Copyright Kenya Bankers Association, 2015

Case Study:

Three cases to demonstrate the risk to business viability from unmanaged E&S impacts

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Three cases to demonstrate how unmanaged E&S impacts can generate business risk

Introduction

The present case study considers three projects

highlighting where community health and safety

issues present a significant business risk - for both

clients and banks providing loans.

The case considers a fertilizer plant, a chemical

plant dealing with highly inflammable substances,

and a production unit for activated carbon from

coconut shells.

Each of the three banks approached for

financing had an Environmental and Social Risk

Management System (ESMS) in place, as well as

a policy requiring clients with high E&S risk profiles

to adhere to the IFC Performance Standards (see

box on p.11).

All three cases clearly show that there is a strong

business case for banks to assess and manage

E&S risks, particularly community health and

safety risks.

While the first bank was able to avoid large losses

by properly formulating conditions prior to

disbursing the loan to its client, the third incurred

them, as it had not properly assessed the risks. In

the second case the bank successfully engaged

its client in mitigation.

All the cases are based on actual facts, and

names have been changed for reasons of

confidentiality.

Cutting the wrong corners

The company concerned is a medium sized

fertilizer manufacturer in sub-Saharan Africa. It is

located two kilometres from a national park and

near to a major

international

watercourse that is

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already considered to be “environmentally

stressed” due to pollution levels.

The company has applied for a long-term loan of

around $10m. The bank categorized its activities

as a high-risk project and engaged an external

consultant to assist with the E&S due diligence.

Findings of the E&S due diligence

The E&S due diligence revealed weaknesses in

E&S management commitment and capacity

(IFC Performance Standard 1), pollution control

(PS 3), community health and safety impact

management (PS 4) and management of

impacts on the nearby national park (PS 6).

In particular, it noted that remediation actions

had not been implemented to control and

manage pollution, or to avoid significant failure

of the effluent holding ponds. These leakage risks

had been known for at least six months and the

local authorities had specifically requested the

company to address them. Specialists hired by

the company had proposed a series of mitigation

measures, a budget, responsibilities and a time

frame.

However, because of financial and time

constraints, and limited expertise, the

recommended actions were not implemented

before the loan request was made. During the

due diligence, the company management

appeared to underestimate the potential risks

associated with leakage from the pond.

Accordingly, and in order to remedy risks for both

the client and the bank, the following condition

precedent was formulated: “Client to successfully

implement all necessary activities to reduce

leakage risk”.

The E&S due

diligence found out

that the

remediation actions

as suggested with

regard to the

leakage risks were

not implemented

even though the

suggested timing

had expired.

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What happened next?

Shortly after the bank agreed to the facility in

accordance with the preconditions, heavy rain

resulted in the release of significant volumes of

polluted effluent into the neighboring river after

the holding ponds had failed.

Wildlife and livestock were affected, with deaths

occurring along a 15km stretch of the river, and

tourism activities had to be suspended.

The local environmental authorities closed the

facilities for several weeks until the root causes

were identified and clean-up measures identified

and implemented.

Fortunately, the first loan disbursement was on

hold pending the implementation of the

condition precedents when the river pollution

incident happened. At the time of writing it is still

unclear whether or not the company will survive.

What do we learn from this case?

1. The characteristics of the receiving environment have a bearing on the

consequences of an impact. In this case, the location on an

environmentally stressed watercourse upstream from a National Park

increased the sensitivity of the environment, and so the client should

have taken more precautions.

2. The bank’s E&S system correctly identified the need for stringent

conditions regarding the repair of the leaks and saved it from potential

losses.

3. Paying attention to the E&S clauses and applying them in the loan

agreement are critical first steps in ensuring improved management of

E&S impacts..

First disbursement was on hold when the river pollution

incident happened.

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Beyond our direct control, so it is

not our business?

The second case relates to a greenfield chemical

plant in East Africa involving highly inflammable

substances. The request was for a multimillion-

dollar long term loan from a Kenyan bank. The

project sponsors are considered to be very

professional and have a good track record in the

industry. The market potential looks good, the

technology used is state of the art, all E&S related

licenses have been obtained, construction is

almost completed, and first trial runs have started.

As part of a belated E&S due diligence, the

investment officer of the bank categorised the

project as “high risk”, triggering the need to

establish whether it was in line with the IFC

Performance Standards. Of particular concern

were the risks to worker and community health

and safety, so an external expert was hired to

undertake a site visit and review the

Environmental and Social Impact Assessment

(ESIA) that had been prepared by the client and

approved by the authorities.

The study was found to address most of the

requirements of the IFC Performance Standards,

but there were a number of issues that had not

been adequately considered by the ESIA:

1. Inadequacy of emergency preparedness

and response plans and the absence of

any engagement with neighbouring

entities or communities;

2. The potentially fatal risks associated with

inadequate emergency services, poor

road infrastructure and a congested

industrial neighborhood;

3. The presence of informal vendors

immediately outside the company walls,

some of whom were preparing food and

beverages on open fires close to the

petroleum intake.

The eight

Performance

Standards have

become the

benchmark standards

for FI’s E&S risk

management.

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The mitigation measures proposed included:

1. The development of a joint emergency response plan in consultation

with neighbouring companies and vendors;

2. Movement of the vendors to a vacant space 50 metres away from the

company boundary;

3. Improvements to the road infrastructure to ensure a quicker response

time of emergency services.

Although the company may not incur any major costs directly, management

must be committed to ensuring that the measures are implemented,

especially as some of them are the responsibility of third parties, such as the

local authority. Without these measures the safety of the public and other

businesses are put at risk.

What do we learn from this case?

1. Be aware when projects with inherently high community health and

safety risks are located in a congested environment. Always ask

whether the location is appropriate, regardless of approvals from

authorities. Are you exposing the bank unnecessarily?

2. Look beyond the factors that are directly within your client’s control.

What impact might your client’s activities have on areas outside their

direct control, such as the road infrastructure? Understand these risks,

establish whether the client has any influence over their management

and identify strategies and the associated costs.

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Activated Carbon

Company from a bird’s

perspective (Source:

Google Earth)

Community kicks up some dust

The third case features a medium size company

that manufactures activated carbon from

coconut shells. Activated carbon is considered to

have several environmental benefits, as it is used

in filters to trap pollutants and is made from

organic waste.

While the product has benefits, its production

generates heavy dust pollution if it is not

managed properly by applying dust abatement

measures throughout the production chain, and

covering the stock to protecting it from the wind.

In order to expand production by developing a

further two hectares, the company requested a

long term loan of $7m. As part of its E&S risk

assessment the bank categorized the project as

medium risk and asked the client to respond to a

standard E&S questionnaire. No E&S specialist

was engaged.

The bank was under some pressure to close the

deal quickly and did not send a representative to

the site before approving and signing the facility

agreement. A clause was included in the

agreement requiring the company to comply

with all relevant local E&S legislation and norms

but at no point was it requested to submit

documentation to demonstrate compliance.

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What could have gone wrong?

Shortly after the loan agreement was signed, the bank learned from a

newspaper report that the company had been closed down by the local

authority. The trigger for the closure was a community protest that had

blocked the factory and turned violent. The community was protesting

against the high levels of dust pollution and was concerned that the factory

expansion would worsen the situation.

It subsequently became clear to the bank that the factory had been

exceeding national emissions levels by a significant amount for some time,

but the local authorities had only issued occasional warnings and taken no

other action. None of this information had been shared with the bank when

the due diligence was undertaken and at no point after signing the loan

agreement did the bank follow it up. Had the bank taken the time to visit the

site and also to consult the employees and surrounding communities it would

not only have seen the high levels of dust but also have heard how the dust

was affecting residents and fuelling their concerns about an expansion.

For reputational reasons, the bank decided to withdraw from the project,

incurring heavy financial losses.

The company just about survived, but needed to install dust abatement

equipment and E&S management systems and invest heavily in corporate

social responsibility activities and community engagement to begin the

process of rebuilding local trust. Had the issue of dust emissions been

addressed earlier, the reputational and financial losses could have been

prevented.

What have we learned?

1. Do not rely on the client to conduct your due diligence, and visit the

site as often as possible, ideally with the help of a specialist. Continue

visiting the site even after disbursements have been made.

2. Talk to other stakeholders during the site visits, especially those directly

affected such as neighboring communities. This can be more revealing

than studying reports.

3. Start to consider E&S issues as early in the process as possible to avoid

cutting corners with the E&S due diligence.

4. Would you and your family like to live next to the project you are

financing? If not, you can probably count on community activism.

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Lessons Learned from all Cases

1. E&S Management Systems in FIs pay: The integration of an E&S risk

assessment into the credit analysis processes can prevent significant

financial losses in the loan portfolio. Unfortunately, experiences show

that banks need to have incurred financial losses due to unmanaged

E&S risks at least once, before they start implementing such a system.

2. E&S risk enquiry must go beyond boundary walls: Understanding the full

scope of a client’s activities, area of influence and potential impacts is

fundamental. High risks can be associated with impacts on a

surrounding community, in the supply chain or an associated activity

that is located apart from the primary operation.

3. Don’t be shy with clients: Engaging with the client on E&S issues does

not damage the relationship between you. On the contrary, as shown

by the chemical industry case study the E&S conversation can be

much appreciated. A bank’s fear over losing business when addressing

E&S risks is rarely justified.

4. Don’t rely on permits only for due diligence: Relying on the clearance

and monitoring of environmental authorities (permits, acceptance of

EIA studies, etc.) may not always be sufficient. There are many

investment projects in which E&S risks have turned into business risks,

and they need to be treated as such, regardless of whether an

authority has passed an approval.

5. When in doubt, involve specialists…: E&S risks are not always obvious

and some can only be identified by experts. For financial institutions, it

is of prime importance to gauge whether a particular project could

have high E&S risks elements, and if so, where the right expert can be

found.

6. …and open your own eyes: Some E&S risks, including those to

neighboring communities, are often obvious and can be identified by

a non-expert. Never underestimate the importance of site visits and

taking the time to see as much as possible for yourself.

7. Be alert to inadequate management commitment and capacity: The

risk of a costly disaster is generally higher when a client’s activities have

inherently high E&S risks and when their track record indicates a lack of

commitment and capacity to act appropriately. This risk is heightened

when the bank is under pressure to close the deal rather than ensure

that the client takes appropriate mitigation measures.

IFC Performance Standard

The IFC Performance Standards (PS) define banks clients’ responsibilities for

managing their environmental and social risks. Together, they establish

standards that the client is to meet throughout the life of an investment.

IFC Performance Standard 1: Assessment and Management of E&S Risks

and Impacts

IFC Performance Standard 2: Labor and Working Conditions

IFC Performance Standard 3: Resource Efficiency and Pollution Prevention

IFC Performance Standard 4: Community Health, Safety, and Security

IFC Performance Standard 5: Land Acquisition and Involuntary Resettlement

IFC Performance Standard 6: Biodiversity Conservation and Sustainable

Management of Living Natural Resources

IFC Performance Standard 7: Indigenous Peoples

IFC Performance Standard 8: Cultural Heritage

IFC PS have become the benchmark standards for a bank’s E&S risk

management.

An estimated 80% of total project finance debt in emerging market economies

is already based on IFC PS.

Adherence to IFC PS and framework is international good banking practice

and significantly reduces risks.

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Bhopal: A

disastrous accident

banks would not

want to be

involved in, and

case to learn from.

Union carbide pesticide plant in

Bhopal

One of the most disastrous industrial accidents of all

times: Bhopal

It occurred on the night of 2–3 December 1984 at

the Union Carbide India Limited (UCIL) pesticide

plant in Bhopal. Over 500,000 people were exposed

to methyl isocyanate and other chemicals.

The toxic substance made its way in and around the

shanty towns located near the plant. Estimates vary

on the death toll. The official immediate death toll

was 2,259. An investigation into the root causes of

the accident revealed that:

1. Gas tanks were filled beyond recommended

levels.

2. Equipment was poorly maintained.

3. There was a failure of several safety systems

(due to poor maintenance).

4. Some Safety systems were switched off (to

save money).

5. Little manpower was used (to save money).

6. No stainless steel used for crucial equipment

parts (to save money).

The problem was made worse by the mushrooming

of slums in the vicinity of the plant, non-existent

emergency response plans, and shortcomings in

health care and socio-economic rehabilitation.

By 2007, more than 1 million cases were filed out of

which some 570 thousand were awarded. The total

financial impact to the firm was in excess of $240m,

not including decontamination and environmental

rehabilitation costs.