.15

OPPORTUNITIES FOR FINANCIAL INSTITUTIONS

OPPORTUNITIES FOR COMMERCIAL B ANKS

30%

40%

50%

60%

70%

80%

Significantly, the survey showed that reputational risk did not just affect institutions with major depositor bases. Additional reputation-driven costs that were highlighted included: the potential loss of depositors, reduced access to capital from private financial institutions and international bond market, increased central bank/finance ministry regulation, and loss of IFI funding (see Figure 2.11, pg. 17). The financial costs of these campaigns are hard to quantify, but the combination of these multiple NPLs may begin to affect the financial performance of a bank directly. Key financial impacts (see Box 2.2, pg. 18)

80%

■

■

■

■

■

■

Accessing international funding: Securing longer term capital available from IFIs with environmental and social performance criteria Providing loans for environmental projects: Gaining market share in the growing environmental products and services sector Providing eco-efficiency and cleaner production advisory services: Gaining market share in the mid and small cap client base, offering advisory services that boost client business including energy efficiency audits, cleaner production assistance, and exporter market opportunity identification Accessing SRI/Ethical investment funds: Gaining access to the long term institutional investors and SRI investors with positive and negative environmental and social screens Providing risk management services to high risk industries: Gaining market share in environmentally and socially complex sectors by providing high value consulting services that enable clients to manage complex social and environmental issues such as resettlement, supply chain management, and community relations Attracting improved terms of insurance: Using reduced social and environmental risk as a means of attracting lower insurance premiums at the portfolio and project level Attracting depositors: Positioning the bank as a dependable institution, with ethically sound corporate governance in its dealings with depositors and other stakeholders

70% 60%

50%

50% 40% 30%

19%

20%

13%

13%

13%

13% 6%

10% 0%

Other

■

69%

Attracting new depositors

The cost of environmental and social campaigns waged against the financial sector are heaviest when they erode the trustworthiness branding that underpins the depositary base. Adverse campaigns can transform the organization’s brand assets into liabilities, turning big into brutal, dominant into dominating, profitable into predatory. An additional impact of these campaigns is the signaling of inadequate management systems and capacity.

Perception Manipulation of market perception Lack of management capacity Lack of resources Short cut/quick-fix Untrustworthy

Accessing ethical investment funds

Attracting improved terms of insurance

Core to the operation of a bank then is the establishment and maintenance of trust.

LOW QUALITY BRAND SIGNAL

26%

Providing risk-management services to high-risk industries

■

■

Providing eco-efficiency and cleaner production advisory services to small and mid-sized clients

Accessing ethical investment funds

■

■

System indicator Quality metrics and management Positioning for long-term Trustworthy

47%

Providing eco-efficiency and cleaner production advisory services to SME

■

■

performing loans/investments and devalued collateral.

70%

Providing loans for environmental projects

Providing loans for environmental projects

■

The New Geography of Risk 21

B OX 2 . 3

Accessing international funding

20 Beyond Risk

In summary, an emerging trend is for the rapid transmission of risk: from the risk of adverse environmental impacts caused by a company’s operations, through risk to the company, through to risk for the financial institution backing the venture. These direct, portfolio and reputational risks combined have the potential to

FIGURE 2.18

OPPORTUNITIES FOR LEASING INSTITUTIONS

OPPORTUNITIES FOR PRIVATE EQUITY INSTITUTIONS

produce a range of costs for the institution–from direct liability to single NPLs to multiple NPLs and reputational risk (see Figure 2.13, pg. 19).

■ 80% 80%

56%

50%

44%

60% 40% 33%

13% 6%

FIGURE 2.17

FIGURE 2.19

OPPORTUNITIES FOR PROJECT FINANCE INSTITUTIONS

SOCIALLY RESPONSIBLE INVESTMENT—GROWTH MARKET

Other

Attracting new depositors

0% Accessing international funding

Other

Attracting new depositors

Attracting improved terms of insurance

Providing risk-management services to high-risk industries

0%

Accessing ethical investment funds

0%

Providing eco-efficiency and cleaner production advisory services to SME

10%

10% Providing loans for environmental projects

25%

20%

13%

Accessing international funding

25%

Attracting improved terms of insurance

30% 20%

25%

30%

27%

Providing risk-management services to high-risk industries

27%

Accessing ethical investment funds

33% 27%

Providing eco-efficiency and cleaner production advisory services to SME

40%

40%

Providing loans for environmental projects

50%

CURRENT TRENDS Is this risk likely to grow? A number of emerging trends for the financial sector suggest that the relevance of sustainability issues will continue to increase:

■

■

80% 70%

64%

64%

60%

Worth over US$2 trillion in US and US$25 billion in UK

50%

50%

36%

Numerous environmental, social and ethical ranking, rating and screening methodologies

36%

40% 30%

21%

20%

21%

SOCIALLY RESPONSIBLE INVESTMENT (SRI) Other

Attracting improved terms of insurance

Providing risk-management services to high-risk industries

Accessing ethical investment funds

Providing eco-efficiency and cleaner production advisory services to SME

0%

Attracting new depositors

7%

10% Providing loans for environmental projects

The growth of socially responsible investment (SRI): A growing number of investors are now conducting negative or positive screens to ensure the social responsibility of their investments. Assets in socially screened investment portfolios rose by more than one-third from 1999 to 2001 to top the $2 trillion mark for the first time ever. This represents just over 10% of the $19.9 trillion in professionally managed investment assets in the U.S. SRI analysis now evaluates financial institutions on their environmental and social performance, potentially impacting on the access to capital for these institutions as well as their portfolio companies (see Figure 2.19, pg. 23).

60%

70%

Significantly, from the credit risk perspective, as these losses escalate conventional risk assessment and management techniques provide less guidance.

■

The New Geography of Risk 23

FIGURE 2.16

Accessing international funding

22 Beyond Risk

One of the fastest growing areas of equity investment

Growing importance in Europe

The emergence of the sustainability analyst industry: A growing number of institutions now offer an analysis of corporate and financial sector practice in terms of sustainability. In 2002, Friends, Ivory & Sime released a benchmark report evaluating the sustainability performance of leading international banks. Additional leaders in the field include Innovest, and Bank Sarasin. Sustainable indices: Both the Dow Jones Group (Dow Jones Sustainability Index) and the Financial Times (FTSE4Good index) have introduced sustainable indices to enable SRI investors to invest in corporations having a superior performance on environmental and social issues. Financial sector standards and codes of conduct: In parallel with the development of more robust methodologies to evaluate corporate performance, a number of codes of conduct for banks are emerging that set out good practice on sustainability. While there is still no widely acknowledged template, current codes include ISO 14000, FORGE and the UNEP Statement on Banking and the Environment.

24 Beyond Risk

■

■

NGO and media campaigns: A number of NGOs are now directing coordinated campaigns towards the financial sector. Key drivers of recent campaigns include Friends of the Earth, the National Wildlife Federation, and Milieu Defensie. International Financing Institution (IFI) conditions: Finally there is increasing demand from IFIs for the financial institutions they invest in to implement management systems that ensure the environmental performance of their portfolio. The procedures of these IFIs prohibit investment in institutions without adequate environmental management systems. IFIs actively addressing this through training and capacity building include IFC, IIC, Proparco, Coface, EBRD, DEG, FMO, ADB, AfDB and CDC.

At the same time, a number of leading financial institutions are beginning to translate these risks into opportunity, by transforming these stakeholders from drivers of risk to drivers of reward. In the survey, the financial institutions were asked to identify what they consider to be the major environment-related opportunities for their business. Key opportunities identified are highlighted below.

Figure 2.14, pg. 21, summarizes the results

for all respondents. Overall, the results indicate that access to international funding, providing loans for environmental projects, providing advisory services to SMEs and accessing ethical investment funds are considered the main opportunities. These opportunities varied significantly by institution type. Figures 2.15–2.18, pgs. 21–23, present the results from commercial banks, leasing, project finance, and private equity institutions. Key conclusions include the following: ■

■

■

Overall, the main opportunity identified by all institutions was access to IFI funding. Providing loans for environmental projects was seen as a key opportunity for project finance institutions and commercial banks. For project finance institutions, providing risk management services to high-risk industries also featured highly along with provision of eco-efficiency and cleaner production services. For private equity, accessing ethical investment was rated highly.

3. THE EMERGING MARKET RESPONSE In practice, how have leading financial institutions started to capitalize on these opportunities?

➜

The Emerging Market Response 27

FIGURE 3.1 PROCEDURE FOR ENVIRONMENT RISK MANAGEMENT

➜ PERFORMANCE BASELINE

Before the IFC workshop, did your institution have a procedure for environmental risk management?

To measure participants progress in implementing environmental change, IFC’s survey sought first of all to create a baseline of environmental management before the workshops.

Yes, a formal procedure 22%

Yes, an informal procedure 43%

➜

Institutions were asked whether, prior to the CEA workshop, they had a formal management system in place to address the issue of environmental risk when considering investments/lending. Figure 3.1, left, summarizes the results.

MOVING BEYOND COMPLIANCE 35%

No

FIGURE 3.2 ENHANCEMENTS UNDERTAKEN TO ENVIRONMENTAL AND SOCIAL ISSUES following the CEA workshop

36%

Training of internal staff Update operating policy Development of environmental/social procedures Rejecting projects with environmental issues Working with clients

35% 33% 32% 30%

Report to Director on opportunities

29%

Overall, 22% of institutions surveyed reported that they had a formal procedure for environmental management before IFC’s workshop, with results varying slightly between commercial banks, private equity groups, leasing companies and project finance institutions. POST-WORKSHOP: RESULTS IFC’s survey also asked institutions to identify enhancements they had made to their environmental and social management capability after the workshop. Figure 3.2, left, presents the overall findings of the survey.

21%

Communications to clients External reporting of EMS

100% of respondents reported that they had implemented measures to enhance their environmental and social management capability after the workshop.

12%

Providing environmental loans

11%

Hiring of internal environmental consultants/staff

5%

Media events

5% 5%

Other 0

5

10

15

20

25

30

35

40

28 Beyond Risk

Despite the possibility of selection and reporting bias, the results show significant uptake at the institutional level. The critical question, however, is the business value of the initiatives implemented. To explore the link between sustainability initiatives and business value, IFC carried out four more detailed case studies, aiming for representation across financial institution types and geographical region. Table 3.1, right, presents the four case studies by institution type and location. These case studies address the following questions: ■ ■

■ ■

What is the institutional background? What initiatives did the institution implement? What are the business benefits? What are the lessons learned?

TABLE 3.1

C ASE 1: PROJECT FINANCE

C ASE EXAMPLES FOR PROJECT FINANCE, COMMERCIAL B ANKING, PRIVATE EQUITY AND LEASING

C ASE EXAMPLE: INFRASTRUCTURE LEASING AND FINANCIAL SERVICES LIMITED (IL&FS)

TYPE OF FINANCING INSTITUTION

ORGANIZATION

COUNTRY

Project Finance

Infrastructure Leasing and Financial Services Ltd (IL&FS)

India

Commercial Banking

Banco BBA Creditanstalt

Brazil

Private Equity

Tuninvest

Tunisia

Leasing

Raiffeisen Bank

Hungary

“ The key issue now is moving beyond compliance towards the management of real social and environmental risks” Background Infrastructure Leasing and Financial Services Limited (IL&FS) was incorporated in India in 1987 and is one of the country’s top five non-banking financial companies. Initial shareholders were the Central Bank of India, Unit Trust of India, and Housing Development Finance Corporation Ltd. IL&FS has offices in Bombay, Bangalore, Delhi and Calcutta, where the organization provides asset management and retail operations services in the areas of commercialization of infrastructure projects and financial services. Key risk drivers for IL&FS clients Operating in the environmentally and socially complex Indian market, IL&FS identifies a number of potential sustainability driven risks for its client base. Key risk drivers for clients include the following: ■ Export market regulators: Loss of markets, particularly the US and EU, for example, an industrial water supply project supplying export industries. Should these industries lose export market potential, this in turn would have a negative impact on the water supply project ■ Media: reputational risk ■ International NGOs: issue-based campaigns ■ Customers: loss of market share ■ Government: shutdown, fines ■ Community: protest over impacts on critical resources Key risk drivers for IL&FS At the same time, infrastructure finance institutions in India face a number of sustainability-related risks: ■ ■ ■ ■ ■ ■ ■ ■ ■ ■

Non-performing loans/investments/leases from environmental/social risks Liability for clean up of contaminated property/collateral Civil or criminal liability for negligence Reduced access to capital from private financial institutions/international bond market Increased central bank/MOF regulation Loss of IFI funding Devalued collateral Reputational risk/Negative publicity Loss of reputation with the concessionaires (state and central governments) Reduced ability to raise money in the international markets

Implementation In response to these emerging risks and opportunities for the institution and its clients, IL&FS sought to attain world-class expertise in environmental management.

Continued on page 30

The Emerging Market Response 29

CASE 1 PROJECT fiNANCE: LESSONS LEARNED The IL&FS case reveals a number of lessons for project finance institutions: ■

■

■

■

■

For project finance clients, there is a critical need for assistance in managing these issues. The local consultant market does not fulfill this need. Banks can use their cross-sectoral risk management expertise to help clients address these needs. Financial institutions, and their clients, can have a range of national and international stakeholders. These various stakeholders can have different and sometimes conflicting performance standards that require extensive negotiation to resolve. The presence of a full time manager can have a major impact on institutional uptake.

30 Beyond Risk

■

■

■

Consulting services represent a costeffective way of establishing ability to handle complex projects. The presence of a full time manager can have a major positive impact on institutional uptake. For project finance institutions, this can be a significant selling point, enabling the institution to win mandates for more complex transactions.

The environmental management capacity that IL&FS has acquired has the potential to generate significant business benefits for the institution (see Box 3.1, pg. 31)

The Emerging Market Response 31

CASE 1 Continued

Environmental risk management services From 1988 to 1994, environment and social issues were the responsibility of a part-time finance/project executive, helped by external consultants. In 1994 IFC provided introductory environmental risk management training in Bombay, followed by a workshop on environmental risk management in 1997. During 1995, IL&FS drew on a WBG line of credit to fund private sector infrastructure projects.As part of the WBG requirements an environment and social report (ESR) was developed and then adopted.The ESR defined the environment and social policy framework for project development and implementation. In early 1996, an in-house environment and social management group (ESMG) was constituted to implement ESR requirements for all projects and investments. After operating successfully for 6 years as a dedicated group responsible for ESR and WBG requirements, in 2001, IL&FS floated a fully-owned company—Ecosmart India Ltd (Ecosmart). The expertise built-up by the ESMG is domiciled in the new company.Apart from providing environmental and social management services to IL&FS investments, Ecosmart provides strategic services to various external businesses including infrastructure projects. IL&FS has also undertaken a range of additional initiatives as part of its environmental management activities. Additional IL&FS Initiatives following the ESR ■ Communications to clients and media events ■ Rejecting projects with adverse environmental issues ■ Working with clients to manage environmental impacts ■ Hiring of internal environmental consultant/staff ■ Development of environmental and social procedures ■ External reporting of EMS ■ Experience sharing with other financial institutions

Results for ILFS Sustainability also provides a number of potential opportunities: ■ ■ ■ ■ ■ ■ ■ ■

Accessing IFI funding Providing loans for environmental projects Providing risk management services through Ecosmart to high-risk industrial sectors, Cross-promoting IL&FS financing for Ecosmart clients Providing eco-efficiency and cleaner production advisory services to small and mid-sized clients Attracting improved terms of insurance Accessing ethical investment funds Identifying funding/financing opportunities in environmental improvement projects

B OX 3 . 1 PROJECT FINANCE OPPORTUNITIES

Barriers for IL&FS IL&FS faced two key challenges in implementing its management system. Initially the lack of consulting expertise proved a major obstacle, but Ecosmart capitalized on this lack of skills and then entered the wider market. Furthermore, the varying policies and standards of different national and international stakeholders when handling the complex environmental and social issues of India, presented an additional hurdle. IL&FS stresses that case studies are needed to highlight the typical differences in IFC/WB policies compared with those of some developing countries, and to provide guidance on how to handle this conflict. On the issue of barriers to implementation, IL&FS’s Vijay Joshi comments,“I strongly feel that we have overcome all the above barriers over the past 6 years. But the major constraint is that recognition of value of environmental and social risk mitigation by implementing an EMS is not, by-and-large, recognized by various stakeholders, including government agencies.”

SUSTAINABILITY DRIVEN OPPORTUNITIES ■

Win new project finance business

■

Lead and manage new complex transactions

■

Gain access to high asset quality clients

■

Develop fee-generating advisory services

■

Successfully complete complex deals as a result of social and environmental due diligence

32 Beyond Risk

The Emerging Market Response 33

C ASE 2: COMMERCIAL INVESTMENT B ANKING C ASE EXAMPLE: B ANCO BB A CREDITANSTA LT (BB A) BRAZIL

CASE 2 COMMERCIAL INVESTMENT BANKING: LESSONS LEARNED The BBA case reveals a number of lessons: ■

IFIs provide a strong incentive for environmental performance. ■ Negatively, IFIs can withhold funding, and the removal of one IFI’s funding for environmental and social reasons may cause other IFIs to withdraw funds. ■ Positively, financial institutions with environmental management systems can access IFI financing that is available for development purposes. This funding is generally lower cost, as in the case of BBA’s funding from BNDES’s environmental credit line. Most significantly IFI financing provides long term lending at tenors critical to wholesale finance that are not commercially available elsewhere.

■

“ Over the last few years, it has become increasingly clear that environmental performance has significant implications for financial institutions. The key issues for banks and other financial institutions include credit, reputation and political risks associated with the environmental status and impact of their portfolios. For commercial and investment

Key initiatives: Following the CEA workshop, BBA has undertaken a number of initiatives. Key initiatives include the following: ■ ■ ■

banks, environmental risk management is now a critical part of the credit risk management process” Roberto Dumas Damas BBA Creditanstalt

■ ■ ■ ■ ■

Background Banco BBA Creditanstalt is the thirteenth largest Brazilian bank in terms of assets, with US$6.63 billion in December 2001. It is positioned as the fifth largest private bank having local control and the largest Brazilian wholesale institution and is among the five major banks on-lending funds from the Brazilian development bank BNDES. Key risks for clients BBA identifies a number of sustainability-driven risks for its client base: ■

Media: reputational risk

■

Customers: loss of market share Government: shutdown, fines Financiers: Loss of financing

■ ■

Key risks for commercial and investment banks In addition, BBA identifies potential sustainability-driven risks for commercial investment banks operating in Brazil: ■ ■ ■ ■ ■

Non-performing loans/investments/leases from environmental/social risks Loss of IFI funding Reputational risk/negative publicity Liability for clean up of contaminated property/collateral Devalued collateral

Implementation In response to these risks, two BBA staff attended the CEA workshop in Washington. BBA has since established a comprehensive environmental management system, the primary objective of which is to focus on economic development that is environmentally sustainable, minimizing exposure to companies with poor environmental practices and facilitating access to multilateral and bilateral capital.

Report to director/board on environmental risks/opportunities Communications to clients and media events Updating the operating policy of the institution Working with clients to manage environmental impacts Development of environmental/social procedure External reporting of EMS Training of internal staff Providing environmental loans

Business benefits of EMS to BBA ■ In the last 2 years BBA was involved in 27 Projects totalling R$ 7 billion in BNDES financing. ■ BBA’s environmental management system has enabled the bank to access the BNDES environment credit line, ensuring improved loan rates and loan terms not otherwise commercially available. ■ BBA has met IFC’s environmental conditions for environmental management and as a result was able to access US$40 million additional IFC funding. ■ BBA was also able to access more than US$100 million of additional funding from other multilateral agencies with environmental screening (including DEG, EIB, and FMO). ■ Lower credit risks. BBA has identified as unacceptable and rejected a number of projects with unacceptable environmental credit risks. ■

BBA has also been recognized as the first domestic Brazilian bank to adopt an EMS.The bank was highlighted in the Friends of the Earth eco-finances bulletin. BBA’s Roberto Dumas Damas was invited by UNEP to make a presentation at the Rio+10 UNEP Conference.

Barriers Key lessons in terms of implementation include the following: DO 1. Involve the key staff of the bank within the process. 2. Stress how environmental issues can lead to credit risks. 3. Establish clearly the roles and responsibilities of relevant staff members within the process. 4. Identify some projects that went wrong environmentally and the impacts suffered by the funding providers. 5. Bring environmental issues to the credit committee. 6. Follow environmental issues within approved projects through external consultancy.

■

BBA’s strategy as a bank is one of cost-effective risk management. BBA works with clients to transform borderline deals. Unlike IL&FS (case 1, pgs. 29–30), though, BBA is not aiming specifically to acquire a critical mass of environmental and social expertise, and position itself to manage environmentally complex transactions. BBA’s strategy involves a low cost operation for screening out rapidly the potential problem project and adhering to donor performance standards. The main business benefits of the approach are listed in Box 3.2, pg.34.

34 Beyond Risk

CASE 2 Continued

The Emerging Market Response 35

C ASE 3: PRIVATE EQUITY C ASE EXAMPLE: TUNINVEST FINANCE GROUP (TUNINVEST)

DO NOT 1. Leave any doubt among the shareholders concerning the economic and financial importance of the EMS. 2. Acknowledge the EMS as a theoretical textbook only. 3. Build an over-optimistic EMS that cannot be put into practice. 4. Let the EMS be viewed as a time consuming decision making process.

Background Tuninvest Finance Group, established in 1984, is the leading private equity and corporate finance firm in North Africa, with teams covering Tunisia, Morocco and Algeria.Tuninvest’s corporate finance team has expertise in mergers and acquisitions, privatization, leveraged buy-outs, initial public offering, and debt structuring.Tuninvest is currently managing five funds totaling about US$ 60 million with a diversified portfolio and a hands-on approach.Tuninvest seeks a 4 to 7 year holding period before exit.

CASE 3 PRIVATE EQUITY: LESSONS LEARNED Key lessons of experience from Tuninvest for private equity groups include the following: ■

Key risks to portfolio companies Tunisia is a signatory to all the international environment conventions and has signed a free trade agreement with the EU.Tunisia’s environment regulations are based on EU guidelines, with environmental impact studies required for new projects and extensions. No project can be implemented without the go-ahead of the national environmental protection agency (ANPE). ■ Key risks to private equity groups Most of Tuninvest’s exits have been and are planned to be through sales to strategic investors, usually from Europe. Compliance of investee companies with international and local environmental guidelines is an important factor in the company’s evaluation.This also affects the amount of the limited term guarantee that Tuninvest will provide as sellers to the new owners to cover any future liability that could arise and that is related to the pre-exit period.

B OX 3 . 2 SUSTAINABILITY BUSINESS DRIVERS for risk-management focused commercial and investment banks

Implementation ■

■ ■

Reduced management workout time

■

Reduced late stage project rejection

■

Reduced reputational risk

■

Reduced default, loss, provisioning

■

Reduced liability for clean up of collateral

■

Reduced legal liability for misrepresentation/negligence

■

Low cost operating structure

■

Access to IFI capital

■

Four members of Tuninvest staff attended the CEA workshops in Washington, Istanbul and Johannesburg. Following the workshops the company began the process of establishing an environmental management system. In July 1998, in collaboration with the IFC and SmArtConsult, a local environment consultancy, Tuninvest formalized its EMS. Tuninvest’s tight operating structure and small team size facilitated adoption of the EMS. Key staff involved included: investment officers, the environmental coordinator, the external consultant, the internal investment committee, the funds’ investment committee and legal counsel.

Business Benefits of EMS to Tuninvest ■ For the investee companies, having an EMS in place improved bargaining power with potential acquirers. This was the case in several examples of deals in Sweden (SOTUPA/SCA) and France (Interchem/CEVA). ■ Tuninvest’s environmental services have enabled the organization to add value to a number of portfolio companies.The cases of SOPAT and Vitalait (a milk producer) illustrate cost savings through improved productivity.The SOPAT slaughterhouse used water inefficiently in the process and managed to optimize the use of water, with substantial savings.Vitalait also managed to reduce the quantity of water used in the process and began recycling it for reuse.

■

Undertake the environmental assessment during the due diligence necessary for making an investment decision. Today, environmental assessment is a part of the investment proposal. For export strategy purposes, do not assess compliance with local regulations alone. Aim, whenever possible, to comply with European and international standards. Consider also the informal requirements imposed by key stakeholders, including the workforce, customers and neighbourhood of the company. Avoid projects with complex environmental issues where there is a high cost to bring them up to standard, or where management is unaware of environmental issues and is not willing to change its stance.

36 Beyond Risk

CASE 3 Continued

The Emerging Market Response 37

B OX 3 . 4 UPSIDE OPPORTUNITIES FOR PORTFOLIO COMPANIES

■

■

■

■

■

■

Introduce environmental covenants within shareholder agreements. Following investment, instigate a program with company management to deal with any major corrective actions, and review regularly (one internal review every six months and once a year by an external expert for verification). Inform all members of the fund management team of any significant environment issues. Seek any available financial subsidies, as there are many subsidized credit lines available, for example for water treatment units. Even though it is necessary for the investment officers to be knowledgeable of EMS and environmental issues, it proved beneficial having an external expert to follow and review the internally prepared EMS. Schedule training for both internal staff and the management of portfolio companies.

■ ■

■

■

Tuninvest has minimized the environmental risk of its portfolio Portfolio companies are focused on exporting and becoming leaders in the Tunisian and Maghreb markets. Sustainability has a role in helping to make these portfolio companies more attractive for an IPO or a sale to potential strategic investors Sustainability has an additional role in helping portfolio companies achieve sustainable growth and improve international competitiveness, as well as helping them achieve an Investment Grade rating in order to tap the bond market Tuninvest’s environmental management system forms part of its presentation to potential IFI and institutional investors. In the first half of 1998,Tuninvest raised an international fund with investors having environmental and social criteria including EIB, IFC, FMO and Proparco.Their success in applying these criteria was a factor in the selection of Tuninvest as a technical partner in a new regional fund covering Morocco, Tunisia, and Algeria raised in 2000 with the same investors and European private institutional investors.

■

Access to SRI funding

■

Access to IFI funding

■

Increased margins through process efficiency

■

Access to new markets

■

Enhanced branding

■

Enhanced sales

CONCLUSIONS FOR PRIVATE EQUITY Sustainability-driven risks can impact private equity groups directly. Key risks for private equity (see Box 3.3, pg. 36). At the same time, sustainability provides a number of opportunities to add value at the level of the portfolio company. Valueadded opportunities (see Box 3.4, pg. 37). Additionally, sustainability may add value at the level of the fund itself. Core opportunities for the fund (see Box 3.5, pg. 37)

B OX 3 . 3

B OX 3 . 5

DOWNSIDE RISKS FOR PRIVATE EQUITY

UPSIDE OPPORTUNITIES FOR PRIVATE EQUITY GROUPS

■

Reduced valuation through environmental stigma

SUSTAINABILITY DRIVEN OPPORTUNITIES

■

IPO brand impacts

■

Access to SRI funding

■

Trade sale stigma

■

Access to IFI funding

■

Incomplete warranties concerning contingent liabilities

■

■

Liability for misrepresentation

Reflecting environmental risk in reduced portfolio company purchase price

■

Liability for negligence

■

■

Reputational risk for limited partners

Reflecting superior environmental and social performance in enhanced liquidity and pricing of portfolio companies

■

Directors liability

■

Criminal liability

38 Beyond Risk

The Emerging Market Response 39

C ASE 4: LEASING RAIFFEISEN B A NK

CASE 4 LEASING: LESSONS LEARNED Key lessons of experience from Raiffeisen Bank include the following: ■

■

■

■

Smaller cap clients face strong competitive pressures, with limited financial and management resources. At the same time, small cap clients represent an under-banked segment compared to large cap top tier clients. For these undercapitalized small cap clients energy efficiency enhancements can boost operating margins significantly as well as reducing operating risks resulting from fire, health and safety issues and legislation driven product obsolescence. In addition, management willingness to engage in longer-term process enhancement may correspond with long-term management commitment to the growth of the company As a result of these factors, the delivery of energy-efficiency services may provide both a critical means of accessing the strategically important smaller cap market, and a means of reducing the credit risk associated with the segment.

■

Background In 1993, Hungary adopted a national energy policy making energy efficiency an integral part of government energy and environmental policies.While energy efficiency has improved significantly since the late 80s, these improvements have taken place mainly in the private sector. Energy efficiency in Hungary is still lower than the EU/OECD countries, with opportunities existing across a range of sectors, ranging from the communal household sector to the publicly owned sector including central government and local municipalities. Raiffeisen Bank was established as Unicbank in December 1986, concurrently with the establishment of the two-tier banking system in Hungary. It was voted, “Best International Bank in Hungary 1999”.The bank was interested in exploring the strategically important Small and Medium Scale Enterprise (SME) sector; a sector that was under-served by the major commercial banks, and where the margins reflected reduced competition compared to large cap corporate clients. IFC, through the Global Environment Facility (GEF), offered guarantee funding as a pilot project for Hungarian Banks to finance energy efficiency projects, opening up a potential opportunity for Raiffeisen to explore the smaller-cap market. IFC also worked with Raiffeisen to structure the project to mitigate the risks associated with energy efficiency financing for SMEs, in particular the lower credit worthiness of small-cap clients, operating risks as a result of technological obsolescence and outdated operating practices, and the low collateral value of energy-efficient equipment. Implementation ■

■

■

■

IFC, through GEF, offered guarantee funding to Raiffeisen to reduce the risk of their loans to the SME sector. A project officer’s salary was subsidized by 50% for the first year, until a real business line was demonstrated which justified the bank’s investment in staff resources. Working through the IFC’s technical assistance facility, created to support program participants in developing the energy efficiency finance business, Raiffeisen forged partnerships with potential business developers, matching its financial structuring expertise with the technical energy efficiency expertise of project developers. In particular, a business incubator service helped potential project developers across the range of energy efficiency innovations to develop viable business plans that could be financed. A technical assistance project helped Raiffeisen in credit risk assessment for these loans to SME Energy Service Companies (ESCOs). As part of this credit risk assessment, three officers from Raiffeisen attended the CEA workshop.The workshop examined potential environmental risks to target Eastern European clients, ranging from major hazards, fire, occupational health and safety, regulatory shut down and EU legislation driven product obsolescence, identifying potential opportunities for energy efficient products with lower risk profiles.

Results ■ Raiffeisen’s participation in the pilot program resulted in the immediate identification of deal flow potential. Core business products included cogeneration development, and boiler/heating center reconstruction for public sector clients with inefficient and unsafe boiler technology. ■ The bank established an energy efficiency business team and continued to year two on a stand alone commercial basis after the 50% staff subsidy ended ■ Raiffeisen invested equity in a project development company Sinesco, whose revenues come from shared energy savings from industrial clients, with a specialization in the hospital sector. ■ In year 3, the bank began financing a number of projects without IFC’s guarantee, judging that it had acquired enough technical expertise in certain proven energy efficiency market sectors and could avoid paying the guarantee fee for these projects. ■ Raiffeisen expanded further into the retail market, offering $800 loans for homeowners to convert to gas and upgrade boilers, as well as developing new products to serve the untapped cooperative “blockhouse” housing sector. ■ As a result of this initiative, Raiffeisen has established a leadership role in serving the strategically important mid and small cap positions, enhancing market share at the retail level as well as undertaking pioneer loans for the previously unserved cooperative housing sector for energy efficiency improvement investments. ■ The project’s commercial success resulted in a number of banks following Raiffeisen into the sector, as well as IFC investing an additional $12million from its own account into the Hungarian Guarantee Facility. Banks currently involved include OTP, K & H Bank and HVB Bank. Table 3.2, pg. 40, presents a summary of current Raiffaisen portfolio projects and transaction size across a range of client segments

■

■

■

Typical clients with energy efficiency opportunities include public sector service providers (e.g. hospitals, transport, utilities) and sectors where energy prices have traditionally been subsidized but are presently increasing. Opportunities also exist for projects with short pay back periods in the retail market Conducting low cost up front energy efficiency audits is a key method of establishing client demand for energy efficiency products. Meeting market demand for these services depends on the banks’ expanding in-house delivery capability. Bank staff training on deal identification and structuring is currently under preparation at K&H Bank, HVB Bank and OTP Bank, followed by banking client workshops in various locations of the country.

40 Beyond Risk

The Emerging Market Response 41

TABLE 3.2

FIGURE 3.4

HUNGARIAN ENERGY EFFICIENCY PROJECT EXAMPLES

EVOLUTION OF BEST PRACTICE

THE SME MARKET SME clients form a key market segment. As Figure 3.3, right, presents, a number PROJECT TYPE

of factors are increasing the strategic importance of the SME market for commercial banks and leasing companies.

TRANSACTION SIZE (US$)

Hospital gas-fired heating system

115,707

Hospital heating project

518,369

Block housing gas heating system Meat packing plant gas boiler system

115,340

Railroad station gas heating system

825,902

Street lighting projects (21)

396,388

Block house window changing

114,078

TOTAL

2,154,219

FIGURE 3.3 DRIVERS FOR SME BUSINESS

Retail Banking Competition

PULL FACTORS

PUSH FACTORS ■ ■ ■ ■ ■ ■

Growth of Bond Market Increased IPO’s Internet Banking Loss of second tier markets Margin reductions Global financial markets

■ ■

➜

To what extent can sustainability enable a financial institution to boost market share in this strategically important segment? Conventional wisdom assumes that SMEs have no time or money to concern themselves with environmental issues. Typical SME characteristics include the following: that they are undercapitalized, facing global competitive threats, using antiquated, resource inefficient technologies, and operating in areas with lower enforcement levels of environmental regulations.

68,435

➜ RETAIL SEGMENT

■ ■

Retail market size Growth rate of market Local knowledge Under-served segments

COMPETITIVE ADVANTAGE

RISK MANAGEMENT FAILURE

RISK ASSESSMENT FAILURE

➜ ➜

➜

Environmental Value-Added

Environmental Compliance Procedures

Financial Compliance Procedures

Although they may appear to be the least likely to have the time or money to focus on business performance, the reality is that this group is likely to gain the most from environmental performance enhancement, as many SMEs use outdated and resource-inefficient technologies. These SMEs, therefore, present opportunities to increase efficiency and reduce costs through cleaner production, productivity improvements, access to premium export markets and management system design.

42 Beyond Risk

TABLE 3.3

PROVIDING ENVIRONMENTAL VALUE-ADDED TO SME CLIENTS

SUSTAINABILITY AS A BUSINESS DRIVER—ILLUSTRATIVE EXAMPLES

Providing these services can generate business benefits for the leasing company. Key business drivers include the following: ■ ■

■

■ ■ ■ ■

■

Develop new SME business Cross-sell existing products to supply and distribution chain Deliver environmental product extensions Reduce client marketing costs Increase inter-client referrals Increase intra-client referrals Build low cost ‘word of mouth’ marketing addressing corporate and individual accounts Build media campaigns

CASE STUDY CONCLUSIONS: FROM COMPLIANCE TO VALUE-ADDED The four cases above provide examples of financial institutions not only performing comprehensive financial and environmental due diligence, but complementing it by offering their clients a range of sustainability-based products and services that address the clients’ business needs.

The Emerging Market Response 43

B OX 3 . 6

Sustainability as a Business Driver: Good Practice Review

SME BUSINESS NEEDS Revenue growth ■ Decreased operating costs (labor, inputs, waste disposal etc) ■ Increased productivity ■ Enhanced quality control ■ Enhanced customer security ■ Access to financing Risk reduction ■ Long term local operating license ■ Long term international operating license ■ Avoided loss of contracts, strikes, government shut down, penalties etc. ■ Access to insurance

BUSINESS OBJECTIVE

BUSINESS DRIVER

Increasing business volume

■

■ ■ ■

■

Providing loans to SME clients

■ ■ ■ ■

■ ■

SUSTAINABILITY PRODU CT S

■

■

Environmental management systems Cleaner production audits Energy efficiency audits Energy efficiency products

Winning microfinance market share

■ ■

■

■

Winning ethically conscious depositors and credit card holders

■

Winning SME market share through offering energy efficiency products

■

■

■ ■

■

Offering finance to sustainable businesses

■ ■ ■

Increasing margins

■

Reducing environmental credit risk provisioning through quality processes

■ ■ ■ ■

■

Providing fee-based advisory services

■ ■ ■

Building long-term competitive position

■

Gaining access to IFI finance

■ ■

■

These cases, then, suggest an evolution in approach: from financial compliance— where client creditworthiness is assessed

Winning mandates for complex projects

GOOD PRACTICE EXAMPLE

Gaining access to SRI finance community

■

■

■

■

Maximizing employee performance

Corporate governance premium

IL & FS IDFC ABN AMRO Banco Cuscatlan Rant Leasing Banco Real Banco Real African Bank Garanti Bank Cooperative Bank Raiffeisen Bank OTP Bank HVB Bank Terra Capital Triodus ASN Bank Indasia Vilniaus Bank Bioventures Fleet Boston Unibanco Tuninvest IL & FS BBA Banco Cuscatlan Capital International Partners Citigroup

■

Cooperative Bank Standard Chartered Bank

■

Bank of Shanghai

■

primarily as a function of the balance sheet, through environmental compliance—where the institution imposes environmental conditions to secure client compliance and, to sustainability— where the financial institution ensures compliance as a core part of risk management. This approach also delivers environmental value-added to clients in a way that enhances its competitive position (see Figure 3.4, pg. 41). To what extent is the market capitalizing on these opportunities? Table 3.3, left, provides examples of current good practice in terms of sustainability initiatives that can increase business volume, increase business margins or enhance the longterm franchise of the institution. SUSTAINABILITY AS A BUSINESS DRIVER While this list is not exhaustive, it exemplifies the potential for sustainability strategies to enhance the core drivers of institutional performance as Figure 3.5, pg. 44, suggests.

44 Beyond Risk

FIGURE 3.5 SUSTAINABILITY AS A STRATEGIC TOOL FOR THE FINANCIAL SECTO R

MARGIN

DURATION

➜

Core opportunities in terms of increasing business longevity include the following: ■ Increasing business longevity: To leverage sustainable portfolio performance to access expansion capital (key sources include IFIs, long term institutional investors, bond markets, pension funds, depositors and SRI investors)

VOLUME P/A

➜

Core opportunities in terms of increasing business margins include the following: ■ Increasing business margins: to reduce critical costs (losses, workout time, insurance costs, capital costs, legal liabilities and provisions), to retain fees from advisory services, syndications/underwriting services, to reflect value-added in premium loan pricing

LONG-TERM PROFIT

➜

Core opportunities in terms of increasing business volume include the following: ■ Increasing business volume: to transform undoable deals into doable ones, and increase the bankable portfolio, to provide additional sustainabilitydriven financing that supplements existing loan products, to finance new sustainable sectors, to reduce attrition, increase client loyalty, and enhance loan renewal rates

MORE DEALS

BIGGER MARGINS

LONG-TERM OPERATION

4. LESSONS FROM THE FIELD: SUSTAINABILITY IN ACTION What are the main lessons learned in terms of implementation?

➜

Sustainability in Action 47

B OX 4 . 1 ISO14000 SERIES

➜ PERFORMANCE-BASED The International Organization for Standardization (ISO) has published a standard on guidance for establishing an EMS–ISO14001.This standard is one in a series of voluntary standards (the ISO14000 series) concerning environmental management, environmental performance, product life cycle assessment and product environment

➜

FOR AN INSTITUTION TO ACHIEVE THESE SUSTAINABILITY BUSINESS GOALS RELIABLY, IT NEEDS A SYSTEMATIC APPROACH.

labeling. Many organizations globally have undergone third party verification of their EMS and have attained certification to the standard. Others have opted for the EU’s EMAS scheme which sets out more demanding requirements. ISO14001 focuses on implementation of the EMS, while EMAS concentrates on actual environmental performance. Both standards are voluntary. Some of the largest banks, for example, Deutsche Bank, UBS, Credit Suisse, Sakura Bank, were among the first in the financial sector to achieve certification to ISO14001. For financing institutions, the most important advantage of certification is likely to be a wider public recognition that the bank’s position on environmental and social issues is sound.

MANAGEMENT SYSTEMS Chapter 3 has identified a range of potential sustainability-driven benefits for financial institutions. What are the key lessons of experience in terms of implementing sustainability initiatives? For an institution to achieve these sustainability business goals reliably, it needs a systematic approach. Priority business goals are identified and the institutions formal and informal structure is then aligned to achieve them. Although these core components are integrated within the organization’s operating systems, a common term used to refer to these elements is an environmental management system (EMS). Where the management systems of the ISO14000 series focus on process conformance, the EMS outlined in this chapter focuses on business performance. There is considerable literature available on the design and implementation of environmental management systems designed to secure process conformance, in particular the ISO14000 series, see

Box 4.1, left.

48 Beyond Risk

Sustainability in Action 49

FIGURE 4.1

B OX 4 . 2

EMS TYPES ACCORDING TO STRATEGIC FOCUS

ELEMENTS OF AN ENVIRONMENTAL MANAGEMENT SYSTEM (EMS)

The objective of this chapter is to examine experience based on creating an EMS that has three aims: TYPE ONE: DEFENSIVE—Core Elements of EMS in Place ■ ■

■

To boost the business of core clients To generate a clear return for the financial institution To work with available resources and minimize the cost of implementation

Customizing the System The scope and structure of an EMS, therefore, varies according to a number of factors, including institution type, client base, and strategic focus. Figure 4.1, right, presents four types of EMS categorized according to strategic focus. Type One focuses on the management of key environmental and social risks with a minimum of resources. Type Two addresses comprehensive environmental and social due diligence to present the financial institution as world class in terms of credit risk management. Type Three manages risk comprehensively but identifies specific value-added opportunities. Type Four orients its business line towards sustainability.

a) Objectives and targets: setting the key business goals for the institution

Management of key environmental and social risks ■ ■

b) Applicable standards: identifying the standards acceptable to key stakeholders

Operational procedure Top management support

c) Procedures: identifying cost-effective processes to achieve those standards at the project level d) Roles and responsibilities: allocating roles internally and externally implement the procedure e) Communications and reporting: periodic monitoring of the system and internal and external reporting against targets and objectives

TYPE TWO: PROTECTIVE—Fully Operational EMS Systematic management of environmental and social risk ■ ■

Operational procedure Application to all relevant sub-projects

B OX 4 . 3 TYPE THREE: OFFENSIVE—Fully Operational EMS

POTENTIAL OBJECTIVES FOR RISK MANAGEMENT FOCUSED COMMERCIAL B ANKS

Systematic management of environmental and social risk Limited environmental and social value-added ■

Operational targets and objectives of EMS (enhanced portfolio quality, reduced provisions, reduced workout time) RISK REDUCTION ■ Reduced management workout time

TYPE FOUR: SUSTAINABLE—Strategic Focus on Environmental & Social Opportunities Systematic management of environmental and social risk Systematic environmental and social value-added ■ ■

Environmental and social opportunities prioritized within existing sectors New sectors

■

Reduced risk of project rejection at a late stage

■

Reduced risk to reputation

■

Reduced risk of defaults, and lower loss provisioning

■

Reduced liability for any environmental clean-up of collateral

■

Reduced legal liability for misrepresentation/negligence

■

Continued access to IFI capital

While the strategic choice will vary with the institution’s context, there are nevertheless a number of key elements that are consistent across EMS types. This chapter focuses on five central elements of the environmental management system, see Box 4.2, left. A) OBJECTIVES AND TARGETS An EMS has value for the institution only in so far as it achieves specific business objectives. For the EMS to provide business value it must define a number of priority business objectives, set specific measurable targets for achieving them and then align key elements of the organizations formal and informal structure to achieve them. The choice of these priority objectives will depend on the business lines, competitive positioning and strategy of the institution. For commercial banks that are focused on risk management, as the case of BBA (see chapter 3) illustrates, a core goal may be risk reduction. Box 4.3, left For project finance-focused institutions, core goals may focus not only on risk reduction, but also on managing the environmental and social issues associated with complex projects, and making those projects work effectively. Box 4.4, pg. 50

50 Beyond Risk

Sustainability in Action 51

B OX 4 . 4

FIGURE 4.2

POTENTIAL OBJECTIVES FOR PROJECT FINANCE INSTITUTIONS that offer environmental

COMPLIANCE APPROACH

advisor y ser vices to high environmental risk clients

For private equity groups, core goals may focus on both downside risk management and on creating business value for the investee company. Box 4.5, right

■

■ ■

■

Fees from environmental due diligence services

■

Positioning for complex structured finance transactions

■

Increased volume of bankable deals

■

Business from new clients

CONDITIONS

SUPERVISION

In 2001, to address these issues, a number of banks based in the Netherlands began to implement corporate-wide forestry policies. A core step in the policy rollout was to identify key stakeholders, including NGOs and industry clients. Policy formulations were then forged in consultation with these stakeholders and have achieved broad consensus.

“COMPLIANCE”

B OX 4 . 5

FIGURE 4.3

POTENTIAL OBJECTIVES FOR PRIVATE EQUITY INSTITUTIONS

FROM COMPLIANCE TO VA LUE-ADDED

DUE DILIGENCE DOWNSIDE AVOIDANCE ■ Reduced valuation through environmental stigma

VALUE CREATION ■

Access to SRI funding

■

Access to IFI funding

BUSINESS NEEDS ASSESSMENT

➜ CONDITIONS

Incomplete warranties

■

Reduced risk pricing at purchase

■

Legal liability to limited partners

■

■

Liability for misrepresentation

■

Value added through process efficiency Value added through new markets

■

Liability for negligence

■

Valued added through premium pricing

SUPERVISION

■

Directors liability

■

■

Criminal liability

Long term positioning for strategic investors

ENVIRONMENTAL PRODUCTS & SERVICES

FOLLOW-UP BUSINESS NEEDS ASSESSMENT

➜

■

➜

B) APPLICABLE STANDARDS Applicable standards are commonly assumed to be the national and local regulations set by government. While these standards apply for all investments, the global economy has started to introduce in addition a range of new stakeholders with their own standards, and potential to penalize companies for non-conformance. These international stakeholders include export market regulators, insurers, SRI investors, NGOs, local communities, and financial institutions.

Reduced cost of capital

➜

■

■

➜

■

The choice of objectives will depend on the competitive positioning and strategy of the institution. The organization should prioritize, resisting the temptation to set too many goals and diffuse the institution’s focus. Go for quick wins that may have a demonstration effect. Pick objectives that have a measurable financial impact. Pick growth client segments. Focus on early goals that minimize intrusion on the bank’s operating processes.

➜

■

DUE DILIGENCE

VALUE CREATION ■ Increased access to long term capital

Key lessons include the following:

Identifying applicable standards, and ensuring compliance with them poses a number of challenges. Relevant stakeholders may be hard to identify. Stakeholders may claim the right to involvement in a project without any legal basis for jurisdiction. In addition, the standards of these stakeholders can conflict. Finally, they can evolve over time, leaving the financial institution with outdated criteria to judge acceptability.

“COMPLIANCE”

“ENVIRONMENTAL VALUE-ADDED”

What are the elements of current good practice for financial institutions in setting applicable standards? Key lessons include the following: ■

Identify local, national and international stakeholders whose support is critical.

■

Identify the standards that they judge to be acceptable (for example, national regulations, EU standards, WBG industry guidelines).

Sustainability in Action 53

52 Beyond Risk

■

■

■

■

Identify the scope of all relevant operations for which the institution may be held liable (for example, company operations, supply chain, distribution chain, previous site use). Identify potential areas of conflict between different stakeholders (for example, conflict between EU market requirements and local regulations). Bring relevant groups together and try to forge a consensus over conflicts in standards, identifying clearly the group’s final position and its justification. Keep the institution open to dialogue on adapting standards over time.

C) PROCEDURE: CONFORMANCE VERSUS PERFORMANCE The new stakeholders identified have the potential to transmit risk to portfolio companies and their financiers. In response to this risk, the standard conformancebased EMS focuses on a due diligence process designed to ensure project compliance with applicable standards and thereby reduce the financial institutions risk. While individual due diligence processes differ, the standard compliance approach follows three broad phases (see Figure 4.2, pg. 51)

Due diligence: During the due diligence phase the financial institution identifies potential risk drivers, including noncompliance with national legislation, potential contamination of site or collateral, occupational health and safety concerns. Conditions: As a condition of investment, the financial institution requires the client to agree to a number of legal conditions designed to ensure compliance with applicable standards. Supervision: Following investment, the financial institution monitors client compliance with applicable standards. Standard monitoring tools include client site visits and annual monitoring reports submitted by the client. The performance-based EMS reverses the process with a three-phased approach: (see Figure 4.3, pg. 51) i) Business needs assessment: During the business needs assessment, instead of identifying risks to the financial institution the focus is on looking at the business risks and opportunities facing the client.

ii) Product and service delivery: Instead of issuing a set of legal conditions with which the client must comply as a condition of financing, the performance EMS focuses on delivering to the client a range of environmental products and services that help the client address those needs. iii) Follow-up business needs assessment: Finally, instead of exclusively monitoring compliance with the bank’s standards, the performance-based EMS aims to track changing markets risks and opportunities. Follow up products and services are then identified that may boost the clients business while renewing the relationship and generating additional business value for the financial institution.

Key lessons in terms of implementing the approach include the following: i) Business needs assessment ■

■

■

Sustainability business needs of clients will vary with sector, region, size, and market conditions. Work with priority client market segments in identifying their sustainability business needs. Key market drivers for the client include: access to new markets, access to capital, process efficiency, brand, enhancement to reputation, access to insurance, employee productivity, community relations and license to operate. IFC’s “Developing Value” report provides a detailed breakdown of business drivers across regions and sectors.

ii) Environmental products and services ■ Identify products and services geared towards the clients primary business needs. ■ Form partnerships that reduce the cost of product and service delivery. ■

Look for related markets, for example using the institution’s environmental and social due diligence processes to increase its ability to mobilize co-financing for complex projects.

iii) Follow-up needs assessment ■ Monitor sector and regional trends and best practice in terms of both risk and opportunity. ■ Offer products and services that respond to evolving market-based risks and opportunities, renewing the client relationship, and reducing attrition. ■ Look for opportunities to use successful delivery to one area of a client’s operations as the basis for expanding the service, including delivery across other national or international plants. ■ Look for operations to cross-sell products and services across strategic businesses, for example linking SME or micro-credit financing to wholesale/project finance operations. D) ROLES AND RESPONSIBILITIES A key challenge for the performancebased EMS is delivering this value to clients and the institution without significantly increasing operating costs. The performance EMS therefore aims to mainstream sustainability, minimizing the central sustainability unit and maximizing its leverage of internal partners.

Within the institution, a number of existing functions have the potential to enhance the value of the EMS, without adding significantly to operating costs. Table 4.1, pg. 54, summarizes internal resources and the potential value added through mainstreaming. Key lessons include the following: ■

■

■

■

Identify champions within the relevant business units. Create a guiding coalition with the champions across relevant units. Align the institution’s incentive systems to reward good performance. Publicize success stories internally.

E) COMMUNICATIONS AND REPORTING There is a growing trend within the financial sector towards sustainability reporting. The British government, for example, recently outlined requirements for pension funds to report on their use of environmental performance criteria. A growing number of bank and non-bank financial institutions now contain environmental sections in their annual reports or provide stand-alone annual environmental reports. What is the business value of these initiatives?

54 Beyond Risk

The performance EMS aims to use communications and reporting not as an end in itself but as a means to generate value for the institution. To achieve this, the performance EMS focuses on providing customized data to stakeholders that will generate specific rewards for the institution.

TABLE 4.2

MAINSTREAMING SUSTAINABILITY

STAKEHOLDER COMMUNIC ATION NEEDS

INTERNAL RESOURCES Human resources

■

■

■

Risk/Credit review

Syndicates

■

■ ■

Marketing/Corporate relations

■

■

■ ■ ■

■

Retail relationship manager

■

■

Table 4.2, pg. 55, provides examples of

the core elements of communications campaigns targeted at stakeholders. In each case the campaign aims to meet the specific sustainability information needs of differing stakeholders, communicating them cost-effectively and securing a performance benefit for the institution.

Wholesale relationship manager

■ ■

■

Treasury

STAKEHOLDER

SUSTAINABILITY INFORMATION NEEDS

IFIs

■

VALUE ADDED

■

As identified in chapter one, there are a number of stakeholders with the potential to have a significant impact on the financial institution and its clients both positively and negatively. At the same time, these various stakeholders have different goals that cannot all be satisfied by the one-way communication of the annual environmental report. The performance EMS therefore aims to select priority stakeholders, identify the objectives and targets relevant to them and communicate this data to them effectively.

Sustainability in Action 55

TABLE 4.1

■ ■

Use the institution’s good sustainability track record to recruit high caliber business school graduates Provide skills training to account officers that focuses on using sustainability to win business from priority market segments Provide incentives and rewards for staff that achieve triple bottom line investments (financially, socially and environmentally high performing) Carry out environmental and social risk assessment of investments Assist loan officers in differential risk pricing of loans Secure lead management of syndicates for complex projects Bring additional co-financing to complex sectors based on the opportunity for other banks to rely on the sound environmental and social due diligence of the institution Work with account officers and priority clients to identify client sustainability business needs Develop marketing materials and communications tools to approach target markets Develop communications tools to mainstream sustainability internally Manage SRI communications Develop communications materials for approaching additional non-client stakeholders (NGOs, raters, analysts etc) Provide crisis management communications Identify smaller-cap client base with sustainability needs (e.g. exportoriented agribusiness operations) Lead sector-wide marketing to client base (e.g. seminars on process efficiency or on identifying export market opportunities for sustainable companies) Complete environmental risk and opportunity screening of the deal flow Compete for complex transactions, using environmental value added as a differentiator Build in a linkage to retail market operations as part of community development for wholesale projects Issue green receivables based on the institutions sustainable portfolio Secure access to international funds

Asset Management and private banking

■

Establish SRI funds/ethical funds for institutional investors and high net worth private banking individuals

Facilities management

■

Increase energy efficiency of facilities

Environment and sustainability

■

Provide strategic overviews Provide central environmental and social advisory function

■

■ ■

Insurers

■ ■

Raters

Analysts

NGOs

■

■

■

Key lessons for implementing a successful monitoring and communications program PERFORMANCE REWARD

Sub-project conformance with national regulations,World Bank polices and applicable guidelines Examples of best practice projects Early warning of problem projects

■

Reduced portfolio risk Reduced risk profile of clients

■

Data on value added to the institution (e.g. increased business, increased margins through fees and environmental credit risk reduction)

■

Information on progress in managing environmental credit risk

■

Transparent communications on institutional policies and project conformance

■ ■

■

Application of negative screens

■

■

■

■ ■

■

SRI investors

Access to IFI finance Speed of processing Positive publicity

include the following:

■

Access to portfolio coverage Access to reduced cost insurance for clients Enhanced ratings leading to reduced cost of capital, enhanced expansion opportunities

Enhanced analyst ratings leading to reduced cost of capital, enhanced expansion opportunities Support for client projects Advisory support on complex policy issues Early warning on problem areas Access to SRI financing, access to long term institutional investors

■

■

■

Identify those stakeholders who will reward sustainability information. Open a dialogue with key stakeholders to establish their exact information needs, including the level of detail required, preferred timing and format of reporting. Monitor institutional performance against the required data, rewarding compliance and diagnosing any systemic faults behind non-compliance. Provide customized data to key stakeholders in their desired format. Follow up with key stakeholders to confirm that the reports are providing credible data. Establish desired changes in communications and reporting format.

56 Beyond Risk

B OX 4 . 6 FOUR B ASIC PHASES OF EMS EXECUTION

IMPLEMENTING THE EMS Implementing the EMS also depends on following a structured approach. Current good practice in implementing environmental management systems, as described in the ISO14000 series, uses a four-phase process covering: ‘plan’, ‘do’, ‘check’ and ‘review’. Box 4.6, right, describes the central elements of the four phases.

PLAN ■ Determine strategy and obtain top management agreement and approval ■

Secure budgets

■

Set targets

■

Develop implementation plan

■

Internal communication of strategy

DO ■ Prepare policy and objectives ■

Develop and organize and write EMS procedures and working documents

■

Incorporate procedures into company management practices

■

Establish monitoring and measurement protocols

■

Train personnel

CHECK ■ Audit EMS and check performance regularly against targets set ■

Prepare report

REVIEW ■ Review report ■

Evaluate performance and lessons learned

■

Receive feedback on success and failures

■

Set new (improved) targets

5. CONCLUSIONS AND RECOMENDATIONS For the financial sector in general, the emergence of a new class of stakeholders with sustainability expectations has presented a series of challenges and business opportunities.

➜

Conclusions and Recomendations 59

FIGURE 5.1 MAIN ENHANCEMENTS UNDERTAKEN TO ENVIRONMENTAL AND SOCIAL ISSUES following the CEA workshop

➜ The sector’s response is evolving, 36%

Training of internal staff Updating operating policy

35%

Development of environmental/social procedures Rejecting projects with environmental issues

➜

33% 32%

Working with clients

30%

Report to Director on opportunites

29%

OVERCOMING BARRIERS TO IMPLEMENTATION

Communications to clients

21% 12%

External reporting of EMS Providing environmental loans 0%

5%

10%

11% 15%

20%

25%

30%

35%

40%

FIGURE 5.2

ranging from the adoption of a purely defensive stance in terms of managing risk, to integrating sustainability into business operations. At the same time, significant barriers to implementation remain, within both developed and emerging markets. OVERCOMING BARRIERS TO IMPLEMENTATION CEA workshop participants were asked to state whether they had environmentrelated risk issues and a system in place to manage them. Prior to the workshops 22% of those surveyed indicated that they had a formal system in place. Subsequently, all respondents reported an enhanced environmental management capability.2

B ARRIERS TO IMPLEMENTING AN EMS ■

22%

It's not standard banking practice Clients don't want it

15%

Lack of reward from financial markets

15%

Lack of best practice information

15%

No qualified staff

For commercial banks, project financing and leasing, the two initiatives most frequently reported actions taken were training of environmental staff and updating the environmental policy.

10%

Lack of specific examples of environmental risk

7%

Lack of time

It should be noted that the result may have been affected by selection bias. While IFC sought to avoid bias by keeping the survey anonymous, participants who have implemented systems to manage environmental risk may have been more likely to respond to the survey, biasing survey results upwards.

2

4%

No qualified consultants

3%

Lack of internal support

1%

Other

6% 0%

5%

10%

15%

20%

25%

B ARRIERS—PRIVATE EQUITY INSTITUTIONS

For private equity the major action reported was working with clients to help them manage their environment issues, followed by development of environmental and social procedures. For leasing, the next key initiatives reported were reporting to the board and communications with clients. For project finance institutions, development of environmental and social procedures and working with clients, both featured highly.

60%

35%

50%

25%

40%

31%

30%

25%

25%

13% 6% 0% Other

Lack of internal support

No qualified consultants

Lack of time

Lack of specific examples of environmental risks

No qualified staff internally

Lack of best practice information

It’s not standard banking practice

Lack of reward from financial markets

0%

Other

Lack of internal support

No qualified consultants

Lack of time

Lack of specific examples of environmental risks

No qualified staff internally

0%

Respondents from leasing companies and commercial banks identified current banking practices as the key barrier to implementation. Other factors included a perceived lack of reward in the marketplace and a view that their clients were unresponsive This was also a major factor for project finance and private equity groups. Significantly, a lack of best practice materials was also cited as a key factor across all the categories. Figures 5.3–5.6, pgs. 60–61, highlight the key barriers to implementation identified by each of the four institution categories. ■

FIGURE 5.4

FIGURE 5.6

B ARRIERS—LEASING INSTITUTIONS

B ARRIERS—PROJECT FINANCE INSTITUTIONS

■ 40%

60%

30% 40%

40%

25% 33%

29%

29% 21%

21%

■ 14%

15%

20%

13%

13%

29%

20%

27% 13%

7%

10% ■

5%

0%

0%

0% Other

Lack of internal support

No qualified consultants

Lack of time

Lack of specific examples of environmental risks

No qualified staff internally

Other

Lack of internal support

No qualified consultants

Lack of time

Lack of specific examples of environmental risks

No qualified staff internally

Lack of best practice information

Lack of best practice information

0%

0%

Lack of reward from financial markets

There are insufficient incentives in the market place Clients don’t want it Lack of best practice materials

10%

29%

Clients don’t want it

It is not standard practice in the financial sector

30%

35%

53%

50%

36%

It’s not standard banking practice

70%

Lack of reward from financial markets

■

13%

5%

0%

0%

Clients don’t want it

■

13%

10%

6%

6%

Clients don’t want it

6%

10%

It’s not standard banking practice

■

13%

20%

60%

■

13%

15%

workshop results.

Overall, the most common barriers identified were the following:

19%

19%

20%

19%

Figure 5.1, pg. 59, summarizes the post

The survey went on to ask respondents to identify what, if any, key barriers were there to implementing a system. Figure 5.2, pg. 59, presents an overview of results across all institution categories surveyed, indicating that a number of significant barriers were identified.

31%

30%

50%

Lack of best practice information

■

B ARRIERS —COMMERCIAL B ANKS

Lack of reward from financial markets

■

FIGURE 5.5

It’s not standard banking practice

■

Conclusions and Recomendations 61

FIGURE 5.3

Clients don’t want it

60 Beyond Risk

For commercial banks, the main problem identified was that sustainability does not form part of standard banking practice. For leasing companies, equally, the main issues identified were current standard practice and the related lack of best practice materials. For private equity institutions fewer overall obstacles were identified, with potential client resistance highlighted. For project finance institutions, client resistance was identified as the major barrier.

62 Beyond Risk

Conclusions and Recomendations 63

FIGURE 5.7 BEST ROLES FOR IFC AND THE DEVELOPMENT FINANCE COMMUNITY

THE ROLE OF THE DEVELOPMENT COMMUNITY—SURVEY RESULTS IFC’s survey asked participants to identify priority initiatives to address these barriers. Survey respondents suggested a number of potential initiatives from the development finance community as high priority. These include: ■

■

■

■

Market briefings: signaling environmental value-added to regional analysts, raters, media, central banks EMS–advanced: Overseas workshops for coordinators on implementing performance-focused EMS. Industry risk briefings: providing updated information on international risks/opportunities by sector. EMS support: “In-house support on EMS implementation to individual institutions, region specific environment and social good practices and case studies” (workshop participant)

Figure 5.7, right, summarizes the results.

CONCLUSIONS Four major conclusions emerge: Industry risk briefings

47%

Market briefings

37%

EMS advanced workshops overseas

31%

EMS support to individual institutions

28%

Local consultant training

16%

Other

3% 0

10

20

30

40

50

1. New classes of stakeholder are transmitting both risk and reward to companies and financial institutions as a result of their environmental and social performance 2. A number of financial institutions are responding rapidly to these market drivers, implementing sustainability initiatives strategically across a range of internal and external operations. 3. Barriers to implementation, however, do remain. One key issue identified is the absence of up to date information in the form of industry risk and opportunity. 4. While supply-side initiatives such as the CEA workshops play a critical role in helping to establish best practice, significant additional barriers include the perceived low market incentives for sustainability and as a consequence, financial sector practices that do not integrate sustainability systematically into operations.

RECOMMENDATIONS ■ The development community should explore opportunities to complement capacity building initiatives with strategic demand-side initiatives that enhance market incentives for sustainable performance ■ A number of market players have the potential to provide critical incentives for sustainable financial sector performance. Performance drivers identified include insurers, analysts, raters, co-financiers, central banks, SRI investors, and long-term institutional investors. ■ An innovative range of capacity building programs is necessary to activate these potential market reward mechanisms—from new methodologies for raters and analysts to assess and reward financial institution performance to sustainability criteria for central bank oversight as a component of prudential bank management.

65

ANNEX A List of boxes, figures, and tables This is a blank page

➜

Annex A 67

66

BOXES, FIGURES, & TABLES BOXES Box 2.1 Summary of forms of direct liability for financial institutions . . . . . . .11

Box 4.5 Potential objectives for private equity institutions . . . . . . . . . . . . . . .50

Box 2.2 Financial costs of environmental non-performance . . . . . . . . . . . . . .18

Box 4.6 Four basic phases of EMS execution . . . . . . . . . . . . . . . . . . . . . . . . . .56

Box 2.3 Performance signals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20 Box 2.4 Opportunities for financial institutions . . . . . . . . . . . . . . . . . . . . . . . .20

FIGURES

Box 3.1 Project finance opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31

Figure 2.1

Box 3.2 Sustainability business drivers for risk management focused

commercial and investment banks . . . . . . . . . . . . . . . . . . . . . . . . . . .34 Box 3.3 Downside risks for private equity . . . . . . . . . . . . . . . . . . . . . . . . . . . .36 Box 3.4 Upside opportunities for portfolio companies . . . . . . . . . . . . . . . . . . .37 Box 3.5 Upside opportunities for private equity groups . . . . . . . . . . . . . . . . . .37 Box 3.6 Providing environmental value added to SME clients . . . . . . . . . . . .42 Box 4.1 ISO14000 series . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47 Box 4.2 Elements of an environmental management system (EMS) . . . . . . . .49 Box 4.3 Potential objectives for risk management focused commercial banks .49 Box 4.4 Potential objectives for project finance institutions that offer

environment advisory services to high environmental risk clients . . . . .50

Competitive threats to the financial sector . . . . . . . . . . . . . . . . . .11 Figure 2.2 Significant sources of environmental risks for clients identified by all financing institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12 Figure 2.3 Export-oriented industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12 Figure 2.4 Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13 Figure 2.5 Domestic general manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . .13 Figure 2.6 High-tech industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14 Figure 2.7 Extractive industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14 Figure 2.8 Connectivity in 1991 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 Figure 2.9 Connectivity in 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 Figure 2.10 Drivers of environmental risk across the corporate value chain . . . 16 Figure 2.11 Environmental risks for financial institutions . . . . . . . . . . . . . . . .17 Figure 2.12 Risk to the emerging markets financial sector . . . . . . . . . . . . . . . .19

68 Beyond Risk

ANNEX B Figure 2.13 The risk management gap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Figure 5.1

Figure 2.14 Sustainability opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21 Figure 2.15 Opportunities for commercial banks . . . . . . . . . . . . . . . . . . . . . . .21

Figure 5.2

Figure 2.16 Opportunities for leasing institutions . . . . . . . . . . . . . . . . . . . . . . .22

Figure 5.3

Figure 2.17 Opportunities for project finance institutions . . . . . . . . . . . . . . . .22

Figure 5.4

Figure 2.18 Opportunities for private equity institutions . . . . . . . . . . . . . . . . .23

Figure 5.5

Figure 2.19 Socially responsible investment—growth market . . . . . . . . . . . . .23

Figure 5.6

Procedure for environment risk management . . . . . . . . . . . . . . . .27 Enhancements undertaken to environmental and social issues following The CEA workshop . . . . . . . . . . . . . . .27 Drivers for SME business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40 Evolution of best practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41 Sustainability as a strategic tool for the financial sector . . . . . . . . .44 EMS types according to strategic focus . . . . . . . . . . . . . . . . . . . . .48 Compliance approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51 From compliance to value-added . . . . . . . . . . . . . . . . . . . . . . . . . .51

Figure 5.7

Figure 3.1 Figure 3.2 Figure 3.3 Figure 3.4 Figure 3.5 Figure 4.1 Figure 4.2 Figure 4.3

Main enhancements undertaken to environmental and social issues following the CEA workshop . . . . . . . . . . . . . . .59 Barriers to implementing an EMS . . . . . . . . . . . . . . . . . . . . . . . . .59 Barriers–commercial banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60 Barriers–leasing institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60 Barriers–private equity institutions . . . . . . . . . . . . . . . . . . . . . . . .61 Barriers–project finance institutions . . . . . . . . . . . . . . . . . . . . . . .61 Best roles for IFC and the development finance community . . . . .62

TABLES Table 3.1 Case examples for project finance, Table 3.2 Table 3.3 Table 4.1 Table 4.2

commercial banking, private equity and leasing . . . . . . . . . . . . . . . .28 Hungarian energy efficiency project examples . . . . . . . . . . . . . . . . .40 Sustainability as a business driver–illustrative examples . . . . . . . . . .43 Mainstreaming sustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54 Stakeholder communications needs . . . . . . . . . . . . . . . . . . . . . . . . .55

Survey, methodology, questionnaire pro-forma, uptake of environment initiatives

➜

Annex Annex A B 71

70

COMPETITIVE ENVIRONMENTAL ADVANTAGE WORKSHOP: QUESTIONNAIRE (Please photocopy and complete the following questionnaire on finance and environment.This data, which will be used only at the aggregate level, will help shape IFC’s program for financial markets capacity-building on environment. Please return to [email protected], or fax to 1-202-974-4348 by October 8th. Many thanks for your help.)

PART 1: INSTITUTIONAL PROFILE

➜

100% OF RESPONDANTS REPORTED MEASURES TO ENHANCE THEIR ENVIRONMENT AND SOCIAL MANAGEMENT CAPABILITY AFTER THE WORKSHOP

1. Main operations of institution

a) Leasing b) Insurance

2. Main sectors financed

a) Extractive industries b) Export-oriented industries c) Domestic general manufacturing

c) Project finance d) Private equity

e) Commercial banking f) Other (please specify):

d) Infrastructure e) Hi-tech f) Other (please specify)

3. Main countries 4. Employees

a) 1–20

b) 20–300

c) 300+

5. Branches

a) 1–20

b) 20–300

c) 300+

6. New transactions a year

a) 1–20

b) 20–300

c) 300+

7. Average US$ deal size

a) <$50k

b) $50k–$500k

c) $500k–$2 m

d) $2 m+

8. Max. US$ deal size

a) <$50k

b) $50k–$500k

c) $500k–$2 m

d) $2 m+

9. Max. term of transactions

a) <1 yr

b) 1yr–3yrs

c) 3yrs+

10. Current Int’l Financial Institution (IFI) partners

Please list: (FMO, EBRD etc.)

11. Which of these officers deal with environmental/ social issues at your institution?

a) None b) Full-time envtl. manager d) Top management

c) Finance executive responsible for environment part-time e) Environmental consultant g) Other (please specify):

12. What level of staff attended the IFC/partner workshop?

a) Top manager b) Senior manager c) Account officer

d) Designated envtl manager e) Corporate relations f) Other (please specify)

Continued on page 72

72 Beyond Risk

Annex Annex A B 73

Continued from page 71

5. Following the workshop, how has your institution enhanced its environmental and social management?

PART 1I: LESSONS OF EXPERIENCE 1. What are the most significant long-term sources of environmental/social risks for clients in your country? a) Export market regulators: Loss of markets (EU, US etc.)

f) Media: reputational risk

b) International NGOs: issue-based campaigns

g) Customers: loss of market share

c) Supply and distribution chain partners: Loss of contracts

h) Government: shutdown, fines

d) Employees: recruitment and retention costs

i) Financiers: Loss of financing

e) Community: protest over impacts on critical resources

j) Insurers: Loss of coverage

a) Report to Director/Board on environmental risks/opportunities

h) Rejecting projects with environmental issues

b) Communications to clients

i) Working with clients to manage envtl impacts

c) Media events

j) Hiring of internal environmental consultant/staff

d) Update operating policy of institution

k) Development of environmental/social procedure

e) Training of internal staff

l) External reporting of EMS

f) Providing environmental loans

m) Other (please specify):

k) Other (please specify): 6. What are the greatest barriers for your financial institution in implementing an EMS? 2. What are the major potential environmental risks for financial institutions of your type? a) Non-performing loans/investments/leases from environmental/social risks

f) Liability for clean up of contaminated property/collateral

b) Civil or criminal liability for negligence

g) Loss of depositors

c) Reduced access to capital from private financial institutions/international bond market

h) Increased Central Bank/MOF regulation

d) Loss of IFI funding

i) Devalued collateral

e) Reputational risk/Negative publicity

j) Other (please specify):

a) No qualified staff/consultants to operate EMS internally

f) Lack of support internally

b) Lack of best practice techniques/materials on environmental management for financial institutions

g) Lack of reward from financial markets (analysts, raters etc)

c) No qualified environmental consultants to support clients

h) Clients don’t want it

d) Lack of specific examples of environmental risk

i) Lack of time

e) It’s not standard banking practice

j) Other (please specify):

PART 11I: FOLLOW UP & RECOMMENDATIONS 3. Before the IFC workshop, did your institution have a procedure for managing environmental risk? a) Formal

b) Informal

c) None

1. What would be the most valuable role for IFC to play? a) Market Briefings: signaling environmental value-added to regional analysts, raters, media, central banks b) EMS Advanced: Advanced overseas workshops for coordinators on implementing performance-focused EMS

4. What are the major environment-related opportunities for your financial institution? a) Accessing intl. financial institution funding

e) Providing loans for environmental projects

b) Providing risk management services to high-risk industrial sectors

f) Providing eco-efficiency and cleaner production advisory services to small and mid-sized clients

c) Attracting new depositors

g) Attracting improved terms of insurance

d) Accessing ethical investment funds

h) Other (please specify):

c) Consultant training:Training of local consultants to assist clients d) EMS support: In-house support on EMS implementation to individual institutions e) Industry risk briefings: provide updated information on international risks/opportunities by sector f) Other (please specify): 2. Do you have any additional comments or suggestions?

Many thanks for all your input.

Annex B 75

FIGURE B1

FIGURE B3

TYPE OF FINANCING INSTITUTION SURVEYED

REGIONAL DISTRIBUTION OF INSTITUTIONS

SURVEY METHODOLOGY IFC surveyed 60 institutions, selected for diversity in region and business type. Figures B1–3, right, illustrate the breakdown of the sample into the following categories: a) the main type of business operations undertaken, b) types of investments financed, and c) location.

World

Other

Middle East & North Africa Commerical Banking

6% 4%

Central & Eastern Europe

10%

Southern Europe & Central Asia 27%

8%

26%

Project Finance 20%

Africa

INTERVIEWS Structured interviews were carried out with representatives from over 30 institutions who had participated in the CEA workshops. Annex C presents a list of those institutions visited. For the selection process, three criteria were applied:

8% ■

East Asia & Pacific

23%

9% 19%

21% Private Equity

South & Southeast Asia

19%

■

Leasing Latin America & Caribbean ■

FIGURE B2

FIGURE B4

MAIN BUSINESS SECTORS MOST COMMONLY FINANCED BY THE INSTITUTIONS

COMMERCIAL B ANKS

60%

56%

50%

Other

44%

9%

Domestic General Manufacturing

4% Hi-tech

37%

8%

44% 38%

40%

25%

30%

25% 19%

20%

19% 13%

13% 6%

10% 18%

Media events

Providing environmental loans Hiring of internal environmental/staff consultants

Export-oriented Industries

External reporting of EMS

24%

Development of environmental/social procedure Rejecting projects with environmental issues Working with clients to manage environmental impacts Report to Director/ Board on environmental risks/opportunities Communications to clients

0% Updating operating policy

Infrastructure

Other

Extractive Industries

56%

Training of internal staff

74 Beyond Risk

A focus on regional diversity: covering Africa, Europe, Middle East, Latin America and Asia A focus on diversity of financial institution type, covering commercial banking, project finance, private equity and leasing. For cost-effectiveness, a focus on countries where there are a number of IFC client institutions.

6%

6% 0%

13%

7%

FIGURE B6

The role potentially that IFC could play in supporting the process 80%

80% 60% 53%

50%

40%

40%

53%

40% 27%

30%

20%

20%

13%

10% External reporting of EMS

Development of environmental/social procedure Rejecting projects with environmental issues Working with clients to manage environmental impacts Report to Director/ Board on environmental risks/opportunities Communications to clients

Updating operating policy

Training of internal staff

Providing environmental loans Hiring of internal environmental/staff consultants

0%

0%

7%

10%

7%

7%

0%

0%

70% 60%

29% 14%

Development of environmental/social procedure Rejecting projects with environmental issues Working with clients to manage environmental impacts Report to Director/ Board on environmental risks/opportunities Communications to clients

6%

10%

90%

29%

20%

20%

LEASING INSTITUTIONS ■

29%

30%

Other

25%

43%

Media events

30%

36%

40%

Providing environmental loans Hiring of internal environmental/staff consultants

31%

External reporting of EMS

31%

50%

50%

38%

Updating operating policy

40%

44% 38%

57%

Training of internal staff

The major barriers, if any, for implementation of environmental management measures and how they have been overcome and,

50%

79%

70% 60%

56%

Other

■

70% 60%

Other

Any identified opportunities for the institution

80%

80%

Media events

■

90%

81%

Media events

Potential environment-driven risks to the institution, and its clients

90%

Providing environmental loans Hiring of internal environmental/staff consultants

■

PROJECT FINANCE INSTITUTIONS

External reporting of EMS

The institution’s background and operations

PRIVATE EQUITY INSTITUTIONS

Development of environmental/social procedure Rejecting projects with environmental issues Working with clients to manage environmental impacts Report to Director/ Board on environmental risks/opportunities Communications to clients

■

FIGURE B7

Updating operating policy

The objective of the interviews was to build on the information generated by the questionnaires and that provided by the participants during the course of the workshops. In particular they addressed the following issues:

Annex B 77

FIGURE B5

Training of internal staff

76 Beyond Risk

SUMMARY OF INSTITUTIONAL UPTAKE OF ENVIRONMENTAL MANAGEMENT 100% of respondents institutions reported that they implemented measures to enhance their environmental and social management capability after the workshop. Figures B4–7, pgs. 75–77, provide a breakdown according to institution type. Specific initiatives varied across institutions as indicated.

ANNEX C List of field interviews This is a blank page

➜

Annex C 81

➜

IN ADDITION TO THE SURVEY A REPRESENTATIVE LIST OF FI’S WERE VISITED

LIST OF FIELD INTERVIEWS PHILIPPINES 1. BPI 2. Planters Bank 3. DBP 4. Walden 5. H & Q BRAZIL 6. Icatu 7. Unibanco 8. Banco Real 9. Bradesco 10. Terra Capital

ARGENTINA 11. Banco Roberts 12. Bansud 13. BGN 14. Latin American Enterprise Fund HUNGARY 15. OTP 16. Budapest Bank 17. Raiffeisen Bank CZECH REPUBLIC 18. CSOB BULGARIA 19. Caresbac 20. BACB 21. Black Sea Fund

INDIA 22. IL & FS 23. IDFC 24. IndAsia TURKEY 25. Garanti Bank 26. Garanti Leasing 27. Alternatif Bank/Leasing 28. TEB bank 29. Ottoman 30. YKL 31. Rant Leasing 32. Finans Leasing 33. Demir Bank

ANNEX D CEA Workshop Participants: Phase I and II This is a blank page

➜

Annex D 85

➜

UP TO THE END OF 2002, SINCE 1997 21 CEA WORKSHOPS HAVE BEEN HELD IN THE U.S., SOUTHEAST ASIA, EUROPE AND AFRICA

WASHINGTON DC, USA, November 1997

WASHINGTON DC, USA, June 1998

Banamex Banco Axial S.A. Banco Bansud Banco Icatu Banco Mercantil Garanti Bank ICATU Equity Partners Interbank Latino Leasing S.A. Rant Leasing Suinternacional Suleasing Internacional S.A. Unibanco Zephyr Management L.p Advent International plc.

Banco Bilbao Vizcaya Banco del Suquia Banco Roberts Garanti Leasing Georgia Microenterprise Bank Honeywell Inc. IDFC Russian Technology Fund Shorebank Advisory Services TCW/ICICI India Private Equity Fund Trust Company of the West Tuninvest Private Equity Fund

PARIS, FRANCE, April 1998

Alternatif Bank A.S. ANZ Investment Bank Azerigazbank Joint-Stock Investment Bank Baku Banks/Azerdemiroylbank Black Sea Fund BMCE CA-Kiev Demir Romlease S.A. Demirbank (Romania) S.A. Finans Leasing Inkombank PEF-Advent PROPARCO RabitaBank Raiffeisen UNIC-Lizing Yapi Kredi Leasing

CAPE TOWN, SOUTH AFRICA, October 1998

Accuro AG Banco de Galicia Brait Capital Partners Development Bank of Southern Africa Ecobank Transnational Inc. FMO—Netherlands Development Finance Company Galicia Capital Markets S.A. Garanti Leasing Groundwork Environmental INCA—Infrastructure Finance Corporation Ltd. International Bank of Southern Africa Limited Santiago del Puerto y Asociados Swaziland Industrial Development Company Ltd. Yapi Kredi Leasing Zader Financial Services

Annex D 87

WASHINGTON DC, USA, November 1998

WASHINGTON DC, USA, May 1999

MILAN, ITALY, November 1999

WASHINGTON DC, USA, March 2000

Bancomer Bulgarian-American Credit Bank CSOB Ceskoslovenska Obchodni Banka Global Trust Bank Hungarian Foreign Trade Bank Ltd. Kula Fund Lac Enterprise Fund Raiffeisen UNIC-Lizing TEB Leasing Tower Fund Tuninvest Private Equity Fund Turk Ekonomi Bankasi Vilniaus Bank

ANZ Investment Bank Asian Infrastructure Fund Banco de la Exportación Banco General de Negocios (BGN) Banco Mercantil Barings Mexfund II Byblos Bank Syndicated CAL Merchant Bank Ltd. Carribean Loan Facility Demirbank (Romania) S.A. Environnemental Qualité International (EQI) Finans Leasing FINARCA—Financiera Arrendadora Centroamericana S.A. Hana Bank Hungarian Foreign Trade Bank Ltd. India Direct Fund International Expeditions Inc. NIS Restructuring Facility Ottoman Bank Romania & Moldova Direct Fund TCW/Latin America Partners. L.L.C Wilderness Gate

Led by the IFC in partnership with the Giordano Dell’Amore Foundation

Advent International Asaka Specialized State Joint-Stock Commericial Bank Banco BBA Creditanstalt S.A. Banco Cuscatlan Banco del ISTMO, S. A. Bank of Shanghai Capital Alliance Nigeria E & Co EIF Group Energy Global International Ltd. FEFAD Bank Garanti Leasing Guyana Bank for Trade and Industry Interbank Kazkommertsbank MBA Private Equity SSA National Bank for Foreign Economic Activity of the Republic of Uzbekistan National Development Bank OTP National Savings and Commercial Bank Ltd. Ottoman Bank Peace Technology Management Ltd. Stopanska Banka A.D. TbilComBank UBS

MANILA, PHILIPPINES, March 1999

Bank Austria Creditanstalt Slovakia A.G. CEAT Financial Services Ecobank Transnational Inc. Far East Bank & Trust Co. Hambrecht & Quist Philippine Ventures IL&FS Venture Corporation Limited Mercantile Leasing Limited Midway Infrastructure Holdings Ltd. Nations Trust Bank Pt Rabobank Duta Indonesia

Barclays Bank of Botswana Limited Bjelovarska Banka d.d. Demirbank (Romania) S.A. Diamond Bank Limited Ecobank Transnational Inc. Finance Bank Zambia Ltd. Finans Leasing Finansbank A.S. Generale de Banque de Mauritanie Guaranty Trust HC Securities & Investment Company Hussein Choucri Investment Bank NAL Merchant Bank SEF Kazkommerts Trust Merchant Bank

WASHINGTON DC, USA 2000

WASHINGTON DC, USA 1999

86 Beyond Risk

88 Beyond Risk

Annex D 89

BUENOS AIRES, ARGENTINA, October 2000

MILAN, ITALY

Led by the IFC & IIC ABN AMRO Banco Aleman Paraguayo Banco de Galicia y Buenos Aires BANCO DEL DESARROLLO Banco del Istmo, S.A. Banco Ficensa Banco General de Negocios Banco Montevideo Banco Nacional de Desenvolvimento Economico e Social Banco Suquia, S.A. CII

Compass Capital Management LLC DELTA LEASING HABITACIONAL, S.A. MSB Bank Argentina, S.A. Nuevo Banco Santa Fe HSBC Bank Argentina S.A. MILAN, ITALY, November 2000

Led by the IFC in partnership with the Giordano Dell’Amore Foundation Agricultural Credit Corporation Agricultural Development Bank Amity Bank Cameroon Plc. Bank of Eritrea Banque de l’Agriculture et du Developpement Banque due Liban Central Bank of Egypt Central Bank of Jordan Commercial Bank of Eritrea Commercial Bank of Malawi ElNilein Bank for Industrial Development Housing and Commerce Bank of Eritrea Metropolitan & Allied Bank (Ghana) Ltd. Ministry of Finance, Ethiopia Ministry of Finance, China National Bank for Development National Bank of Ethiopia Nile Bank Palestine Monetary Authority T.C. Ziraat Bankasi Tanzania Investment Bank The Treasury, Kenya

Led by IFC in partnership with the Black Sea Trade & Development Bank, the German Investment and Development Company, the European Bank for Reconstruction and Development, the Netherlands Development Finance Company, the Nordic Investment Bank, and the United Nations Environment Programme-Division of Technology, Industry and Economics. Akbank American Bank of Albania Baltic American Enterprise Fund Banca Romaneasca S.A. Banque Saradar, sal. Baring Vostok Capital Partners Limited CSOB Ceskoslovenska Obchodni Banka Demirbank (Romania) S.A. Energy House Capital Corporation, A Sibsidiary of E&Co ECO Solutions Co. Ltd. Global Finance S.A. ICICI Limited IDLC Industrial Development Leasing Company of Bangladesh Limited Industrial Promotion and Development Company of Bangladesh Limited ILFC International Leasing and Finance Co. Ltd. IBTC Investment Banking & Trust Co. Ltd. Kenya Commercial Bank Ltd. Kocbank Azerbaijan Ltd. Lebanese Leasing Company

Nordic Investment Bank MarocInvest Finance Group Middle East Investment Bank Muslim Commercial Bank Ltd. ORIX Leasing Egypt S.A.E. JSCB “Parvina-Bank” Small Enterprise Assistance Funds Neftebank Plc. SREI International Finance Limited Tuninvest Finance Group VUB Vseobecna Uverova Banka

ISTANBUL,TURKEY

American Bank of Albania Credit Lyonnais Raiffeisen Bank IL&FS Infrastrcuture Leasing and Financial Services Ltd. Energia Global International Ltd. H&Q Asia Pacific IndAsia Fund Advisors Pvt. Ltd. IBTC Investment Banking & Trust Co. Ltd. Komercijalna Banka a.d. Korea Development Leasing Corporation Oyak Bank A.S. Planters Development Bank Scotiabank Provident Group

ISTANBUL, TURKEY, November 2000

DAKAR, SENEGAL, March 2001

Led by IFC in partnership with the African Development Bank. ACEP Arab Banking Corporation BHM Banque del’Habitat du Mali BICEC Banque Internationale du Cameroun pour l’Epargne et le Credit BMCI Banque Mauritannienne pour le Commerce International Bank of Africa CBAO Compagnie Bancaire de L’Afrique Occidentale Ecobank—Senegal Generale de Banque de Mauritanie Ministere de l’Economie et des Finances, Senegal Environmental Tropicana Consultants SODIDA Societe de Gestion du Domaine Industriel de Dakar

DAKAR, SENEGAL

WASHINGTON DC, USA 2000

WASHINGTON DC, USA, June 2000

MIAMI, USA, June 2001

BUDAPEST, HUNGARY, June 2001

JOHANNESBURG, SOUTH AFRICA, November 2001

MANILA, PHILIPPINES, November 2001

Led by the Inter-American Investment Corporation in partnership with the Corporación Andina de Fomento and the IFC.

Led by the IFC in partnership with the Black Sea Trade & Development Bank, the German Investment and Development Company, the European Bank for Reconstruction and Development, the Netherlands Development Finance Company, and the Nordic Investment Bank.

Led by IFC in partnership with the Asian Development Bank, Development Bank of South Africa and United Nations Environment Programme.

Led by IFC in partnership with the Asian Development Bank and the Japan Bank for International Cooperation.

A2R Ltda Amigos da Terra Andrade Gutierrez Concessoes Ltda Banco Cuscatlan Banco del Bajio Banco del Pichincha C.A. Banco Grupo el Ahorro Hondureno Banco Impropsa S.A. Banco Interfin S.A. Banco Nacional de Obras y Servicios Publicos. S.N.C. Banco Popular Banco Santos Brazilian Mortgages BBVA Bancomer, S.A. Citibank Caja Los Andes S.A. Comprartamos FSB International Bank Plc. Wamex S.A. de C.V. Nuevo Banco de Santa Fe Small Enterprise Assistance Funds Environmental Enterprises Assistance Fund Suleasing Internacional S.A. TCW/Latin America Partners. L.L.C. Royal Merchant Bank and Finance Company Limited The Royal Bank of Trinidad and Tobago Limited

Advent International Axon Leasing Banc Post S.A. Banca Romaneasca S.A. Bank TuranAlem Citibank Croatia Banka Croatian Bank for Reconstruction and Development Demir Romlease S.A. Finansbank A.S. Hipoteku banka—Latvian Mortgage and Land Bank Raiffeisen Bank EFM (Slovak Post Privatization Fund) TBC Bank Turk Venture Partners VUB Vseobecna Uverova Banka

Banco de Microfinance de Mozambique BHM Banque del’Habitat du Mali Bioventures Brait Merchant Bank Ltd. Citibank DFCU Bank DFCU Leasing Company Limited Diamond Bank Limited Ecobank Ghana Ltd. Ecobank Nigeria Plc. Ecobank Togo EFG-Hermes Holding-SAE Emerging Markets Partnership First City Monument Bank First Merchant Bank of Zimbabwe Limited FRB/RMBID Futuregrowth Asset Management Gensec Bank Investment Banking & Trust Co. Ltd. Novo Banco ORIX Leasing Egypt S.A.E. Rand Merchant Bank The Mauritius Commercial Bank Ltd. Tuninvest Finance Group

AIF Asian Infrastructure Fund Management Ltd Asia Opportunity Fund L.P. Bank NISP Bank of South Pacific (BSP) BNP Paribas Asset Management Asia Ltd. Dragon Capital Hambrecht & Quist Philippine Ventures J.P. Morgan Partners Asia Liberty Pacific Direct Investments Ltd. Lombard/APIC (HK) Limited Muslim Commercial Bank Ltd. Oman Orix Leasing Company SAOG Prudential Asia Infrastructure Investors Limited SME Loan Hong Kong Ltd. The Vysya Bank Limited United Bank For Africa Plc. United Leasing Company Limited

JOHANNESBURG, SOUTH AFRICA

Annex D 91

MANILA, PHILIPPINES

BUDAPEST, HUNGARY

90 Beyond Risk

MIAMI, USA

92 Beyond Risk

MIAMI, USA, February 2002

MIAMI, USA, September 2002

Led by the Inter-American Investment Corporation in partnership with the Corporación Andina de Fomento and the IFC.

Led by the Inter-American Investment Corporation in partnership with the IFC.

Alliant Energy International America Leasing Advent International Banamex Banco Bradesco S.A. Banco Caja Social Banco de Credito Centroamericano Banco Interfin S.A. Banco Itau S.A. Brazilian Securities Cori Capital Partners, LP Corporacion Financiera Nacional y Suramericana S.A. Corporacion Interamericana para el. CIFI—Financiamiento de Infrastructura, S.A. Financiera Calpia S.A. FINARCA—Financiera Arrendadora Centroamericana S.A. FondElec America Latina Inc. Grupo Financiero Banorte Latin America Agribusiness Development Corporation Mibanco Small Enterprise Assistance Funds Su Casita Hipotecana Suramericana De Inversiones Trust Company of the West Unibanco Walden International Zephyr Management L.p

Bancentro Banco Cuscatlan Banco Interfin S.A. Banco Latinoamericano de Exportacion—Bladex CEA Latin American Communciations Communication Equity Associates Darby Overseas Investment Lt. Deutsche Asset Management Inter-American Investment Corporation Negocios Regionales Republic Bank Limited Scudder Investments Suleasing Internacional S.A.

MOSCOW, RUSSIA, October 2002

Organized by IFC Agroindustrial Finance Company Alenir Baltiskii Leasing Delta Leasing Deutsche Leasing Vostok KMB Leasing KNK Leasing Microleasing Moscow Leasing Company

ANNEX E References, links and further information sources

➜

Annex E 95

A2R website: http://www.a2r.com.br/ ABN AMRO website: www.abnamro.com/com/about/about.asp Angus Reid Group (Ipsos-Reid), Corporate Social Responsibility and the BC Public, Canada, April 2000. Arnold, Matthew B. and Robert M. Day. The Next Bottom Line: Making Sustainable Development Tangible. World Resources Institute. 1998.

➜

IN ADDITION TO THE SOURCES LISTED WE ARE VERY GRATEFUL TO ALL THE INDIVIDUALS AND COMPANIES THAT HAVE CONTRIBUTED TO THIS CASEBOOK

Atkisson, Alan, “The Innovation Diffusion Game” in Making It Happen, Spring, 1991.

Citibank website: citibank.com/citigroup/corporate/issues/data/env.htm Cleemann, “Insurance and Sustainability: Risk Assessment within a Changing World”, Allianz Center or Technology/Industrial Technology International Symposium, Zurich, 2001. Co-operative Bank, Partnership Report. (2000 and 2001) ENTOVATION International, “The Knowledge Value Proposition”

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Hikima, Masafumi, “New Horizons in Asset Management: The Japanese Experience.” Seminar delivered at the International Symposium, September 2001, Zurich. Holman and Kahn, “Intangibles: The Measures that Matter,” Ernst & Young LLP, 2001. HSBC Holdings website: www.hsbc.com/

96 Beyond Risk

Hurley, Stephen T. Internal Marketing: Measuring and Communicating Value. Information Technology Services Marketing Association, 2001. Infrastructure Development Finance Corporation website: www.idfc.com/pages/Environ/environm.html

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Jeucken, Marcel: “Sustainable Finance and Banking: The Financial Sector and the Future of the Planet” 2001. Longstreth, “The Prudent Man Rule Today— Variations on a Single Theme”, 1987. National Development Bank website: www.ndb.org/pages/e-fri.htm

Trillium Asset Management website: www.trilliuminvest.com/pages/sri/sri_home.asp

Beyond Risk First printing, June 2003 Printed on recycled paper using soy-based ink

Tuninvest Finance Group website: www.tuninvest.com/

Principal author: Leo Johnson, Consultant

UBS Media Relations, “UBS and the Global Compact.” Zurich/Basel, July 26, 2000.

Copyright © 2003 International Finance Corporation (IFC) 2121 Pennsylvania Avenue, N.W. Washington, D.C. 20433 USA www.ifc.org

UNEP Finance Initiatives: www.unepfi.net. Weiler, “Review of Environmental Risk Management at Banking Institutions and Potential Relevance of ISO 14000", Working Paper, April 1997. DESIGN | [email protected]

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