beyond risk (2003)
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BEYOND R ISK
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.
JAPAN/IFC
COMPREHENSIVE
TECHNICAL ASSISTANCE
TRUST FUND
INTERNATIONAL
FINANCE CORPORATION
A Member of the
World Bank Group
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S US TA INA BI L ITY A ND THE E ME RGING MA RKE TS F INA NCIA L S E CTOR FOREWORD
With support from the Japan/IFC Comprehensive Technical AssistanceTrust 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
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ACKNOWLEDGEMENTSThis 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.
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 OKeefe, Michael ONeill, Niamh
OSullivan, 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.
Table ofContents
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
ANNEXES
A) LIST OF BOXES,FIGURES AND TABLES . . . . . . . . . . . . . . . . . . . . .65
B) SURVEY, METHODOLOGY,QUESTIONNAIRE PRO-FORMA,
UPTAKE OF ENVIRONMENT INITIATIVES . . . . . . . . . . . . . . . . . . . .69
C) LIST OF SITE VISITS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79
D) CEA WORKSHOPS AND PARTICIPANTS . . . . . . . . . . . . . . . . . . . .83
E) REFERENCES,LINKS AND FURTHER INFORMATION SOURCES . . . . . . . .93
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4
ISO International Organization for Standardization
MOF Ministry of Finance
NGO Non-Governmental Organization
NPL Non-Performing LoanOECD Organization of Economic Cooperation and Development
SME Small and Medium-sized Enterprise
SRI Socially Responsible Investment
UNEP United Nations Environment Program
USAID United States Agency for International Development
WB World Bank
WBG World Bank Group
WCED World Commission on Environment and Development
WTO World Trade Organizatio n
WWF World Wide Fund for Nature
1.INTRODUCTION
A successful bank can no longer just look a t the
commercial performance of a customer. It has to
consider its broader performance in environmentaland social issues.
Roberto Dumas Damas
Banco BBA Creditanstalt,Brazil
ACRONYMS
ADB Asian Development Bank
AFDB African Development Bank
CEA Competitive Environmental Advantage
CDC Commonwealth Development CorporationEBRD European Bank for Reconstruction and Development
EIB European Investment Bank
EMAS Eco-Management and Audit Scheme
EMS Environmental Management System
ESMG Environment and Social Management Group
EU European Union
FI Financial Intermediary
IFC International Finance Corporation
IFI International Financial Institution
IPO Initial Public Offering
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SINCE 1997,OVER 375 MANAGERS FROM 275 FINANCIAL INSTITUTIONSAND 45 NATIONS HAVE PARTICIPATED IN THE C OMPETITIVE
ENVIRONMENTAL ADVANTAGE WORKSHOP SERIES
7
Since mid-1997, as part of a two-phased programfunded by the Japan/IFC Comprehensive Technical
Assistance Trust Fund, IFC has collaborated with
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
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 manage-
ment 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 commer-
cial 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.
Under the second phase of the program IFC set out
to complete three tasks:
s a website on environmental management for the
financial sector
s development of a Trainers Manual
s publication of a casebook on environmental man-
agement 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 cap-
ture the lessons of experience of IFCs 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.
Introduction
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8
2.THE NEWGEOGRAPHY OF RISK
What is the relevance of sustainability to the
emerging markets financial sector?
METHODOLOGY
For this casebook IFC used a three-part approach
designed to capture the experiences and expertise
of the workshop participants:
s IFC conducted a series of in-depth interviews
with senior management participants of the CEA
workshops.
s IFC conducted a detailed questionnaire survey
of a representative sample of 60 institutions from
different regions.
s In addition, IFC reviewed current best practice
among institutions in the international financial
sector.
Annex B presents a more detailed review of the
methodology.
Beyond Risk
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Beyond Risk The New Geography of Risk
THE SIGNIFICANCE OF ENVIRONMENTAL AND SOCIAL ISSUES FORFINANCIAL INSTITUTIONS HAS,IN GENERAL, BEEN CONSIDERED LIMITED
WHAT IS THE RELEVANCEOF 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).
What is the relevance of environmental
and social factors to the performance of
a financial institution?
The significance of environmental and
social issues for financial institutions has,
in general, been considered limited. In
a number of developed countries, wherebanks 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 dili-
gence 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 con-
cern 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, sum-
marizes a range of direct liabilities for
financial institutions.
11
BOX 2.1
SUMMARY OF FORMS OF DIRECT LIABILITY FOR FINANCIAL INSTITUTIONS
FIGURE 2.1
COMPETITIVE THREATS TO THE FINANCIAL SECTOR
TECHNOLOGICAL
CHANGE
s Internet
s Electronic Banking
s ATM
s Virtual Banks
ECONOMIC
INTEGRATION
s GATT/NAFTA/WTO
s Reduced Tariffs
s Currencies linked
s Global Capital flows
s Diversification
MATURATION
OF DEVELOPED
COUNTRY
MARKETS
s Slower Growth
s Aggressive Exporters
s Deregulation
DECLINE OF
COMMUNISM
s Privatization
s Corporate Growth
s Global Private
Capital Flows
FINANCIAL SECTOR COMPETITIVE THREAT
Source:Furrer,Increasing a Companys Value Through Environmental Management
s Liability for the clean up of any contaminated collateral
(for example,asbestos,heavy metals, polychlorinated bi-phenols).
s Liability for misrepresentation of environmental risks
(e.g.to co-financiers).
s Liability for negligence in any failure to assess actual and potential envi-
ronmental risks.
s Direct liability if the financial institution is a principal,general partner
or owner.
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Beyond Risk The New Geography of Risk
Primary sources of risk were found to
vary according to the type of financial
institution surveyed. Figures 2.32.7,pgs.
1214, present the results for institutions
that are financing sectors which sub-
divided into the following categories: a)
export-oriented industries, b) infrastructure,
c) domestic general manufacturing, d) high-
tech 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 envi-
ronmental and social risk for client orga-
nizations. Risk drivers were found to vary
significantly according to the client base.
For those institutions financing export-
oriented 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.
Risk of shutdown/fines was also identified
as a key risk for infrastructure clients and
domestic general manufacturingalong with
reputational risk, protests over critical
resources and loss of market.
13
The Emergence of Indirect Liabilities
Are these legal liabilities also the prime
risk drivers for emerging markets? To
address the topic, IFCs survey requested
60 emerging market institutions to iden-
tity 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.
Survey Results: New Stakeholders
Figure 2.2, right, summarizes the most sig-
nificant sources of environmental risk
that institutions identified for their clients
The survey showed that all the respon-
dents 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 respon-
dents cited the influence of export market
regulators as a key risk driver for their
customer base1.
12 FIGURE 2.4
INFRASTRUCTURE
FIGURE 2.5
DOMESTIC GENERAL MANUFACTURING
FIGURE 2.2
SIGNIFICANT SOURCES OF ENVIRONMENTAL RISKS for clients identified by all financing institutions
FIGURE 2.3
EXPORT-ORIENTED IND USTRIES
The most significant long-term sources of environmentalsocial risks as identified by infrastructure institutions
The most significant long-term sources of environmentalsocial risks as identified by domestic general manufacturers
1As an example, in the past 5 years, the impositionof environmental standards requirements has been
widely perceived as the major driver in a numberof Asian export-dependent markets, particularly
consumer electronic related. This appears to have
been one of the main reasons for the rapid uptakeof industry environmental management systemscertified to the internationally recognized
ISO14001 standard.
0% 10% 20% 30% 40% 50% 60% 70%
Government (e.g.shutdown,fines)
Export market regulators
Media (reputational risk,negative publicity)
Community
Financiers
Customers
Supply and distribution chain partners
Insurers
International NGOs
Employees
Other
60%
56%
40%
38%
36%
28%
12%
12%
10%
8%
20%
0%
10%
20%
30%
40%
50%
60%
70%
80%
Government
Exportm
arket
regu
lators
Media
Comm
unity
Fina
nciers
Customers
Supply&
distr.
chainpartners
Insurers
International
NGOs
Employees
Other
4%4%
17%13%
25%29%
46%46%50%
75%
67%
0%
10%
20%
30%
40%
50%
60%
70%
80%68%
53%
63%
53% 58%
37%
11%
32%
16%
5%
16%
Other
Employees
International
NGOs
Insurers
Supply&distr.
chainpartners
Customers
Financiers
Community
Media
Exportmarket
regulators
Government
0%
10%
20%
30%
40%
50%
60%
70%
80%
Govern
ment
Exportm
arket
Media
Comm
unity
Financiers
Custo
mers
Sup
ply&
distr.chain
Ins
urers
International
N
GOs
Employees
Other
5%8%
16%
11%
24%32%32%
35%41%
68%
59%
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Beyond Risk The New Geography of Risk
Forgeneral 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.
THE CHANGING
GEOGRAPHY OF RISK
Several conclusions can be drawn from
these results. Conventional wisdom sug-
gests that environmental risk derives from
the enforcement of national legislation
with resultant civil and criminal penal-
ties. Government, therefore, is held to
be the key risk driver and where local or
national government does not have the
resources to enforce environmental regu-
lation, there is thought to be no risk.
BEYOND COMPLIANCE
A more complex reality appears to be
emerging. A decade ago, information was
accessible by only parts of the interna-
tional community. Distance separated a
company with a poor environmental track
record, or a proposed project with poten-
tially significant environmental impacts,
from key national and international stake-
holders. But changes in information
technology, including the growth in
internet and fixed and cell phone usage
appear to have lessened that distance.
The two Figures 2.8 and 2.9, left, show
changes in international connectivity
between 19911997
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:
s Stakeholders can readily acquire infor-
mation about the impact on environ-
mental resources.
s Stakeholders have a low-risk means of
preparing a coordinated international
response to these impacts.
s Finally, they have a cost-effective
means to implement these campaigns.
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 companys 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.
14 15FIGURE 2.8
PRESENTS CONNECTIVITY IN 1991
FIGURE 2.6
HIGH-TECH INDUSTRIES
FIGURE 2.7
EXTRACTIVE INDUSTRIES
0%
10%
20%
30%
40%
50%
60%
70%
80%67%
33%
78%
56%
33%
22%
11%
0%
33%
11%
0%
Other
Employees
International
NGOs
Insurers
Supply&
distr.chain
Customers
Financiers
Community
Media
E
xportmarket
Government
The most significant long-term sources of environmentalsocial risks as identified by high-tech industries
0%
10%
20%
30%
40%
50%
60%
70%
80%
Government
Exportmarket
regulators
M
edia
Community
Finan
ciers
Customers
Supply&distr.
chainpartners
Insurers
International
N
GOs
Employees
O
ther
0%0%
50%
0%
25%25%
0%
25%25%
75%
25%
The most significant long-term sources of environmental
social risks as identified by extractive industries
IBRD 32423
IBRD 32424
FIGURE 2.9
PRESENTS CONNECTIVITY IN 1997
INTERNATIONAL CONNECTIVITYVersion2- 9/91
Internet
Bitnet but not Internet
EMail Only (UUCP,Fido Net)
No Connectivity
No Data
Source: Larry Landweber and the Internet Society.
INTERNATIONAL CONNECTIVITYVersion2- 9/91
Internet
Bitnet but not Internet
EMail Only (UUCP,Fido Net)
No Connectivity
No Data
Source: Larry Landweber and the Internet Society.
FIGURE 2.9
PRESENTS CONNECTIVITY IN 1997
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Beyond Risk
These risks are presented in Figure
2.10, right.
In this networked economy, corporate
performance depends not solely on reg-
ulatory compliance, but on the ability
to understand and satisfy the expecta-
tions 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 operationsto be affected by the scrutiny from stake-
holders, 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.
Overall, the prime risk was identified as
non-performing assets. A number of
otherissues were also identified as
significant, again varying by institutional
type. Key risks identified include the fol-
lowing: devalued collateral, reputational
risk and loss of international financial
institution funding.
CONCLUSIONS: EMERGING
MARKETS ENVIRONMENTAL RISK
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 insti-
tutions 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.
Traditionally, where the primary environ-mental risk drivers for financial institu-
tions have been restricted to the threat
of direct legal risks, these new stakehold-
ers, 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 non-
performing 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.
16 17FIGURE 2.11
ENVIRONMENTAL RISKS FOR FINANCIAL INSTITUTIONS
The New Geography of RiskFIGURE 2.10
DRIVERS OF ENVIRONMENTAL RISK ACROSS THE CORPORATE VALUE CHAIN
CONSUMER BOYCOTT
s Entry of substitute product
s Product liabilities
s Product replacement
LABOR RECRUITMENT,
RETENTION
s Productivity
s Strikes or sabotage
s Shut-down
s Fines,penalties
s Compensation for health
s Operating liabilities
AVAILABILITY OF
WATER SUPPLY
s Raw materials access
s Raw materials price
s Permit rejection
PERMITTING DELAY
OR REJECTION
s Insurance access or cost
s Construction delay
s Contract lost
s Labor supply
s Contract terms
s Infrastructure obligation
s Cost of capital,access
SALES AND DISTRIBUTION
MANUFACTURING
MATERIALS ACQUISITION
START-UP
0% 10% 20% 30% 40% 50% 60% 70%
Non-performing loans/leases/investments
Devalued collateral
Reputational risk/Negative publicity
Loss of IFI funding
Reduced access to private/international capital
Liability for cleanup of contaminated collateral
Civil or criminal liability for negligence
Increased central bank/MOF regulation
Loss of depositors
Other
58%
46%
46%
42%
35%
23%
10%
4%
6%
13%
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Indirect environmental and social risks,
then, can affect a financial institutions
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-perform-
ing 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 prob-
ability 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:
s The company may have insurance.
s Debt service coverage ratios may be
unaffected and payments may proceed
on time.
s The financial institution may have
collateral that is unaffected by envi-
ronmental stigma.
More significant for the financial institu-
tion though is the potential for multiple
non-performing loans.
LEVEL 2: MULTIPLE
NON-PERFORMING LOANS
New stakeholders have the potential to
cause not just single NPLs but multiple
NPLs within a banks 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:
s Government regulators may respond
by invoking a change to regulations
that can lead to a virtual closure of
the sector, or the alternative of incur-
ring prohibitive switching costs
s Export market regulators may impose
restrictions.
s NGOs may lead national or interna-
tional product boycotts.
s Consumers may lead product or cor-
porate boycotts, or enter into sector-
focused class action lawsuits.
s 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
18 19
FIGURE 2.13
THE RISK MANAGEMENT GAP
BOX 2.2
FINANCIAL COSTS OF ENVIRONMENTAL NON-PERFORMANCE
The New Geography of RiskBeyond Risk
s Decreased quality of assets
s Increased need for provisioning
s Reduced capital adequacy
s Increased cost of funds
s Reduced liquidity
s Reduced profitability
s Reduced rating
Unmanaged Risk
Single NPL
Multiple Sector NPL
Multiple Regional NPL
Reputational Risk
COVERED
Current RiskAssessmentCapacity
High
Low
Potential Losses
FIGURE 2.12
RISK TO THE EMERGING MARKETS FINANCIAL SECTOR
LEVEL 3: Reputational risk
LEVEL 2: Multiple non-performing loan
LEVEL 1: Single non-performing loan
Low High
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BOX 2.3
PERFORMANCE SIGNALS
HIGH QUALITY
BRAND SIGNAL
s System indicator
s Quality metrics and management
s Positioning for long-term
s Trustworthy
LOW QUALITY
BRAND SIGNAL
s Perception
s Manipulation of market perception
s Lack of management capacity
s Lack of resources
s Short cut/quick-fix
s Untrustworthy
Beyond Risk
s Resource-based conflict can cause
multiple defaults within multiple sec-
tors, impacting wholesale, retail and
individual accounts.
LEVEL 3: REPUTATIONAL RISK
For deposit-taking financial institutions,
reputation and brand image are of critical
importance. In particular, a deposit-taking
commercial banks operations are built
on a borrow-short, lend-long strategy
that depends on three elements:
s Depositor belief that the bank has
a critical mass of deposits to smoothover potential asset-liability mismatches
s Mass trust among consumer base
s Mass branding as trustable
Core to the operation of a bank then is the
establishment and maintenance of trust.
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 organizations brand
assets into liabilities, turning big into
brutal, dominant into dominating,
profitable into predatory. An additional
impact of these campaigns is the signal-
ing of inadequate management systems
and capacity.
Reputational risk as a whole was ranked
the third most important risk after non-
performing loans/investments and deval-
ued collateral.
Significantly, the survey showed that
reputational risk did not just affect insti-
tutions with major depositor bases.
Additional reputation-driven costs that
were highlighted included: the potential
loss of depositors, reduced access to capi-
tal 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)
In summary, an emerging trend is for the
rapid transmission of risk: from the risk
of adverse environmental impacts caused
by a companys 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
20 21FIGURE 2.14
SUSTAINABILITY OPPORTUNITIES
FIGURE 2.15
OPPORTUNITIES FOR COMMERCIAL BANKS
The New Geography of Risk
BOX 2.4
OPPORTUNITIES FOR FINANCIAL INSTITUTIONS
s Accessing international funding: Securing longer term capital available from IFIs with environmental and
social performance criteria
s Providing loans for environmental projects: Gaining market share in the growing environmental products
and services sector
s 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
s Accessing SRI/Ethical investment funds: Gaining access to the long term institutional investors and SRI
investors with positive and negative environmental and social screens
s 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
s 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
s Attracting depositors: Positioning the bank as a dependable institution,with ethically sound corporate
governancein its dealings with depositors and other stakeholders
0% 10% 20% 30% 40% 50% 60% 70% 80%
Accessing international funding
Providing loans for environmental projects
Providing eco-efficiency and cleaner productionadvisory services to small and mid-sized clients
Accessing ethical investment funds
Providing risk-management servicesto high-risk industries
Attracting improved terms of insurance
Attracting new depositors
Other
70%
47%
26%
26%
9%
15%
9%
21%
0%
10%
20%
30%
40%
50%
60%
70%
80%
Accessing
international
funding
Providingloansfor
environmentalprojects
Providingeco-efficiency
andcleanerproduction
advisoryservicestoSME
Accessingethical
investmentfunds
Providing
risk-management
servicesto
high
-riskindustries
Attractingimproved
term
sofinsurance
Attractingnew
depositors
Other
13%
6%
13%13%13%19%
50%
69%
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The New Geography of Risk
produce a range of costs for the institu-
tionfrom direct liability to single NPLs
to multiple NPLs and reputational risk
(see Figure 2.13,pg. 19).
Significantly, from the credit risk per-
spective, as these losses escalate conven-
tional risk assessment and management
techniques provide less guidance.
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:
s The growth of socially responsible invest-
ment (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 rep-
resents just over 10% of the $19.9
trillion in professionally managed
investment assets in the U.S. SRI
analysis now evaluates financial insti-
tutions on their environmental and
social performance, potentially impact-
ing on the access to capital for these
institutions as well as their portfolio
companies (see Figure 2.19,pg. 23).
s The emergence of the sustainability ana-
lyst 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 sus-
tainability performance of leading
international banks. Additional lead-
ers in the field include Innovest, and
Bank Sarasin.
s 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.
s Financial sector standards and codes of
conduct: In parallel with the develop-
ment 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.
22 23FIGURE 2.16
OPPORTUNITIES FOR LEASING INSTITUTIONS
FIGURE 2.17
OPPORTUNITIES FOR PROJECT FINANCE INSTITUTIONS
Beyond Risk FIGURE 2.18
OPPORTUNITIES FOR PRIVATE EQUITY INSTITUTIONS
0%
10%
20%
30%
40%
50%
60%
70%
80%
Accessing
international
funding
Providingloansfor
environmentalprojects
Providingeco-efficiency
and
cleanerproduction
advisoryservicestoSME
Accessingethical
investmentfunds
Providing
risk-management
servicestohigh-risk
industries
Attractingimproved
termsofinsurance
Attracting
newdepositors
Other
80%
40%
27%
33%
27%
33%
27%
13%
0%
10%
20%
30%
40%
50%
60%
70%
80%
Accessing
international
funding
Providingloansfor
environm
entalprojects
Providing
eco-efficiency
andclean
erproduction
advisoryse
rvicestoSME
Accessingethical
investmentfunds
Providing
risk-management
servicestohigh-risk
industries
Attrac
tingimproved
term
sofinsurance
Attracting
newdepositors
Other
64% 64%
50%
36% 36%
21%
7%
21%
0%
10%
20%
30%
40%
50%
60%
Accessing
international
funding
Providingloansfor
environmentalprojects
Providingeco-efficiency
and
cleanerproduction
advisoryservicestoSME
Accessingethical
investmentfunds
Providing
risk-management
s
ervicestohigh-risk
industries
A
ttractingimproved
termsofinsurance
Attracting
newdepositors
Other
56%
25% 25%
44%
25%
13%
0%
6%
FIGURE 2.19
SOCIALLY RESPONSIBLE INVESTMENTGROWTH MARKET
SOCIALLY RESPONSIBLE INVESTMENT (SRI)
Worth over US$2 trillion in
US and US$25 billion in UK
Numerous environmental,socialand ethical ranking,rating and
screening methodologies
One of the fastest growing
areas of equity investment
Growing importance in Europe
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Beyond Risk
Figure 2.14,pg. 21, summarizes the results
for all respondents. Overall, the results
indicate that access to international
funding, providing loans for environmen-
tal projects, providing advisory services
to SMEs and accessing ethical invest-
ment funds are considered the main
opportunities.
These opportunities varied significantly
by institution type. Figures 2.152.18,
pgs. 2123,present the results from com-
mercial banks, leasing, project finance,
and private equity institutions.
Key conclusions include the following:
s Overall, the main opportunity ident-
ified 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.
s 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.
s Forprivate equity, accessing ethical
investment was rated highly.
24
s NGO and media campaigns: A number
of NGOs are now directing coordinated
campaigns towards the financial sec-
tor. Key drivers of recent campaigns
include Friends of the Earth, the
National Wildlife Federation, and
Milieu Defensie.
s International Financing Institution (IFI)
conditions: Finally there is increasing
demand from IFIs for the financial
institutions they invest in to imple-
ment management systems that ensure
the environmental performance of
their portfolio. The procedures of
these IFIs prohibit investment in
institutions without adequate envi-
ronmental management systems. IFIs
actively addressing this through train-
ing 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 dri-
vers 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 oppor-
tunities for their business. Key opportu-
nities identified are highlighted below.
3.THE EMERGINGMARKET RESPONSE
In practice, how have leading financial institutions
started to capitalize on these opportunities?
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PERFORMANCE BASELINETo measure participants progress in imple-
mentingenvironmental change, IFCs
survey sought first of all to create a base-
line of environmental management before
the workshops.
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.
Overall, 22% of institutions surveyed
reported that they had a formal procedure
for environmental management before
IFCs workshop, with results varying
slightly between commercial banks, pri-
vate equity groups, leasing companies
and project finance institutions.
POST-WORKSHOP: RESULTS
IFCs survey also asked institutions to
identify enhancements they had made to
their environmental and social manage-
ment capability after the workshop. Figure
3.2, left, presents the overall findings of
the survey.
100% of respondents reported that they
had implemented measures to enhance
their environmental and social manage-
ment capability after the workshop.
27FIGURE 3.1
PROCEDURE FOR ENVIRONMENT RISK MANAGEMENT
FIGURE 3.2
ENHANCEMENTS UNDERTAKEN TO ENVIRONMENTAL AND SOCIAL ISSUES fol lowing the CEA workshop
The Emerging Market Response
Yes,a formal procedure
22%
43%
35%
Yes,an informal procedure
No
Before the IFC workshop,did your institution have a procedure for
environmental risk management?
5 10 15 20 25 0 35 40
Training of internal staff
Update operating policy
Development ofenvironmental/social procedures
Rejecting projects withenvironmental issues
Working with clients
Report to Directoron opportunities
Communications to clients
External reporting of EMS
Providing environmental loans
Hiring of internalenvironmental consultants/staff
Media events
Other
36%
35%
33%
30%
12%
21%
11%
29%
32%
5%
5%
5%
MOVING BEYOND COMPLIANCE
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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 institu-
tiontypes and geographical region. Table
3.1, right, presents the four case studies by
institutiontype and location.
These case studies addressthe following
questions:
s What is the institutional background?
s What initiatives did the institution
implement?
s What are the business benefits?
s What are the lessons learned?
CASE 1
PROJECT fiNANCE:
LESSONS LEARNED
The IL&FS case reveals a number of
lessons for project finance institutions:
s For project finance clients, there is a
critical need for assistance in manag-
ing these issues.
s The local consultant market does not
fulfill this need.
s Banks can use their cross-sectoral risk
management expertise to help clients
address these needs.
s Financial institutions, and theirclients, can have a range of national
and international stakeholders. These
various stakeholders can have different
and sometimes conflicting performance
standards that require extensive nego-
tiation to resolve.
s The presence of a full time manager
can have a major impact on institu-
tional uptake.
28 29TABLE 3.1
CASE EXAMPLES FOR PROJECT FINANCE,COMMERCIAL BA NKING, PRIVATE EQUITY AND LEASING
The Emerging Market ResponseBeyond Risk
TYPE OF FINANCING ORGANIZATION COUNTRY
INSTITUTION
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 countrys 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:
s 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 inturn would have a negative impact on the water supply project
s Media:reputational risk
s International NGOs:issue-based campaigns
s Customers:loss of market share
s Government:shutdown,fines
s 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:
s Non-performing loans/investments/leases from environmental/social risks
s Liability for clean up of contaminated property/collateral
s Civil or criminal liability for negligence
s Reduced access to capital from private financial institutions/international bond market
s Increased central bank/MOF regulation
s Loss of IFI funding
s Devalued collateral
s Reputational risk/Negative publicity
s Loss of reputation with the concessionaires (state and central governments)
s 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
CASE 1: PROJECT FINANCE
CASE EXAMPLE: INFRASTRUCTURE LEASING AND FINANCIAL SERVICES LIMITED ( IL&FS)
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s Consulting services represent a cost-
effective way of establishing ability to
handle complex projects.
s The presence of a full time manager
can have a major positive impact on
institutional uptake.
s For project finance institutions, this
can be a significant selling point,
enabling the institution to win man-
dates 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)
30 31
BOX 3.1
PROJECT FINANCE OPPORTUNITIES
CASE 1 Continued The Emerging Market ResponseBeyond Risk
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 envi-
ronment 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 companyEcosmart 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
s Communications to clients and media events
s
Rejecting projects with adverse environmental issuess Working with clients to manage environmental impacts
s Hiring of internal environmental consultant/staff
s Development of environmental and social procedures
s External reporting of EMS
s Experience sharing with other financial institutions
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&FSs 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 environ-
mental and social risk mitigation by implementing an EMS is not,by-and-large, recognized by various
stakeholders,including government agencies.
SUSTAINABILITY DRIVEN OPPORTUNITIES
s Win new project finance business
s Lead and manage new complex transactions
s Gain access to high asset quality clients
s Develop fee-generating advisory services
s Successfully complete complex deals as a result of social and environ-
mental due diligence
Results for ILFS
Sustainability also provides a number of potential opportunities:
s Accessing IFI funding
s Providing loans for environmental projects
s Providing risk management services through Ecosmart to high-risk industrial sectors,
s Cross-promoting IL&FS financing for Ecosmart clients
s Providing eco-efficiency and cleaner production advisory services to small and mid-sized clients
s Attracting improved terms of insurance
s Accessing ethical investment funds
s Identifying funding/financing opportunities in environmental improvement projects
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32 33The Emerging Market ResponseBeyond Risk
Over the last few years,it has become increasingly clear that environmental perfor-
mance 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
banks,environmental risk management is now a critical part of the credit risk manage-
ment process
Roberto Dumas Damas
BBA Creditanstalt
Background
Banco BBA Creditanstalt is the thirteenth largest Brazilian bank in terms of assets,with US$6.63 billion
in December 2001.It is positioned as the fifth largest private bank having local control and the largest
Brazilian wholesale institution and is among the five major banks on-lending funds from the Brazilian
development bank BNDES.
Key risks for clients
BBA identifies a number of sustainability-driven risks for its client base:
s Media:reputational risk
s Customers:loss of market share
s Government:shutdown,fines
s Financiers:Loss offinancing
Key risks for commercial and investment banks
In addition,BBA identifies potential sustainability-driven risks for commercial investment banks
operating in Brazil:
s Non-performing loans/investments/leases from environmental/social risks
s Loss of IFI funding
s Reputational risk/negative publicity
s Liability for clean up of contaminated property/collateral
s Devalued collateral
Implementation
In response to these risks, two BBA staff attended the CEA workshop in Washington.BBA has since
established a comprehensive environmental management system,the primary objective of which is to
focus on economic development that is environmentally sustainable,minimizing exposure to companies
with poor environmental practices and facilitating access to multilateral and bilateral capital.
Key initiatives:
Following the CEA workshop,BBA has undertaken a number of initiatives. Key initiatives include the following:
s Report to director/board on environmental risks/opportunities
s Communications to clients and media events
s Updating the operating policy of the institution
s Working with clients to manage environmental impacts
s Development of environmental/social procedure
s External reporting of EMS
s Training of internal staff
s Providing environmental loans
Business benefits of EMS to BBA
s In the last 2 years BBA was involved in 27 Projects totalling R$ 7 billion in BNDES financing.
s BBAs 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.
s BBA has met IFCs environmental conditions for environmental management and as a result was able to
access US$40 million additional IFC funding.
s 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).
s Lower credit risks.BBA has identified as unacceptable and rejected a number of projects with
unacceptable environmental credit risks.
s 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.BBAs 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.
CASE 2: COMMERCIAL INVESTMENT BANKING
CASE EXAMPLE: BANCO BBA CREDITANSTALT (BBA) BRAZIL
CASE 2
COMMERCIAL INVESTMENT
BANKING: LESSONS LEARNED
The BBA case reveals a number of lessons:
s IFIs provide a strong incentive for
environmental performance.
s Negatively, IFIs can withhold fund-
ing, and the removal of one IFIs
funding for environmental and
social reasons may cause other IFIs
to withdraw funds.
s Positively, financial institutions
with environmental management
systems can access IFI financingthat is available for development
purposes. This funding is generally
lower cost, as in the case of BBAs
funding from BNDESs environ-
mental credit line. Most significantly
IFI financing provides long term
lending at tenors critical to whole-
sale finance that are not commer-
cially available elsewhere.
s BBAs strategy as a bank is one of
cost-effective risk management. BBA
works with clients to transform border-
line deals. Unlike IL&FS (case 1,pgs.
2930), though, BBA is not aiming
specifically to acquire a critical mass of
environmental and social expertise,
and position itself to manage environ-
mentally complex transactions. BBAs
strategy involves a low cost operation
for screening out rapidly the potential
problem project and adhering to donor
performance standards.
s The main business benefits of the
approach are listed in Box 3.2,pg.34.
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BOX 3 4 37Th E i M k t R p36 B d Ri k CASE 3 Continued
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BOX 3.4
UPSIDE OPPORTUNITIES FOR PORTFOLIO COMPANIES
s Access to SRI funding
s Access to IFI funding
s Increased margins through process efficiency
s Access to new markets
s Enhanced branding
s Enhanced sales
37
BOX 3.5
UPSIDE OPPORTUNITIES FOR PRIVATE EQUITY GROUPS
The Emerging Market Response36 Beyond Risk
s Tuninvest has minimized the environmental risk of its portfolio
s 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
s 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
s Tuninvests 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 environ-
mental 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.
CASE 3 Continued
BOX 3.3
DOWNSIDE RISKS FOR PRIVATE EQUITY
s Reduced valuation through environmental stigma
s IPO brand impacts
s Trade sale stigma
s Incomplete warranties concerning contingent liabilities
s Liability for misrepresentation
s Liability for negligence
s Reputational risk for limited partners
s Directors liability
s Criminal liability
s Introduce environmental covenants
within shareholder agreements.
s 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).
s Inform all members of the fund man-
agement team of any significant envi-
ronment issues.
s Seek any available financial subsidies,
as there are many subsidized credit
lines available, for example for watertreatment units.
s 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 inter-
nally prepared EMS.
s Schedule training for both internal
staff and the management of portfolio
companies.
SUSTAINABILITY DRIVEN OPPORTUNITIES
s Access to SRI funding
s Access to IFI funding
s Reflecting environmental risk in reduced portfolio company
purchase price
s Reflecting superior environmental and social performance
in enhanced liquidity and pricing of portfolio companies
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. Value-
added opportunities (see Box 3.4,pg. 37).
Additionally, sustainability may add value
at the level of the fund itself. Core oppor-
tunities for the fund (see Box 3.5,pg. 37)
39The Emerging Market Response38 Beyond Risk CA SE 4 : L EA S ING
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CASE 4
LEASING: LESSONS LEARNED
Key lessons of experience from Raiffeisen
Bank include the following:
s 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.
s For these undercapitalized small cap
clients energy efficiency enhance-
ments can boost operating margins
significantly as well as reducing oper-ating risks resulting from fire, health
and safety issues and legislation driven
product obsolescence.
s In addition, management willingness
to engage in longer-term process
enhancement may correspond with
long-term management commitment
to the growth of the company
s As a result of these factors, the delivery
of energy-efficiency services may pro-
vide both a critical means of accessing
the strategically important smaller cap
market, and a means of reducing the
credit risk associated with the segment.
39The Emerging Market Response38 Beyond Risk
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
s IFC,through GEF,offered guarantee funding to Raiffeisen to reduce the risk of their loans to the
SME sector.
s A project officers salary was subsidized by 50% for the first year,until a real business line was demon-
strated which justified the banks investment in staff resources.
s Working through the IFCs technical assistance facility,created to support program participants in devel-
oping 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.
s 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
s Raiffeisens participation in the pilot program resulted in the immediate identification of deal flow
potential.Core business products included cogeneration development, and boiler/heating center recon-
struction for public sector clients with inefficient and unsafe boiler technology.
s 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
s 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.
s In year 3,the bank began financing a number of projects without IFCs 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.
s 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 cooperativeblock-
house housing sector.
s 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 improve-
ment investments.
s The projects 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
CA SE 4 : L EA S ING
RAIFFEISEN BANK
s Typical clients with energy efficiency
opportunities include public sector
service providers (e.g. hospitals, trans-
port, utilities) and sectors where energy
prices have traditionally been subsi-
dized but are presently increasing.
s Opportunities also exist for projects
with short pay back periods in the
retail market
s Conducting low cost up front energy
efficiency audits is a key method of
establishing client demand for energy
efficiency products.
s Meeting market demand for these
services depends on the banks expand-ing in-house delivery capability. Bank
staff training on deal identification
andstructuring is currently under
preparation at K&H Bank, HVB
Bank and OTP Bank, followed by
banking client workshops in various
locations of the country.
41The Emerging Market Response40 Beyond Risk TABLE 3 2 FIGURE 3 4
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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 enhance-
ment, as many SMEs use outdated and
resource-inefficient technologies.
These SMEs, therefore, present opportuni-
ties to increase efficiency and reduce costs
through cleaner production, productivity
improvements, access to premium export
markets and management system design.
41The Emerging Market Response
THE SME MARKET
SME clients form a key market segment.
As Figure 3.3, right, presents, a number
of factors are increasing the strategic
importance of the SME market for com-
mercial banks and leasing companies.
To what extent can sustainability enable
a financial institution to boost market
share in this strategically important seg-
ment? 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 undercapital-ized, facing global competitive threats,
using antiquated, resource inefficient
technologies, and operating in areas
with lower enforcement levels of envi-
ronmental regulations.
40 Beyond Risk TABLE 3.2
HUNGARIAN ENERGY EFFICIENCY PROJECT EXAMPLES
PROJECT TYPE TRANSACTION SIZE (US$)
Hospital gas-fired heating system 115,707
Hospital heating project 518,369
Block housing gas heating system 68,435
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
s Growth of Bond Market
s Increased IPOs
s Internet Banking
s Loss of second tier markets
s Margin reductions
s Global financial markets
s Retail market size
s Growth rate of market
s Local knowledge
s Under-served segmentsRETAIL SEGMENT
PUSH FACTORS PULL FACTORS
Retail Banking Competition
FIGURE 3.4
EVOLUTION OF BEST PRACTICE
FinancialComplianceProcedures
EnvironmentalValue-Added
EnvironmentalComplianceProcedures
COMPETITIVE ADVANTAGE
RISK
MANAGEMENT
FAILURE
RISK
ASSESSMENT
FAILURE
43The Emerging Market Response42 Beyond Risk BOX 3.6 TABLE 3 3
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The Emerging Market Response
Providing these services can generate
business benefits for the leasing company.
Key business drivers include the following:
s Develop new SME business
s Cross-sell existing products to supply
and distribution chain
s Deliver environmental product
extensions
s Reduce client marketing costs
s Increase inter-client referrals
s Increase intra-client referrals
s Build low cost word of mouth
marketing addressing corporate
and individual accountss Build media campaigns
CASE STUDY CONCLUSIONS:
FROM COMPLIANCE TO
VALUE-ADDED
The four cases above provide examples
of financial institutions not only per-
forming comprehensive financial and
environmental due diligence, but com-
plementing it by offering their clients a
range of sustainability-based products
and services that address the clients
business needs.
These cases, then, suggest an evolution
in approach: from financial compliance
where client creditworthiness is assessed
Beyond Risk
primarily as a function of the balance
sheet, through environmental compli-
ancewhere the institution imposes
environmental conditions to secure client
compliance and, to sustainability
where the financial institution ensures
compliance as a core part of risk man-
agement.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 practicein terms of sustainability initiatives that
can increase business volume, increase
business margins or enhance the long-
term 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.
BOX 3.6
PROVIDING ENVIRONMENTAL VALUE-ADDED TO SME CLIENTS
SME BUSINESS NEEDS
Revenue growth
s Decreased operating costs
(labor,inputs,waste disposal etc)
s Increased productivity
s Enhanced quality control
s Enhanced customer security
s Access to financing
Risk reduction
s Long term local operating license
s Long term international operatinglicense
s Avoided loss of contracts,strikes,
government shut down,penalties etc.
s Access to insurance
SUSTAINABILITY
PRODUCTS
s Environmental management systems
s Cleaner production audits
s Energy efficiency audits
s Energy efficiency products
TABLE 3.3
SUSTAINABILITY AS A BUSINESS DRIVERILLUSTRATIVE EXAMPLES
Sustainability as a Business Driver: Good Practice Review
GOOD PRACTICE
BUSINESS OBJECTIVE BUSINESS DRIVER EXAMPLE
s Winning mandates for complex
projects
s Providing loans to SME clients
s Winning microfinance market share
s Winning ethically conscious
depositors and credit card holders
s Winning SME market share through
offering energy efficiency products
s Offering finance to sustainable
businesses
s Reducing environmental credit
risk provisioning through quality
processes
s Providing fee-based advisory services
s Gaining access to IFI finance
s Gaining access to SRI finance
community
s Maximizing employee performance
s
Corporate governance premium
s IL & FSs IDFCs ABN AMRO
s Banco Cuscatlans Rant Leasings Banco Real
s Banco Reals African Bank
s Garanti Banks Cooperative Bank
s Raiffeisen Banks OTP Banks HVB Bank
s Terra Capitals Trioduss ASN Bank
s Indasias Vilniaus Banks Bioventuress Fleet Boston
s Unibancos Tuninvests IL & FS
s BBAs Banco Cuscatlan
s Capital International
Partnerss Citigroup
s Cooperative Banks Standard Chartered Bank
s
Bank of Shanghai
Increasing business volume
Increasing margins
Building long-term
competitive position
44 Beyond Risk FIGURE 3.5
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4.LESSONS FROM THE FIELD:SUSTAINABILITY IN ACTION
What are the main lessons learned in terms
of implementation?
Core opportunities in terms of increasing
business volume include the following:
s Increasing business volume: to trans-
form undoable deals into doable ones,
and increase the bankable portfolio,
to provide additional sustainability-
driven financing that supplements
existing loan products, to finance new
sustainable sectors, to reduce attrition,
increase client loyalty, and enhance
loan renewal rates
Core opportunities in terms of increasing
business margins include the following:
s
Increasing business margins: toreducecritical costs (losses, workout
time, insurance costs, capital costs,
legal liabilities and provisions), to
retain feesfrom advisory services,
syndications/underwriting services,
to reflect value-added in premium
loan pricing
Core opportunities in terms of increasing
business longevity include the following:
s Increasing business longevity: To
leverage sustainable portfolio perfor-
mance to access expansion capital
(key sources include IFIs, long term
institutional investors, bond markets,
pension funds, depositors and SRI
investors)
y
SUSTAINABILITY AS A STRATEGIC TOOL FOR THE FINANCIAL SECTOR
VOLUME P/A
LONG-TERM PROFIT
MARGIN DURATION
MORE DEALS BIGGER MA RGINS LONG-TERM OPERATION
47BOX 4.1 Sustainability in Action
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PERFORMANCE-BASEDMANAGEMENT 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 organizations operating sys-tems,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.
ISO14000 SERIES
FOR AN INSTITUTION TO ACHIEVE THESE SUSTAINABILITYBUSINESS GOALS RELIABLY, IT NEEDS A SYSTEMATIC APPROACH.
The International Organization for Standardization (ISO) has published a standard
on guidance for establishing an EMSISO14001.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
labeling.Many organizations globally have undergone third party verification of their
EMS and have attained certification to the standard.Others have opted for the EUs
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 banks position on environmental and social issues is sound.
49BOX 4.2 Sustainability in Action48 FIGURE 4.1Beyond Risk
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While the strategic choice will vary with
the institutions context, there are never-
theless a number of key elements that
are consistent across EMS types. This
chapter focuses on five central elements
of the environmental management sys-
tem, see Box 4.2, left.
A) OBJECTIVES AND TARGETS
An EMS has value for the institution
only in so far as it achieves specific busi-
ness objectives. For the EMS to provide
business value it must define a number of
priority business objectives, set specific
measurable targets for achieving themand then align key elements of the orga-
nizations formal and informal structure
to achieve them.
The choice of these priority objectives
will depend on the business lines, com-
petitive 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
ELEMENTS OF AN ENVIRONMENTAL MANAGEMENT SYSTEM (EMS)
BOX 4.3
POTENTIAL OBJECTIVES FOR RISK MANAGEMENT FOCUSED COMMERCIAL BANKS
The objective of this chapter is to examine
experience based on creating an EMS
that has three aims:
s To boost the business of core clients
s To generate a clear return for the
financial institution
s 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 catego-
rized 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 envi-
ronmental 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 oppor-
tunities.
Type Four orients its business line towards
sustainability.
EMS TYPES ACCORDING TO STRATEGIC FOCUS
TYPE ONE:DEFENSIVECore Elements of EMS in Place
Management of key environmental and social risks
s Operational procedures Top management support
TYPE TWO:PROTECTIVEFully Operational EMS
Systematic management of environmental and social risk
s Operational procedures
Application to all relevant sub-projects
TYPE THREE:OFFENSIVEFully Operational EMS
Systematic management of environmental and social risk
Limited environmental and social value-added
s Operational targets and objectives of EMS (enhanced portfolio quality,
reduced provisions,r educed workout time)
TYPE FOUR:SUSTAINABLEStrategic Focus on Environmental & Social Opportunities
Systematic management of environmental and social risk
Systematic environmental and social value-added
s Environmental and social opportunities prioritized within existing sectorss New sectors
a) Objectives and targets: setting the key business goals for the institution
b) Applicable standards: identifying the standards acceptable to key stakeholders
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
RISK REDUCTION
s Reduced management workout time
s Reduced risk of project rejection at a late stage
s Reduced risk to reputation
s Reduced risk of defaults, and lower loss provisioning
s Reduced liability for any environmental clean-up of collateral
s Reduced legal liability for misrepresentation/negligence
s Continued access to IFI capital
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Identifying applicable standards, and
ensuring compliance with them poses a
number of challenges. Relevant stakehold-
ersmay be hard to identify. Stakeholders
may claim the right to involvement in a
project without any legal basis for juris-
diction. 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.
In 2001, to address these issues, a number
of banks based in the Netherlands began
to implement corporate-wide forestry poli-
cies.A core step in the policy rollout was
to identify key stakeholders, including
NGOsand industry clients. Policy for-
mulations were then forged in consultation
with these stakeholders and have achieved
broad consensus.
What are the elements of current good
practice for financial institutions in setting
applicable standards? Key lessons include
the following:
s Identify local, national and interna-
tional stakeholders whose support is
critical.
s Identify the standards that they judge
to be acceptable (for example, national
regulations, EU standards, WBG
industry guidelines).
COMPLIANCE APPROACH
FIGURE 4.3
FROM COMPLIANCE TO VALUE-ADDED
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
Key lessons include the following:
s The choice of objectives will depend
on the competitive positioning and
strategy of the institution.
s The organization should prioritize,
resisting the temptation to set too many
goals and diffuse the institutionsfocus.
s Go for qui
top related