Banking Sustainability Regulator

8/12/2019 Banking Sustainability Regulator

1/20

Global Banks As Global Sustainability Regulators:

Te Equator Principles

Cynthia A. Williams*

Te concept of unintended consequences is well-known in the law literature. Uniformly, the

phrase refers to the unintended negative consequences of a regulation or policy. In this Article,

we focus instead on one unintended, potentially positive, and quite surprising consequence of

the deregulatory, privatization trend in public development finance that occurred in the 1990s.

his trend had a number of significant components. he privatization of public and state-

owned services such as energy, water, resource extraction, and basic industries required by

World Bank and International Monetary Fund structural adjustments in the 1980s and 1990s

set the stage for private banks to play a much larger role in infrastructure investment than

previously. Simultaneously, the World Bank Group and other multilateral public development

banks began to withdraw from large infrastructure investment, including such high-profile

projects as the Tree Gorges Dam project in China, and the Narmada Valley series of dams

in India, having been battered by effective activism by environmental non-governmental

organizations (NGOs). 1)

* Professor of Law, Osler Chair in Business Law Osgoode Hall Law School. Co-authors: Peer Zumbansen,

Poonam Puri, Deborah Rupp, John Conley and Ruth Aguilera. Tis paper is presented at INERNAIONAL

CONFERENCE entitled GLOBAL BUSINESS LAW: MAJOR ISSUES AND CHALLENGES held on Friday,

November 30, 2007 at Grnad Hiton Hotel, Seoul, Korea, Organized by Kyung Hee Institute of Legal Studies.

1)SeeFranck Amalric, Te Equator Principles: A Step owards Sustainability?,Center for Corporate Responsibilityand Sustainability, the University of Zurich, CCRS Working Paper Series No. 01/05 at 10 (Jan. 2005)(copy on

file with authors).

I.

II.

III.

IV.

V.

Requirements of the Equator Principles

An Example of Greater Uptake: HSBC

Motives of the Equator Principles Banks

Teoretical Perspectives

Conclusion


2/20

1 1

Tese trends were viewed with dismay by those same NGOs. One reason for their dismay,among many, was that they had worked assiduously, and successfully, throughout the late

1980s and early to mid-1990s to require public funding agencies such as the World Bank, the

International Finance Corporation (IFC), various regional development banks, and Export-

Import Credit agencies to incorporate explicit social and environmental standards for projects

being funded with development finance. Now, with the entrance of Wall Street and City banks

into the development market, that work would need to be done again, and without the public-

regarding official mandate of the World Bank and the IFC to use as leverage.

And yet, as an unintended consequence of this retrenchment and privatization, private

banks with global reach have begun to play a regulatory role throughout the world, imposing

developed-country social and environmental sensitivities, procedures and standards across the

entire range of the worlds industries and development activities. Te mechanism through which

this has occurred is the Equator Principles, first promulgated in 2003 and then revised in 2006.

his voluntary agreement encompasses a set of industry-wide standards for assessing and

managing environmental and social risk that was taken directly from IFC standards, as further

described below. he Equator Principles apply only to project finance, which is the method

used to provide capital to develop large infrastructure projects, such as telecommunications

facilities, oil and gas pipelines, mines, electrical power plants and hydro-electric dams. Tese

are non-recourse loans, meaning that lenders are repaid only through the revenues generated

by the project. As a result, even where the project sponsor (the borrower) is one of the world

s most profitable companies, such as Exxon Mobil, Royal Dutch Shell or Wal Mart, the banks

have particularized financial risks from anything that might slow down or derail the project. As

a result, the banks need to be concerned about human rights issues, labor issues, community

relationships, indigenous peoples rights, environmental issues, political turmoil: anything that

might lead to pipelines being destroyed, forests being deliberately burned, or production being

shut down or slowed down by labor problems.

Unlike some other voluntary sustainability initiatives, there are no agreed certifying

organizations or actual certifications that a project meets Equator Principles standards; rather

each institution that adopts the Principles will a individually declare that it has or will put in

place internal policies and processes that are consistent with the Equator Principles.2)hose

processes include using a common framework to identify infrastructure investments as posing

2)Te Equator Principles, Frequently Asked Questions, available at http://www.equator-principles.com/faq.shtml(last visited June 29, 2006).

14 | KHU


3/20

200

high, medium or low environmental or social risk, on the basis of an Environmental and SocialImpact Assessment, typically done by outside consultants. In many OECD countries, an

Environmental Impact Assessment will have been required by law as a condition for regulatory

approval of the project, but in many developing countries the Assessments will be performed

only because a bank has agreed to participate in the Equator Principles. Where a project

is identified as medium or high risk, participating banks will require their clients to have a

management plan designed to mitigate those risks, and loan covenants that require clients to

comply with those management plans or be declared in default.

Forty-one international financial institutions agreed to implement the first Equator Principles,

including such global banks as ABN AMRO, Barclays, Citibank, Credit Suisse, Dresdner Bank,

HSBC, ING Group, JP Morgan/Chase, Royal Bank of Scotland, and Wells Fargo.3)Fifty-four

international financial institutions have signed on to the revised Principles as of October 1,

2007. he revised Principles include stricter standards for social issues, such as expanded

requirements concerning labor protections, community health, safety and security, enhanced

requirements for community consultation prior to a projects initiation, implementation of

dispute resolution mechanisms, and some requirements for public reporting on the Banks

implementation of the Principles.4)As a result of this broad adoption, the Equator Principles are

now in use by lenders for approximately 85% of global project finance.5)

Te implications of this process are profound, at least in theory. As one set of commentators

have stated, A[b]ecause project financing is often used outside of the worlds developed

economies and legal systems, it is not uncommon for the project documentation to form the

principal legal framework for the transaction. Tus, the Equator Principles, like other standards

of social and environmental behavior or company codes of conduct, have the potential to

>importrule of law and developed country business norms into the worlds emerging economies,

at least with respect to large development projects. It is thus a concrete example of the

proliferating forms of global regulation that collectively (and inaccurately) are known as a new

3)SeeEquator Principles, available at http://www.equator-principles.com.4)SeeDemetri Sevastopulo,Revisions Raise Social Hurdles, Financial imes, Special Report: Sustainable Banking,

2 (June12, 2006). See alsoEquator Principles, available at http://www.equator-principles.com.

5)SeeDealogic Says Equator Banks Arranged 75% of Project Loans in 2003,London: June 4, 2004 Press Release,available at http://www.equator-principles.com. Update to 2007.

15|Global Banks As Global Sustainability Regulators: The Equator Principles


4/20

1 1

governance or a soft law.

6)

And yet the potential future import of the Equator Principles goes beyond regulation of

project finance, important as that might ultimately turn out to be. While 80% of project

financings are now understood to be subject to the Equator Principle standards, project

finance is only about 5% of a typical banks book of business. What is particularly intriguing

is that in some banks, such as Barclays, HSBC, and JPMorgan Chase, the process of signing

onto the Equator Principles seems to be both evidence of, and a further catalyst for, cultural

change within the bank. hose banks have made decisions to apply the Equator social

and environmental standards for a sustainable banking across product categories, such as

underwriting, commercial lending, and retail banking, and across industries. Moreover,

given the need to syndicate bank financing for many kinds of large projects, including project

finance ventures, companiesjoint ventures, high-value commercial loans and underwriting of

stock and bond offerings, even where non-Equator banks are in the lead on a project, Equator

Principles are starting to be the standard that is being applied to social and environmental risk

management in order to be able to actually syndicate the project. Tat is, asserting that the

project is being managed in accordance with the Equator Principles is becoming the expected

global standard of social and environmental risk assessment, mitigation and management.

hus, what began as a change in lending procedures by a number of global banks in an

important but limited arenaBproject financeBis reverberating throughout the industry, and

in some cases is starting to transform the values and business practices of the banks across a

wide spectrum of lending and underwriting activities. What we are seeing is thus not only self-

regulation of the banks, but the beginnings of social and environmental regulation of global

business by the banks.

Te potential importance of this development and we stress the word potential is profound.

We academics, commentators, the press and policy makers have been seduced by the capital

markets. Among academics concerned with companies social relationships and responsibilities,

much attention has been paid to changing companies behavior through changes in corporate

disclosure to the markets and changes in shareholder voting, engagement, investment and

6) Inaccurate because these means of shaping behavior are neither new (seeSir Henry Sumner Maine, AncientLaw: the Connection with the Early History of Society and its Relations to Modern Ideas,113-170 (17thed. 1901),

discussing norms of family relationships in ancient Rome and their relation to later parallel systems of law),

nor are they a law. Still, there is an important concept being described in the linguistic shift from government

to governance, one that better describes the actual state of regulatory play, with treaties, statutes, regulations,

codes of best practice, Commissions recommendations, norms and business practice all structuring global

business relationships. Tus, we will continue to use the term a new governance.

16 | KHU


5/20

200

divestment. Yet, changes in credit market behavior could ultimately be a powerful mechanismto affect companys social behavior, and those changes have not been subjected to the same

attention as have equity market interventions. While the market capitalization of listed

companies in the US, as a percentage of GDP, was 130.3% in 2003, domestic credit to the

private sector, as a percentage of GDP, was 238.7%. 7) A similar relationship obtains throughout

the developed world, with bank finance greater than stock market capitalization, with the

exception of Canada, where stock market capitalization is greater than bank finance (104.4%

of GDP versus 81.3%).8) In the rapidly emerging markets, the so-called BRIC countries, stock

market capitalization is about the same size as the credit markets, as a percentage GDP, with

the exception of China, where stock market capitalization is 48.1% of GDP, and bank finance

is 147.3%.9) For developing countries, the pattern is of bank financing being a more important

source of external finance than is the stock market.10)

Tere are many questions that these developments provoke. Why have so many banks signed

onto the Equator Principles, including banks that were not particularly exposed to the kinds

of reputation risk that motivated some of the early adopters and leaders? What predictions

can we make about which banks will be vigorous implementers and which not? How will

regional patterns of adoption affect the efficacy of the Equator Principles as global regulation?

What implications, if any, are there for our theories of corporate governance from these

developments, given that we observe external networks within an industry having an effect

within the corporation in a number of global banks? And, perhaps most intriguing, why are

some banks exhibiting what seems to be a more profound uptake of the Equator Principles,

leading to changes in business practices and standards for lending, underwriting and on-going

client relationships across industries?

We are just at the start of investigating this phenomenon, and so have no definitive answers

to these questions yet to offer. We can develop a framework within which to do further work,

however, which is the purpose of this paper. What follows in Section I is some greater detail

about what the Equator Principles now require, both procedurally and substantively. Section

7)SeeBen Scholtens,Finance as a Driver of Corporate Social Responsibility,68 J. BUS. EHICS 19 (2006), citingWorld Bank, World Development Indicators, 2005. Make sure this is domestic credit to companies being

measured: seems it could well include mortgage finance and even credit card debt.

8)See id.(average stock market capitalization for Argentina, Brazil, China, India, Indonesia, Russia and SouthAfrica is 59.9% of GDP, and domestic credit is 58.9%.).

9)See id.10)See id. (average stock market capitalization is 12.7% of GDP, while domestic credit is 28.1% of GDP).



6/20

1 1

II will provide an illustrative example at one bank of the more thorough-going uptake that wehave mentioned above. Section III will explore some theories that have been advanced in the

literature about the motives of participating banks. Section IV will discuss some of the apparent

benefits and limitations of the Equator Principles as global regulation, both as self-regulation

of project finance and as broader outward regulation of businesses more generally as EP

Banks start to apply the motivating impetus behind the Principles Battending more carefully to

broad categories of social and environmental risk-- across categories of industries (agriculture,

energy, finance, forestry, oil and gas, mining, for instance) and across business lines within the

bank (commercial banking, investment banking, underwriting). While the Equator Principles

are fairly new, certainly in relation to the time frame of infrastructure investment, a number

of projects have begun in accordance with the Principles, and some of the underlying social

and environmental assessments, contracts, management systems and progress reports and

evaluations are available to use as resources for this evaluation. Section V will turn to theory,

exploring both the corporate governance implications of the Equator Principles, and theories

from anthropology, organizational psychology, sociology and law that might explain why

adopting the Principles may lead to greater cultural change within some banks. Section VI will

conclude by discussing managerial and policy implications.

I. REQUIREMENS OF HE EQUAOR PRINCIPLES

Adopters of the 2006 Equator Principles (EP2) pledge to apply a systematic environmental

and social assessment framework to categorize project loans with a total cost of $10 million,

reduced from a $50 million trigger in the 2003 Equator Principles (EP1). he purpose is to

ensure that the projects the [Equator Principles Financial Institutions] finance are developed in

a manner that is socially responsible and reflect sound environmental management practices.11)

Te banks that agree to the Principles state that they will not provide loans to projects where

the borrower will not or is unable to comply with our respective social and environmental

policies.12)

Nine principles are included in EP2. Principle 1 commits the banks to review new

11)Te Equator Principles, AA Financial industry benchmark for determining, assessing and managing social andenvironmental risk in project financing, available at www.equator-principles.com (last visited Sept. 27, 2007).

12)Id.at Preamble.

1 | KHU


7/20

200

projects, expansions of existing projects or advising on projects in accordance with the IFCs environmental and social screening criteria. hese screening criteria will consider in an

integrated manner the potential social and environmental (including labor, health, and safety)

risks and impacts of the project13)considering the type of project, location, sensitivity of the

environment, characteristics of the community and the like. For all category A (high risk) and

category B (medium risk) projects, the borrower must conduct a Social and Environmental

Assessment (or have one conducted by specialists), as well as identify what measures can be

taken to mitigate and/or manage the risks identified in the Assessment. 14)For all Category A

and B projects in non-OECD countries or non-high income OECD countries, the Assessment

will rely upon the then applicable IFC Performance Standards for social and environmental

assessment and management.15)Ten, borrowers will develop a mitigation and management

plan (the Action Plan), incorporating on-going monitoring of the risk factors.16)As part of the

assessment process, the borrower will consult with all affected communities in a structured and

culturally appropriate manner.17)pecific requirements exist for the consultation: that affected

communities be provided with the assessment and action plan in their languages and in a

culturally appropriate manner; that community concerns be taken account of; and that there be

documentation of how communitiesconcerns were taken into account.18)

Principle 6 requires the borrower to establish a grievance mechanism for all Category

A projects and category B projects in non-OECD countries, as appropriate, to ensure that

consultation, disclosure and community engagement continues throughout construction and

operation of the project.19)It also requires the borrower to inform the affected communities

of the grievance mechanism, and to ensure that the process resolves grievances promptly and

transparently.20)Principle 7 requires an independent review of the Social and Environmental

Assessment, Action Plan and consultation process documentation in order to assist the Banks

in their due diligence and assess EP2 compliance.21)

13)International Finance Corporation,Performance Standard One: Social and Environmental Assessment andManagement Systems,&4 (Apr. 30, 2006).

14)Equator Principles,supranote 10, Principle 2.15)Id.,Principle 3.16)Id.,Principle 4.17)Id.,Principle 5.18)Id.19)Id.,Principle 6.20)Id.21)Id.,Principle 7.



8/20

1 1

he Equator Principle Financial Institutions (AEPFIs) view an important strength of thePrinciples [to be] the incorporation of covenants linked to compliance in the financing

documentation; thus, Principle 8 details a number of specific covenants that will be included,

such as a covenant to comply with the Action Plan, to provide periodic reports that document

compliance with the Action Plan, and to decommission the project, where appropriate, in

accordance with the plan.22)If there are breaches of these covenants, the Banks agree to work

with the borrowers to bring them into compliance, and if those efforts fail, the Banks will have

whatever remedies theyve agreed upon for breach in the financing documents.23)

Finally, there are monitoring and reporting requirements. Principle 9 requires that the

borrowers appoint an independent environmental and social expert to evaluate its periodic

reports to the Banks; this is a requirement for all Category A projects, and Category B projects

as necessary.24)Principle 10 commits Equator Principles Banks to report publicly on an

annual basis about its EP2 implementation, taking into account appropriate confidentially

considerations.25)he reporting should at a minimum include the number of transactions

screened by each EP Financial Institution, including the categorisation accorded to

transactions (and may include a breakdown by sector or region), and information regarding

implementation.26)And, the EP2 ends with a disclaimer stating that the EP2 instrument is a

financial industry benchmark for developing individual, internal social and environmental

policies, procedures and practices, and do not create any rights in, or liabilities to, any person,

public or private.27)

II. AN EXAMPLE OF GREAER UPAKE: HSBC

As one example of the cultural change that we suggest is occurring within some Equator

Principles banks, we would point to HSBC, but we could have just as easily chosen to highlight

developments at Barclays or JPMorgan Chase or Citibank (although these latter two banks are

at an earlier stage in the transformative process). HSBC was awarded the Financial imes first

22)Id.,Principle 8.23)Id.,Principle 8.24)Id.,Principle 9.25)Id.,Principle 10.26)Id.27)Id.,Disclaimer.

20 | KHU


9/20


10/20

1 1

of commercial logging operations in primary tropical moist forests; high conservation valueforests; logging in violation of local or national laws; or logging that risks species identified as

endangered according to international agreements.32)Particularly interesting, HSBC states that

it is its preference to deal with customers that are either operating managed forests that are

certified by the Forest Stewardship Council (AFSC), or equivalent FSC recognized standard, or

trade in products that are FSC-certified or equivalent.33)Te Forest Stewardship Council is an

industry/NGO collaboration that developed standards for sustainable forestry, and its standard

is not only the one that HSBC recognizes as best in class, but is one academic evaluation has

also recognized as more protective than competing standards.34)It is interesting that HSBC

has not only chosen a rigorous standard by which to select its projects, but that it is willing to

piggy-back upon a multi-stakeholder voluntary standard to use as a gatekeeper for its forestry

activities.

Similar patterns obtain with respect to the other sector guidelines. All of them refer to

HSBCs commitment to the Equator Principles. Where there are well-recognized voluntary

standards that have been developed by industry participants and NGOs or international

financial organizations such as the World Bank and the IFC, HSBC uses those as a benchmark

and as guidance in lending, underwriting, asset management and advising. Tus we can see

some evidence of how new governance is operating in the financial services sector, and the

way voluntary articulations of best practices are becoming adopted by leaders in the industry.

For instance, HSBCs freshwater infrastructure guideline, which was its first sector guide to be

published in May of 2005, relies upon the World Commission on Dams (WCD) Framework for

Decisionmaking on building new dams, and commits to not provide any financial assistance,

including any credit facilities, advising or underwriting, for projects that do not conform to the

WCD framework, or that impinge upon critical habitats, internationally protected wetlands,

or UNESCO world heritage sites.35)Te chemical sector guideline (August 2005) relies upon

the World Bank and IFCs guidelines and standards, while also stating that it will not provide

any facilities or financial advice or underwriting for chemical weapons or persistent organic

32)HSBC Website, available athttp://www.hsbc.com/1/2/corporate social responsibility/forestlandpdf.33)See id.34)Seeim Bartley, Certifying Forests and Factories: States, Social Movements, and the Rise of Private Regulation

in the Apparel and Forest Products Fields,31:3 POLIICS AND SOCIEY 433 (2003).

35)See HSBC Infrastructure Sector Guidelines, available at http://www.hsbc.com/1/PA_1_1_S5/content/assets/csr/freshwater_infrastructure_guideline.pdf (last visited Oct. 1, 2007).

22 | KHU


11/20

200

pollutants.

36)

With respect to energy (June 2006), there is no agreed standard but HSBCreferences development in accordance with the Equator Principles, World Bank and IFC

pollution prevention standards, as well as Kyoto and its own efforts to support reductions

of greenhouse gas emissions, as well as a commitment not to finance projects in UNESCO

World Heritage cites; important wetlands and forests.37)Te most recent sector guideline to be

published, for the mining and metals sector, explicitly builds upon HSBCs commitment to the

Equator Principles, references development in accordance with World Bank and IFC pollution

prevention standards, as well as a commitment not to finance projects in UNESCO World

Heritage cites; important wetlands and forests; not to finance uranium projects where the

uranium will be used for weapons production; and not to finance diamond mining where the

diamonds will not be certified conflict-free by virtue of the Kimberly Certification Process.38)

III. MOIVES OF HE EQUAOR PRINCIPLES BANKS

Clearly, questions concerning motives come to mind when a global commercial enterprise

like HSBC (and Barclays similarly) withdraws from potentially profitable transactions based

on environmental and social factors, or when fifty-four banks commit to using social and

environmental factors to assess and structure new infrastructure development under the

Equator Principles. A number of ideas have been put forward to explain the banksmotives

in developing and joining the Equator Principles. A pragmatic view is offered by practicing

attorneys Robert Lawrence and William homas, who suggest that A one of the motivating

factors for adopting the guidelines was a desire to level the playing field [between banks], and

establish a minimum standard to which the major project financing lenders would adhere.39)

A number of academic assessments similarly suggest that this Motive is at work: that banks

36)SeeHSBC Chemical Sector Guidelines, available at http://www.hsbc.com/1/PA_1_1_S5/content/assets/csr/chemicals.pdf (last visited Oct. 1, 2007).

37)SeeHSBC Energy Sector Guidelines, available at http://www.hsbc.com/1/PA_1_1_S5/content/assets/csr/energy.pdf (last visited Oct. 1, 2007).

38)SeeHSBC Mining and Metals Sector Guidelines, available athttp://www.hsbc.com/1/PA_1_1_S5/content/assets/csr/mining.pdf (last visited Oct. 1, 2007).

39)See Robert F. Lawrence and William L. Tomas, Te Equator Principles and Project Finance: Sustainability inPractice?,19 NA. RESOURCES & ENV. 20 (Fall 2004).



12/20

1 1

facing different reputation risk from their activities were motivated to level the playing field.

40)

Tis assessment is supported by the fact that the most active banks in developing the Equator

PrinciplesBABN AMRO, Barclays, Citigroup, Calyon, CSFB, HSBC, HBV Group, Rabobank

Group, the Royal Bank of Scotland, West LB, Westpac Banking Corporation-- are almost all

banks with large retail businesses, and thus banks particularly sensitive to NGO activism and its

impact on their reputation.41)Te question then, as posed by Prof. Amalric, is why other banks

without retail exposure would also participate in the Equator Principles. He suggests that the

answer to this lies in the structure of project finance: since these deals require loan syndication,

and since the original group of EP1 banks comprised about 30% of project finance capacity, it

may have been too expensive to get full syndicates put together if one were forced to exclude

30% of that capacity.42)

Another motive that seems clearly to be at play (and partially related) is that of managing

risk: the Equator Principles comprise a systematic tool that allows banks to identify social and

environmental risks from projects, and thus to price them correctly. 43)One of the bankers

we interviewed clearly identified this as a reason his bank got involved in environmental

management generally. As he put it, pricing risk is what bankers do. He considers himself

a Abog-standard banker, whose career spanned a number of places around the world, all in

commercial lending, before he moved into sustainability. He thinks of the as Equator Principles

a good tool for categorizing and calculating risks that may be particularly salient given the

long time-frame of infrastructure investment. For that reason he felt that the revisions to EP1

that gave more emphasis to social risk were quite useful. As he put it, everyone is focused on

environmental risk, but those kinds of risk eventuate over a much longer period of time than

40)See, e.g.,Benjamin J. Richardson, he Equator Principles: he Voluntary Approach to EnvironmentallySustainable Finance,EUR. ENVIR. L. REV. 280, 286 (Nov. 2005); Franck Amalric, The Equator Principles:

A Step owards Sustainability?,Center for Corproate Responsibility and Sustainability at the University of

Zurich, Working Paper No. 01/05 (January 2005)[find out if there is a published cite to this paper].

41)SeeAmalric,supranote 39, at 6. West LB, a German bank, apparently does not have a strong retail presence,but it has definitely been targeted by NGO activism: in [year] a mountain-climber scaled Wests corporate

headquarters in Frankfurt, Germany; unfurled a large banner accusing West of supporting projects that

were destroying the environment, which banner remained in place for ten days until the mountain-climber

got hungry enough so that he could be persuaded to climb down. he banner was only part of a ten-

day environmental protest at West LBs headquarters that was reported on daily in the German press, an

experience that West executives suggest was important in their interest in participating in the Equator

Principles. Personal interview of [insert name], London, England (Sept. 16, 2007)(notes on file with authors).

42)SeeAlmaric,supranote 39, at 7.43)SeeRichardson,supranote 39, at 286; Christopher Wright and Alexis Rwabizambuga, Institutional Pressures,

Corporate Reputation, and Voluntary Codes of Conduct: an Examination of the Equator Principles,111:1 BUS.

& SOC. REV. 89, 96 (2006).

24 | KHU


13/20

200

do social risks. If the workers in a field walk away with the product or burn it because theyare being treated badly, or if there is a labor shut-down, it can have immediate, short-term,

demonstrable effects on the ability of the project sponsors to make good on their financial

commitments to the bank.

A number of other pragmatic reasons have been posited for the Equator Principles. Global

banks see value in the Equator Principles, as with international sustainability practices

generally, in that they are useful management tools for negotiating differences in regulations

and regulatory approaches between countries.44)Countering the oft-heard race to the bottom

argument, many leading operating companies have imposed a common environmental policy

on their subsidiaries and contract partners, thereby transcending the limitations of nation-

specific regulation.45)It would not be surprising if global banks also found utility in global

standards for their personnel to use in making lending decisions, particularly given the need

for global reputation management. A commitment to sustainable banking may also be a

differentiation-based rategy to achieve competitive advantage in the industry.46)Ironically, that

advantage is undermined the more broad-based participation becomes, and is also undermined

if some number of firms can engage in green-washing, free-riding, or committing by issuing

a press release and doing nothing more, concerns we repeatedly heard expressed at a recent

conference in London devoted to sustainable finance and the Equator Principles.

Franck Amalric, at the University of Zurich, posits two additional pragmatic rationales for

the development of the Equator Principles. One is that as development banks and the IFC

began to withdraw from project finance in light of persistent NGO criticism (recall the Battle

of Seattle, among other violent, and violently suppressed, demonstrations against the symbols

of globalization, the World Bank and the International Monetary Fund), a due diligence

vacuum was created. While formerly the World Bank, the IMF and the IFC did the social

and environmental analysis described in IFC Performance Standards [need to have described

more clearly and earlier what these are], with their withdrawal the banks would need to take

up that expensive task. Te Equator Principles were thus an excellent way to shift the costs

of this process back to the borrowers, with requirements for outside review of all assessments

44)SeeTomas R. Wotruba,Industry Self-Regulation: A Review and Extension to a Global Setting, 16:1 J. OFPUB.POL. & MKNG 38 (Spr. 1997).

45)SeeMarc Allen Eisner, Corporate Environmentalism, Regulatory Reform, and Industry Self-Regulation: owardGenuine Regulatory Reinvention in the United States, 17:2 GOVERNANCE: AN INL J. OF POLICY,

ADMIN., & INSIUIONS 145, 152 (Apr. 2004).

46)See id.,at 149-50.



14/20

1 1

and monitoring reports, comparable to outside audits of a companys financial statements.

47)

A second theory is that given the increasing contestation of large-scale infrastructure

development, the Equator Principles were a way to give a place in the debate to commercial

banks.48) In essence, the Equator Principles permitted banks to counter critics of large

development projects by asserting the ability to manage the risks of those projects.49)

As articulated, all of these motives are self-interested, and thus instrumental. 50)In one way

or another, the Equator Principles are construed as good for business, even if they limit the

business opportunities of any one bank in the near term. Tat banks articulate instrumental

motives should not surprise us, since we expect business managers to make decisions that are

in the perceived instrumental, self-interest of the firm and its shareholders. What is more

intriguing is to explore the processes by which these instrumentally-derived commitments are

being introduced in a business organization, and in a number of cases are leading to what seems

to be deeper engagement with the goals and underlying impulses of social and environmental

concern. Are some employeesand managersdeontic capacities becoming involved in the

process? Can we assert with any accuracy that there are changes occurringBin some cases

rapid changesBin the culture of the organization? Tese are the questions that we take up in

later sections of this paper using theories from organizational psychology (justice as a contagion

theory); sociology of business (institutional theories of isomorphism and engagement);

anthropology (actor/network theory); and law (new governance).

47)See id.,at 10.48)See id.,at 13-15.49)More problematic motives have also been suggested. As part of an excellent analysis of the Equator Principles,

Prof. Ben Richardson suggests, among other motives, that the standards expected under EP1 may haverepresented business as usual. SeeRichardson, supra note 40, at 286. Under that scenario, there would be

little cost, but potential benefit, from participating. A number of early readers of this paper, participating in

the Vanderbilt Roundtable on Global Regulation of Financial Institutions, suggested that the Principles may

have anti-competitive effects, permitting collusion among banks in a context that does not invite government

scrutiny. Our preliminary interviews give no evidence of this, but it is a concern well worth keeping in mind.

50)SeeRuth V. Aguilera, Deborah E. Rupp, Cynthia A. Williams and Jyoti Ganapathi, Putting the S Banck incorporate Social Responsibility: A Multilevel Teory of Social Change in Orgnaizations,32:3 ACAD. MNGM.

REV. 836 (2007). In this paper, we applied findings from the justice strand of organizational psychology

research to argue that actors at various levels of analysis (individual employee, organizational, national,

transnational) have three main motives for pressuing firms to engage in CSR. Tese motives are instrumental

(self-interest driven), relational(concerned with relationships among group members), and moral(concerned

with ethical standards and moral principles).

26 | KHU


15/20

200

IV. HEOREICAL PERSPECIVES

Te EPs emerge at a time when financial institutions and other globally active corporations

are increasingly subject to claims that their status should be defined by public purposes in

addition to their private, profit-seeking motives. As financial institutions and other important

corporate actors become self-consciously >quasi-politicalactors, in the best way described by

Adolf Berle in 1954, it is time to undertake a more holistic study of the relationship between

these institutions, their decision-making and management practices, particularly with respect

to social and environmental issues, and the fast-evolving transnational regulatory environment

in which they operate. his complex relationship is at the core of a rapidly-growing body of

scholarship in law (Conley & Williams, 2005; Williams & Conley, 2005; Zumbansen, 2007),

business (Matten & Moon, forthcoming 2008; Scherer & Palazzo, 2007; Lazonick, 2007),

management theory (Aguilera & Jackson, 2003; Campbell, 1997; Dijksterhuis, Van den Bosch &

Volberda, 1999) and organizational psychology (Cropazano, Rupp, Mohler & Schminke, 2001;

Aguilera, Rupp, Williams and Ganapathi, 2007) that seeks a better understanding of the business

corporation as a societal actor (Bansal & Roth, 2000; DiMaggio & Powell, 2001). Moreover,

in a context of distrust of both the agenda and competence of financially- and structurally-

exhausted welfare states (Habermas, 1989), the business corporationsassuming formerly public

functions becomes a vital issue. Tis move is evident in the EPs, since this initiative represents

not only self-regulation of the banks, but regulation by the banks of borrowers across industries

that are subject to the newly-imposed sustainability conditions.

A. Transnational Regulatory Theory:he exploration of this voluntary but nonetheless

highly ambitious regulatory framework poses distinct challenges. One of the theoretical

starting points for our project is the concept of rough consensus, running code [RCRC],

which was first experimented with in the context of Internet governance (Russell, 2005) and

subsequently taken up to address challenges of contemporary transnational governance (Calliess

& Zumbansen, 2007). RCRC aims at capturing the process by which >privateinstitutions such

as standardization councils, organizations or, as in our case, financial institutions, develop a

framework of norms which they will operationalize within the context of an ongoing practice.

Te need for such initiatives taken by norm-entrepreneurs arises out of the structural inability

of nation states or international bodies to effectively regulate the behavior of transnational

actors. While in most domestic legal orders there exists a specific hierarchy of legal authority,



16/20

1 1

such an ordering scheme is largely absent in the emerging transnational legal order (Cutler,2003). RCRC, then, is central to transnational governance, a term aiming to capture an

increasingly messy field, which is characterized by an expansion of regulatory fields, both

territorial and de-territorial in nature, and by a proliferation of norm-creating actors, both

public and private (Jessup, 1956; eubner, 1997). Tese norm entrepreneurs are either acting

by delegation from government agencies or by self-authorization. Expert commissions,

associations, standardization organizations, and other non-state actors escape a clear-cut divide

between public or private actors when involved in transnational governance (Wood, 2006).

RCRC presents a form of norm-creation which does not replace but complements existing

modes of norm-creation and lawmaking. RCRC operates on the basis that a group of norm-

entrepreneurs within an industry conceptualizes, negotiates and continuously refines standards,

which are then being >floated, >showcasedand submitted to review to a >market for norms

within the industry. Tis market rejects, approves or amends these norms by contributing to a

fluid norm-making regime. Growing out of this open review process is an evolving set of norms

that have benefited from the expertise and input from norm-entrepreneurs in the same and

related fields of regulation. RCRC, as evidenced in the EPs, brings together norm entrepreneurs

operating within the different sections of large banks with experts, policy makers, non-

governmental organizations (ANGOs), stakeholders and consumers outside.

We are using >rough consensus, running codeas both an explanatory and a constructive tool

to describe and to assess the EPs as a unique and new, particularly ambitious, lawmaking regime

in the transnational arena. As with the changed nature of the institutional status of the actors

involved, the EPs stand in contrast to traditional, so-called official >hardlaw. Yet, what we plan

to study is how the adoption of these >softlaw mechanisms is nonetheless profoundly changing

firm practices and culture, employee engagement, and regulatory compliance with respect to

sustainability and the firms social and environmental relationships.

B. Management of Sustainability: Institutional studies emphasize the evolutionary

selection and adoption of management practices, or organizational forms, in firms within the

same industry competing for scarce resources and conforming to similar pressures at supra-

organizational levels (DiMaggio & Powell, 1983; Scott, 2004). Within institutional theory, there

are two important models that we will use to understand how the EPs have been introduced,

internalized and diffused between and within banks. First, there is actor-centered institutional

theory (Aguilera & Jackson, 2003), which highlights how various actors shape the institutional

2 | KHU


17/20

200

environment in which they operate. his concept is important within institutional theorybecause the field has otherwise favored uni-directional structuralist views in which institutions

shape organizational actors, but not the other way around. We seek to illuminate which actors

are shaping these financial institutions, and why; and which management practices are likely to

be the most effective in that endeavor.

Second, the agentic turn in the study of the diffusion of managerial practices emphasizes

the role of discourse in the translation and rationalization of managerial practices, and has

presented diffusion as contingent on the quality of managerial rhetoric (Green, 2004; Sahlin-

Anderson, 1996; Strang & Meyer, 1993; Zilber, 2006). hese models state the core neo-

institutional argument that managerial practices diffuse out of managersneed to comply with

social norms of progress and rationality (Meyer & Rowan, 1977; Abrahamson, 1996). he

model also incorporates the rhetorical perspective, arguing that the legitimating discourse

to which managers are exposed through embedded organizational networks, professional

organizations, management migration processes, and the like, governs the supply and demand

for types of management knowledge, and explains the adoption of specific management

practices (Abrahamson, 1996; Abrahamson & Fairchild, 1999, 2001). hrough qualitative

comparative analysis (see methodology section, below), we can evaluate the attributes that lead

to various diffusion patterns within EPs financial institutions.

C. Social and Organizational Psychology: his research context can also be used to

investigate why firms sign on to voluntary social and environmental standards, and how their

motives change over time as the standards become institutionalized. Our exploration of theory

here will be based on Aguilera, Rupp, Williams, and Ganapathis (2007) multilevel theory of

social change in organizations, which asserts that multiple actors (employees, top management

teams, governments, NGOs, transnational organizations) can put pressure on firms to engage

in CSR initiatives, and that each of these actors can have instrumental, relational, and morality-

based motives for doing so. In this project we will extend this model to explore how these

motives may change within organizations, and in particular how initiatives that are adopted

for instrumental reasons within the firm may engender deeper employee engagement with the

initiative and the firm, based on the employeesrelational or morality-based needs.

he social and organizational psychology literatures are rich with theories of motives and

changes in attitudes that can be applied to groups of individuals internal and external to the

firm. For example, self-determination theory (Ryan & Deci, 2000) discusses how individuals



18/20


19/20

200

In the context of this research study, the questions to be explored are what the processes arethat have been used (guidelines, rulebooks, employee training and monitoring) to have the

principles filter down within each of these organizations, and what are the relative efficacy of

those processes?

In a context in which it appears that investors, especially retail investors, have a low tolerance

for incidents of wrongdoing in capital markets, and to some extent are motivated to seek

investments where good corporate governance and a commitment to social responsibility

are a factor, it is worthwhile to consider the contribution that effective new governance and

compliance-based regulation can make to producing market integrity. he challenge is to

create manageable compliance strategies and new governance mechanisms that require firms to

deviate as little as possible from a focus on their ongoing business activities.

E. Firms as Cultural Entities:Tis project is also related to the growing body of literature

in anthropology and qualitative sociology concerning the corporation as a cultural entity and

the causes and effects of corporate behavior. Some of this work has its roots in the writings

of James Scott, especially his Seeing Like a State (Scott, 1998), a critique of large-scale state

action that he extended to the current world of downsized states and relatively unconstrained

global corporations. James Ferguson (2005), for example, uses the specific example of the

multinational oil company as the successor to the nineteenth- and twentieth-century colonialist

state. He asks specific questions about the implications of this shift in power for the concept

of governance. We will ask similar questions as we examine the multinational banks that seek

to impose a regime of private rules on the financing of infrastructure in the developing world

(the EPs). In a related development, legal anthropologists have begun to explore human rights

as cultural practice (e.g., Merry, 2006; Riles, 2006), with particular attention to the place of

corporate behavior in this practice. Our project will contribute to this literature by considering

the EPs as an example of corporate participation in the culture of human rights.

Actor-network theory exemplifies the qualitative sociological literature to which this

project may contribute. As recently expounded by Latour (2005), this approach criticizes the

explanatory use of such vague, Durkheimian concepts as a globalization. Instead, it is necessary

to investigate the associations that comprise our primary evidence of how the world works.

Importantly, actor-network theory is not limited to things that we recognize as networks;

rather, by studying the details of associations, you can provide a network account of topics

which have in no way the shape of a network's symphony, a piece of legislation ( ibid., 131). Our



20/20

1 1

research into the EPs specifically, and the CSR movement generally, will provide an opportunityto examine in detail the role of actual associations in constituting the phenomenon we call

globalization.

V. Conclusion

he correlation between a bank's search for profitable and sustainable investment and its

transformation towards a learning firm (eubner, 1988; Lazonick, 2007; Zumbansen, 2007)

takes place in the context of a globalizing knowledge economy (Bell, 1974; Drucker 1993;

Worldbank, 2000; Ladeur, 2006). As banks and other globally operating companies begin to

assume an expanding number of public interest functions with regard to environmentally

and socially sustainable business practices, managers become innovative, risk-taking business

and legal actors, relying on an ever proliferating pool of fragmented, societal knowledge (Law

Commission 2005; Valverde & Levi 2005), when developing strategies and compliance rules, of

which the EPs form a part. Tis no longer merely 'private' >business knowledge' (Trift, 2005,

at 75) becomes a public good (Foray, 2004, at 113) and demands an entirely new organizational

framework of management (Foray, 2004, at 207), as it becomes a reflexive asset of a virtual,

globalized capitalism (Trift, 2005). Combining theory and practice, we can profitably study

this development through the lens of the EPs.

32 | KHU

Documents

Banking Sustainability Regulator