1
The Higgins study included questionnaire-based interviews with more than 100 IFC project sponsors. To field test and verify the questionnaire responses, the study team also visited more than 20 percent of the projects surveyed.
2 Exceptions are mining and milling, both open pit and underground. World Bank guidelines are currently in use, but are not contained in the Pollution Prevention and Abatement Handbook. 3
“Procedure for Environmental and Social Review of Projects” (July 1998). Earlier procedures mentioned in this text include “Procedure for Environmental Review of IFC Projects” (March 1990), “Internal Procedure for Environmental Review of International Finance Corporation Projects” (December 1992), and “Environmental Analysis and Review of Projects” (September 1993). The requirements are found in the “Procedure for Environmental and Social Review of Projects” (1998); the “Policy on Disclosure of Information” (1998); and several IFC operational policies, particularly Operational Policy 4.01, “Environmental Assessment.”
4
4
T
LESSONS LEARNED
he economic promise was enormous, but so were the potential E&S problems. The launching of the Mozal aluminum smelter in Mozambique was a proving ground for many of the lessons of experience IFC and its partners in the public and private sectors have been accumulating on E&S issues. For Mozambique, one of the world’s poorest countries, emerging from decades of civil war and making the difficult transition from a centralized command economy to a market-oriented one, Mozal marks the beginning of a host of new projects and foreign direct investment flows into the country and region. For IFC, Mozal has been among its most ambitious and pioneering undertakings. The Mozal project, at a cost of $1.34 billion, is the largest private investment to date in Mozambique and one of the most complex capital-intensive projects undertaken in southern Africa. IFC’s $120 million investment represents its largest single investment in its account in the nonfinancial sector. The project’s sheer size in relation to the host economy; Mozambique’s weak legal, financial, and environmental institutional capacity; and the complex risk-sharing financial structure all presented challenges. For the other project sponsors—BHP Billiton, the Japanese global conglomerate Mitsubishi, and the Industrial Development Corporation of South Africa—the project was a learning experience. At that time, this was the first project for BHP Billiton funded through finance outside of South Africa, the largest investment for Mitsubishi in the nonferrous metals sector, and the first Industrial Development Corporation investment outside South Africa.1 The greenfield smelter, commissioned in June 2000, is operating at capacity and will produce 250,000 tons of primary aluminum ingot a year, all of which will be exported. The smelter is expected to be a low-cost and high-quality aluminum producer. Financing for a second phase for the project was also completed in June 2001, with operations expected to commence in late 2003. The project’s E&S dimensions were daunting. The initial site, located at the harbor of Maputo, was proposed for financial and technical reasons and promised low transport costs. However, this was a densely populated area, and roughly 1,000 families—some 7,420 people—might have had to be resettled. Furthermore, it was in a low-lying area, which posed problems with the dispersal of fluoride emissions and the viability of vegetation. From the outset, IFC mobilized a team of E&S specialists to help shape the project. The sponsors took a hard look at the site and researched all relevant issues— including soil conditions; the availability of transport, infrastructure, water, sewerage, electricity, telecommunications, and other infrastructure; economic activities in the area; and the potential need for resettle-
39
40
LESSONS OF EXPERIENCE
ment—for three alternative sites. They also commissioned a social impact assessment to provide data for their analysis. Based on their findings, the team chose a new site. One result was significant savings in project costs. The site finally selected was in an elevated, undeveloped industrial zone some distance from Maputo. This eliminated the risk of negative effects of the air emissions. It also reduced the economic costs of establishing infrastructure and services, because other companies in the industrial zone could share these amenities. Furthermore, only a few households had to be relocated: the overall resettlement costs for the alternative site were about 3 percent of the estimated costs for the original site. Mozal served as a seed for a new industrial estate in Mozambique. Given the government’s financial constraints, it could not fully address the E&S aspects of the project, so resources from Mozal were used for this purpose. The sponsors developed the 140-acre smelter site and built the necessary supporting infrastructure on behalf of the government. In addition, about 700 hectares of nearby farmland were prepared to accommodate the 1,200 farmers relocated from the construction areas, thereby providing food and long-term agricultural income for affected families.
Mozal has set a precedent for future projects in Mozambique. In addition, it illustrates the clear advantages of incorporating E&S issues early on and completely in project development. As such, it reflects the approach and procedures IFC has been refining and putting in place to deal with E&S issues.
DEALING WITH COMPLEX AND RISKY E&S ISSUES During the past decade, development projects like Mozal have grown increasingly complex, with multiple lenders, long-term investment requirements, and a multitude of risk factors.2 Many of these projects are in countries or sectors where institutional and regulatory frameworks are only partially developed. Under such circumstances, a careful assessment of the various risks and issues surrounding a project is essential when structuring the project (for a detailed discussion of project risks see IFC 1999a, chapter 4).
Such attention to project structuring becomes particularly important for IFC for two main reasons. First, IFC invests in projects in more than 100 countries, many of which are frontier countries where perceived and actual project risks are high. Given IFC’s focus on drawing in private investors, detailed risk assessment and sound project structuring are necessary to ensure that projects run smoothly and are financially viable.
Box 4.1 Lessons Learned 1. Early incorporation of E&S standards in project structuring is important, perhaps essential. Early incorporation ■ Leads to better projects with lower costs, simpler issues, and quicker closure ■ Allows the sponsor to define and assess issues independently ■ Helps inform sponsors and financiers about possible choices and options. 2. The role of the sponsor is critical. ■ Determining the sponsor’s capacity and attitude toward E&S issues early on—during project evaluation— is essential. 3. Disclosure and transparency up front are necessary to build and maintain credibility. 4. Close and tailored IFC engagement in E&S issues throughout the project improves outcomes. 5. Adequate internal capacity is essential for project evaluation. 6. Strict adherence to sound E&S principles is necessary, although some flexibility is important. 7. SMEs do not need separate procedures, but field-based E&S expertise is especially valuable to them. 8. Large projects are fundamentally different from conventional IFC projects. 9. For FIs, capacity building is necessary for sustainability.
LESSONS LEARNED
41
Second, as an international organization whose objective is to promote sustainable private sector development, IFC must ensure that projects are not only financially profitable in the short run, but are also financially, economically, environmentally, and socially sustainable over the long run. Sustainability necessarily requires IFC to incorporate all pertinent E&S issues into its analysis in addition to financial and economic issues. This chapter focuses on lessons IFC has learned in dealing comprehensively with E&S issues. In outlining these lessons the chapter draws on several sources, including discussions with IFC staff, an internal review of selected IFC projects between 1993 and 1999 done for this study, a survey of IFC’s private sector clients, and independent reviews of IFC projects conducted by the OEG. The lessons reported here are more in the form of stylized facts than detailed, rigorous, economic analyses (box 4.1). The focus of this chapter is not whether E&S engagement makes sense, but on what IFC has learned as it has become involved in E&S issues in
recent years. An initial objective of the internal review of selected projects was to quantify E&S costs and benefits. However, information about project-level costs was limited, and rarely contained details specific enough to help calculate the economic benefits of specific E&S actions. Accordingly, the review focused on a survey of the original project teams to obtain an internal perspective on such issues as IFC’s role and contribution. Except in a handful of cases, quantified data were unavailable, and going back to original project sources to collect the data was unfeasible. Several projects for which data were more extensive are profiled as case studies or boxes.3
INTERNAL REVIEW OF SELECTED IFC PROJECTS, 1993–1999 Selected IFC projects were reviewed in several ways. First, the reviewers analyzed all category A and B projects in which IFC invested between 1993 and 1999 for broad trends. Second, the team identified a subset of projects for closer review and interviewed project teams, with the aim of gaining a better understanding of IFC’s role in project-related E&S issues.4 The team
Figure 4.1 Sectoral Distribution of IFC's Category A Investment: 1993–1999
Mining and Extraction Infrastructure Chemicals and Petrochemicals Oil Refining Hotels and Tourism Cement and Construction Materials Manufacturing Food and Agribusiness 0 10 20 30 40 50
Percent of all Projects
Note: Total number of projects, 35; total value, $1.6 billion.
42
LESSONS OF EXPERIENCE
chose the time frame of 1993 to 1999 as a period between two milestones: 1993, when IFC adopted a newer procedure that gave specific consideration to its private sector activities, and 1999, when IFC adopted its current, significantly improved E&S procedures. (For a list of IFC projects from 1993 to 1999 see appendix B.)
Analysis of IFC’s Portfolio by Degree of Environmental or Social Impact This section presents the results of the analysis of selected IFC projects.
tourism, cement and construction materials, manufacturing, and food and agribusiness (figure 4.1). On a regional basis, IFC’s category A projects between 1993 and 1999 were concentrated in four regions: Asia (39 percent), Southern Europe and Central Asia (22 percent), Sub-Saharan Africa (21 percent), and Latin America (15 percent). The disproportionately high share of category A projects in Sub-Saharan Africa and Southern Europe and Central Asia was primarily because many projects in these two regions were in the infrastructure and mining and extraction sectors. Category B investments. During 1993–99 IFC invested $6.5 billion in 366 category B projects. These were sectorally more diversified than category A projects, but regionally more concentrated. Sectorally, the highest volume of investment ($1.5 billion) went to infrastructure, followed by food and agribusiness ($1.2 billion). Regionally, Latin America (44 percent) and Asia (22 percent) accounted for two-thirds of all category B project investments (figure 4.2).
Category A investments. During 1993–99, IFC made net investments of $1.6 billion in 35 category A projects. Of these investments, 78 percent were in two sectors: mining and extraction (47 percent) and infrastructure (31 percent). This is not surprising, as projects in these sectors are particularly likely to have significant E&S issues associated with them. The remaining 22 percent were divided among several sectors: chemicals and petrochemicals, oil refining, hotels and
Figure 4.2 Sectoral Distribution of IFC's Category B Investments: 1993–1999
Food and Agribusiness Infrastructure Manufacturing Mining and Extraction Timber, Pulp and Paper Cement and Construction Materials Hotels and Tourism Textiles Chemicals and Petrochemicals Industrial and Consumer Services Motor Vehicles and Components Other Oil Refining 0 5 10 15 20 25
Percent of all Projects
Note: Total number of projects, 366; total value, $6.5 billion.
LESSONS LEARNED
43
Assessing Risk By their very nature, category A and B projects involve a variety of risks. Some risks are project specific. Others are more country, region, or sector specific, affecting all projects in a particular country, region, or sector equally.
projects—are greenfield projects (figure 4.4). A greenfield project is one that is conceived and executed where no project company organization, assets, or operations previously existed. By contrast, expansion projects can include modernization, refurbishment, and expansion of existing operations. As category A projects have more significant adverse environmental impacts than category B projects, and also tend to be larger in terms of project costs, it is beneficial that the majority of these are greenfield projects, because greenfield projects are more amenable to front-end solutions, which almost always tend to be more cost-effective than after-the-fact solutions (retrofittings).
Project Team Perspectives The experience of the original IFC project teams offers some insight on dealing with E&S issues. Accordingly, the study team asked selected project teams a series of questions about such issues as the E&S process used during the project, IFC’s role and performance, and
IFC considers several factors in determining country risk levels, including market and political risks. Different institutions use different risk rating methodologies. The one used for the analysis in this section is from Institutional Investor magazine.5 Figure 4.3 breaks down IFC’s net investments for 1993–99 based on the Institutional Investor’s ranking methodology. By this measure, none of IFC’s category A projects are in the low risk group (above 60), whereas more than 32 percent are in the highest risk category (below 31).
Greenfield Projects An important way to control adverse impacts is to address them from the start. Accordingly, as the sample reveals, a significant percentage of projects—66 percent of category A projects and 31 percent of category B
Figure 4.3 IFC Net Investment by Country Risk Classification: 1993–1999 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 IFC Net Investment in Category A Projects IFC Net Investment in Category B Projects
61 to 100 31 to 60 0 to 30
Note: Ranking as of September 1999
Millions of Dollars
44
LESSONS OF EXPERIENCE
how IFC’s requirements differed from those of other institutions.6 The interviews covered 36 category A projects and 50 category B projects. An interesting result was that IFC’s interventions appear to have been more effective in the inherently riskier and more complex category A projects than in category B projects. The following paragraphs summarize respondents’ answers to specific interview questions. Separately, see Box 4.2 for a client perspective. Did IFC’s involvement improve the E&S component of the project? For category A projects, 66 percent of the project teams indicated that IFC’s involvement made a difference. Specifically, the teams cited the following as useful interventions by the firm in order to meet IFC’s E&S requirements: removing lethal gas from a project site; improving safety measures for the transport of volatile and hazardous chemicals; capturing released polyvinylchoride dust; upgrading environmental standards; increasing the scale of clean-up; and helping resolve resettlement issues, including rights-of-way issues. For the roughly one-third of category A cases where project teams
did not think that IFC’s involvement made a difference, in most cases this was because the sponsors were international companies with E&S procedures comparable to IFC’s. The results were less dramatic for category B projects. IFC’s interventions appear to have made a difference in 28 percent of projects. Once again, in most of the cases where IFC’s approach did not make a difference, the sponsors were international companies with comparable policies and procedures. In addition, by definition the E&S issues involved in category B projects were less critical. Did IFC’s approach to E&S issues affect projects’ processing time? Once again, IFC’s interventions appeared to have a greater impact on the more complicated projects (from an E&S standpoint). IFC’s E&S approach delayed 28 percent of category A projects and 8 percent of category B projects, that is, a delay relative to the time that would normally be required to complete the project without adhering to IFC’s E&S approach.
Figure 4.4 Number of Greenfield vs. Expansion Projects in Categories A & B: 1993–1999
300 250 Number of Projects 200 150 100 50 0 Category A Category B
Greenfield Expansions
LESSONS LEARNED
45
Do differences exist between IFC’s approach and that of others involved in the project (sponsors, cofinanciers, host governments)? Here the study team defined differences as either in guidelines and procedures, or in implementation, or both. Once again, the differences appear to be more sharply defined for category A projects. IFC’s approach was different and stricter in 80 percent of category A projects and 33 percent of category B projects.
CASE STUDIES Case Study 1: Cleaner Production, Girsa, Mexico Girsa S.A. de C.V. is a Mexican-owned chemicals and industrial group with annual net sales of around $700 million. It has long been considered a leader in environmental issues in Mexico.
Girsa began work almost immediately to improve the efficiency of the NHUMO facility. Since 1993 the company has invested more than $20 million in various efficiency improvements, including equipment to capture and re-use energy released during the carbon black production process. In its efforts to improve relations with the surrounding community, Girsa went beyond merely mitigating the NHUMO plant’s impacts. It has partnered with both technical institutes and universities to offer training and conduct research and development activities. It has also instituted various community outreach activities and offers other businesses the opportunity to tour the plant in an effort to share best practices. The environmental benefits of reductions in emissions, resource use, and waste product production are impressive. From 1991–98 the amount of carbon dioxide emitted per ton of carbon black produced dropped from 3.9 to 0.65 tons, the amount of wastewater released per ton of production fell from 13.7 to 1.5 cubic meters, and the amount of solid waste generated per ton of production plummeted from 69.8 to 5.3 pounds. The NHUMO plant’s production capacity more than tripled during this period. The plant’s financial success has followed right behind these eco-efficiency gains. The $20 million investment in environmentally friendly technologies has already paid off by yielding $30 million in savings. The NHUMO’s net income as a percentage of sales rose
Girsa’s experience with its Productor de Negro de Humos Mercados (NHUMO) carbon black facility is a compelling example of the financial gains that can result from increased attention to environmental concerns. Carbon black is a fine black powder used to strengthen rubber products and as an input into various paints, inks, and plastics. When Girsa bought the NHUMO facility in 1990 it had serious environmental problems and significant financial losses. The year after Girsa had purchased it, the NHUMO plant posted a loss of 40 percent of sales and the plant had been the object of numerous community complaints concerning its appearance and pollution.
Box 4.2 The Client’s Perspective on IFC’s Approach to E&S Issues In May and June 2001 IFC commissioned a client survey to ascertain how its private sector partners feel about IFC’s approach to a number of issues, including E&S issues. To preserve complete client confidentiality, a thirdparty firm conducted the survey. Clients responded by Internet, e-mail, and fax. The firm surveyed some 333 clients, of which 163 responded. The sample was designed so that the same selection criteria could be used to conduct a similar survey in subsequent years. One question asked was whether clients viewed IFC’s E&S approach primarily as a requirement that they had to meet or primarily as helpful to their long-term business interests. Sixty-six percent responded that they viewed IFC’s E&S approach as primarily helpful to their long-term interests. Clients from industries with difficult E&S issues sent a stronger message: 95 percent of clients from the mining, oil, gas, and chemicals sectors indicated that they viewed IFC’s E&S approach as primarily helpful to their long-term business interests. Source: IFC.
46
LESSONS OF EXPERIENCE
from negative 40 percent in 1991 to 21 percent in 1998. In addition, the plant has gone from being a major source of controversy in the surrounding community to a model corporate citizen that locals are proud to claim as their own. Formal community complaints lodged against the plant dropped from 12 in 1991 to none in 1998. Girsa’s NHUMO plant has also won numerous accolades for its performance at the national and international levels. Mexico’s Ministry of Environment, Natural Resources, and Fishing awarded Girsa the 1997 National Quality Award and the 1999 National Award for Ecological Merit, and it also became the second carbon black facility in the world to attain ISO 14001 certification. In 1996 IFC provided a $155 million financing package for Girsa’s capital expansion activities, which took place from 1993 to 1998. Girsa used the package to increase production along various product lines and to improve the efficiency and environmental performance of its facilities. Girsa returned to IFC for further financing in 1999 to allow it to modernize its operations and further improve its competitiveness in the international marketplace. The financing vehicle for this second investment phase was highly innovative. At Girsa’s request IFC devised a way for Girsa to tap the U.S. institutional investors’ market through a Crédit Suisse First Boston private placement with U.S. insurance companies. IFC provided a syndicated loan of $60 million for the account of participants, in addition to $45 million it lent for its own account. Thanks to IFC’s preferred creditor status and Girsa’s own creditworthiness, the private placement was assigned a BBB rating, giving it a rating higher than Mexico’s sovereign rating. IFC’s willingness to pursue this innovative approach was facilitated by the company’s continuing commitment to sustainability. Case Study 2: Environmental Overhaul, Intercell, Poland Intercell is a pulp and paper-products producer in Poland. A timely investment in pollution control technology and some innovative uses for its waste materials not only kept it in business, but improved environmental quality in the surrounding area.
IFC, which has made three investments in Intercell to date, initially extended an $11 million loan and a $7 million equity investment to finance an expansion in capacity and a shift in product line. Annual production increased from 178,000 to 211,000 metric tons, and the share of corrugated boxes, paper sacks, and other converted products increased from 50 to 80 percent. The company also sought to decrease the environmental fees incurred by its operations. Before the overhaul, Intercell was paying some $2 million per year in discharge fees, discharge penalties, and water consumption charges. The company installed new equipment and devised innovative uses for some of its waste materials that led to significant cost reductions. It reduced wateruse by 7 percent and chemical oxygen demand concentration in liquid effluent and in hydrogen sulfide emissions by 70 and 87 percent, respectively. Intercell’s efforts to reduce its chemical oxygen demand and hydrogen sulfide discharges could not have been more timely. Polish government discharge fees for chemical oxygen demand concentration and hydrogen sulfide emissions nearly tripled from 1992 to 1999. Had the project not installed new equipment to reduce these discharge levels, government fees would have shut it down. As it was, during this period the company’s costs resulting from discharge fees grew by a mere 5 percent for chemical oxygen demand and fell by half for hydrogen sulfide emissions. Before the overhaul, poorly treated liquid waste and untreated leachate and runoff from a bark storage pile were all discharged into the Narew River, which feeds Warsaw’s primary source for potable water, the Wisla. Thanks to the overhaul, effluent that enters the Narew now complies with World Bank Group environmental standards. In a truly innovative move Intercell now trades unused bark and the sludge from its wastewater treatment activities to a neighboring power plant in exchange for electricity. The plant uses the cleanerburning bark and sludge in place of coal as fuel. The pioneering in-kind exchange system between the power plant and Intercell has resulted in significant reductions in both the power plant’s air emissions and Intercell’s energy costs, while virtually eliminating Intercell’s solid waste disposal issues. The costs to the
LESSONS LEARNED
47
Polish government and the people of Warsaw of a polluted river have also been significantly reduced through the use of better wastewater treatment processes. The emission control measures and innovative uses for waste materials have significantly improved Intercell’s financial performance, made the project sustainable in the face of increased government regulation, and improved the area’s quality of life. Case Study 3: Advantages from Sustainable Development, Cembrit Bohemia, Czech Republic In 1995 IFC funded the modernization of Cembrit Bohemia a.s., a recently privatized producer of building materials in the Czech Republic. The focus of the $14.7 million project was switching from a hazardous, asbestos-based production process for making roofing materials to an environmentally sound cellulose-based process. The project also facilitated an extensive environmental clean-up, including the safe and proper decommissioning of the asbestos cement operations. The project is jointly owned by Dansk Eternit Holding (68 percent) and the Danish Investment Fund for Central and Eastern Europe. Dansk Eternit Holding has a long-standing commitment to E&S sustainability. In the mid-1980s it became the first company to introduce a comprehensive range of asbestos-free fiber cement products. With the aim of expanding its operations in Western and Central Europe, Dansk Eternit Holding identified Cembrit as a partner and contributed its proprietary know-how. To market under the Cembrit trademark, Cembrit must ensure that all its products pass the test for quality, durability, and a clean process. Cembrit’s attention to E&S issues also addressed possible local problems. In the early 1990s the Czech government stated its intention to introduce legislation prohibiting the use of asbestos materials in line with the trend in EU countries. Thus, if Cembrit had not undertaken the project, it would eventually have been shut down. By proactively addressing future regulatory requirements, Cembrit continued, and even expanded, its operations. The company’s elimination of asbestos, coupled with the clean-up of its plant facilities, generated a competitive advantage. The company can now readily export to
the EU and other nonasbestos export markets. Although the original business plan projected that only 20 percent of production would be exported, today exports exceed 50 percent and include markets in Belgium, Denmark, France, Ireland, the Netherlands, and the United Kingdom in addition to Slovakia and Slovenia. In 2000 Cembrit had total sales of $17 million, a 22 percent increase over the previous year. Not only did Cembrit’s foresight save the company during the late 1990s when it offset a downturn in local demand through increased exports, but it also helped preserve hundreds of jobs both at Cembrit and in local supporting industries. In addition, the modernization resulted in many benefits to human health and environmental quality. By removing asbestos technology from its operations, the project has helped enhance life expectancy and reduce further negative health impacts on workers and local consumers. By converting from coal to gas-oil fuel, the plant reduced air emissions almost 100 percent and made a cleaner source of energy available to local neighborhoods. By constructing a pretreatment facility and connecting to the municipal sewage system, the project stopped the discharge of untreated liquid effluent into the Berounka River. Moreover, the project has yielded many upstream benefits, including strengthening several local businesses such as suppliers of pigments and spare parts. These businesses enjoyed some $3 million in incremental sales in 1998 because of the project. Finally, corporate benefits from the project have been significant, including on-the-job staff training and visits to Denmark by a number of local management and technical staff to study the sponsor’s operations. In 2000 a Czech national was appointed managing director, replacing a Danish expatriate. Cembrit encourages and pays for its staff to take English language training at a local language school, provides staff and their families with annual medical examinations, provides subsidized housing to its employees, and has established a social fund for employees’ families. The company is also considered to be a wage leader in the community.
LESSONS LEARNED Through trial and error; through examination of best practices around the world; through the expertise of specialists; and through careful consultation, observation, monitoring, and reflection, IFC has culled a num-
48
LESSONS OF EXPERIENCE
ber of lessons from its experience in dealing with E&S challenges. The following section summarizes some of the key lessons. Lesson 1: E&S Issues Should Be Addressed Early during Project Structuring. As a general rule, the early incorporation of E&S issues in project structuring leads to projects that are better designed and structured, thus providing tangible benefits and cost savings.7 Such projects are also likely to be implemented on or ahead of schedule. An early review of plant design and processes means that enhancements and alternatives can be considered from the onset rather than later during the project’s life, thereby avoiding redesign delays or expensive retrofittings. For example, introducing energy conservation systems at the front end can lead to a more fully integrated system with both upstream and downstream linkages. In addition, an initial analysis of the project’s overall scope and impact on the local community often brings to light issues whose resolution can benefit greatly from thoughtful foresight.
In a number of IFC projects, an early review of E&S issues highlighted possible areas of improvement in plant processes and design (box 4.3). The recycling of waste products is another benefit that can arise from an early environmental review. These reviews often result in close scrutiny of waste materials, idle equipment, or pollutant outputs at the production site. To bring themselves into compliance some companies undertake detailed inventory checks, which often generate economic benefits. Sometimes a company sells outdated equipment for scrap and recycles pollutants. For example, in a steel plant in the Caribbean the installation of a hood improved the plant’s efficiency and reduced clean-up costs. The hood collected airborne steel dust, which was then recycled, not only reducing particulate emissions from the furnace, but also reducing the amount of scrap metal needed for the steel-making process. Early incorporation of environmental issues reduces the need for costly retrofitting when local E&S standards
Box 4.3 Early Incorporation of E&S Issues Reduces Project Costs, Malteria Pampa, Argentina Malteria Pampa is Argentina’s largest producer of malt. The company sought to capitalize on Argentina’s highly favorable environment for growing malting barley to become the leading supplier of malt to the rapidly growing South American brewing industry. At the time of IFC’s first investment in 1991, Londrina S.A. (Londrina) and Companhia Cervejaria Brahma (Brahma) of Brazil each held 50 percent of Malteria Pampa’s equity. Currently, Malteria Pampa is a wholly owned subsidiary of Companhia Brasileira de Bebidas (a new operating company after the merger between Brahma and Companhia Antarctica Paulista). The project doubled production capacity and was IFC’s second investment in Argentina’s agro-industry sector. During the initial project appraisal, IFC’s E&S review identified the need to improve the treatment of liquid effluents. By identifying this requirement early, a corrective action plan was developed that involved doubling the size of the sedimentation tank and using the best available technology for primary and secondary treatment of the waste. This not only greatly increased throughput capacity, but also produced a far greater benefit. The company had been compensating for undercapacity by increasing its use of chemicals. By using a substantially larger tank and hiring a chemical engineer, in 1997 the company was able to shift from an intensive chemical process to a process that used virtually no chemicals. Not only has this change in process design been extremely beneficial to the environment, but it has also saved an estimated $30,000 a month in chemical expenses. While full cost recovery was expected to take approximately three years when the program was first implemented in 1997, the sponsors and IFC concurred that the long-term environmental and cost benefits outweighed any short-term cost considerations. A second notable achievement, the introduction of energy conservation systems, led to further benefits and cost reductions. Malteria Pampa was the first malting plant in Latin America—and one of only three worldwide—to use electrical cogeneration. An intelligent plant design that uses natural gas to drive the turbines and recycles the waste heat to dry the malt has significantly reduced utility costs and has provided the company with a competitive cost advantage, with among the lowest unit utility costs in the industry.
LESSONS LEARNED
49
tighten. In Indonesia, for example, the introduction of low-pollution technology in a facility manufacturing viscose rayon staple fiber at the onset of a project gave the company a competitive advantage over other local mills that were required to retrofit as environmental standards tightened. The production of viscose rayon staple fiber, a man-made derivative of wood fiber used in textile manufacturing, can generate a considerable amount of air pollution, primarily sulfur compounds, and water pollution. Without the appropriate capturing or processing technologies in place, surrounding areas can suffer serious damage. By adding equipment to recover and re-use sulfur compounds and to recycle heat from the production process, the company estimated that it would recoup the cost of its investment in this equipment in less than 10 years. Well-structured projects that have duly considered and incorporated all E&S issues generate less pollution and are less susceptible to unscheduled closures caused by litigation or activism. While historically such concerns as litigation and activism have been confined to the industrial world, they are becoming increasingly commonplace in the developing world. Liability issues, costly retrofitting, and expensive clean-ups are but a few of the possible outcomes of failing to consider E&S impacts (see Davis 1998 for numerous examples). Project reviews must consider not only financial, economic, and environmental issues, but social issues. By assessing possible social issues at the onset, project sponsors can ensure that appropriate action plans are developed, thereby avoiding some of the problems that arise with late interventions. For example, IFC’s experience has been that resettlement plans must be devised early to avoid excessive disruption to both the project and to families and communities and costs. In a number of cases, by identifying social issues early on and encouraging sponsors to play a role in this process, IFC had a positive impact on both social issues and on project costs and outcomes. Sponsor participation is important even when the government is carrying out the resettlement for a number of reasons. First, resettlement is usually a complex matter and takes time to resolve. The pace of the resettlement process affects the project’s construction
schedule, and delays almost always raise sponsors’ costs. Second, the World Bank Group’s standards for resettlement often differ from those required by host governments, and project sponsors must satisfy the higher standard.8 By being proactive, the sponsor can not only facilitate the government’s work, and thus reduce construction delays, but can also ensure that the government is working with the appropriate resettlement standards. In addition to the sponsors, the engineering, procurement, and construction contractors have a strong financial incentive to complete the project on or ahead of schedule, and thus they too can benefit from active engagement with the government on issues such as resettlement. While ongoing sponsor engagement with governments on resettlement issues makes sense, sponsors do not often—or consistently—become involved. Typically the relevant authorities promise the sponsor a cleared site for a lump sum payment. Thus the sponsor generally does not see a need to work with the government and ensure that resettlement is taking place smoothly and quickly. In practice, however, sponsor cooperation and engagement with the relevant government authority can speed the process significantly, and when done well is less likely to create future problems. For many companies their reputation plays an important role in their ability to conduct business effectively. As chapter 2 notes, companies with good reputations are likely to achieve better financial results and to receive a higher equity valuation from the market. In the case of developing countries, a company with a solid record on E&S issues can find that having a good reputation on E&S issues often works to its advantage, both in dealing with governments and the local community. Specifically, such companies may gain local government support more easily, an important resource when they must obtain operating permits and acquire land for the project. Furthermore, the local community is often helpful when unexpected complications create problems for the project. From IFC’s viewpoint another important reason to incorporate E&S issues into the early planning stages of a project is that it allows the sponsor to establish direct contact with the local community. This early interaction between the sponsor and stakeholders is
50
LESSONS OF EXPERIENCE
important, because it leads to a dialogue between the concerned parties and makes for a better project with shorter or no delays and no surprises. The later the dialogue begins, the less the flexibility in terms of choices. For example, once the sponsor has chosen the plant site and broken ground or has purchased or contracted for equipment and machinery, the sponsor is locked in in terms of site or technology. Any significant environmental or social issues that arise at or after this point tend to be costly and often introduce expensive delays. Sponsors’ involvement can also help them buy into IFC’s E&S approach. This is important in a number of IFC projects, particularly in the case of smaller sponsors and those with whom IFC is working for the first time. In such cases IFC invests considerable time in demonstrating the merits of its E&S approach and then working with the companies in areas such as capacity building to enable them to satisfy the E&S requirements. As the time involved is not inconsequential, early incorporation of E&S issues makes more projects more efficient. For example, one of IFC’s hotel investments in Latin America was an expansion project. IFC’s E&S assessment indicated that the hotel expansion, as envisaged, would greatly increase the hotel’s water consumption, thereby drawing down the local aquifer, with potential local, and possibly regional, impacts. Initially the sponsor could not understand why a private sector firm should consider local and regional aspects, and viewed these as issues that ought to be within the purview of the appropriate government authority. Further discus-
sion with the sponsor made it clear that the only option under the current plan was to install a desalination plant, an option the sponsor deemed too expensive. This prompted it to rethink the issue and, at IFC’s recommendation, to commission a study of the aquifer, which allowed the sponsor to calculate an optimal drawdown rate that would satisfy its own water requirements, but not affect the community adversely. The decision to commission an aquifer study resulted in an option that was not only the least expensive option from the sponsor’s point of view, but also the most sustainable from a social point of view. Early sponsor involvement with the community is particularly helpful, because it allows sponsors and the community to raise and obtain answers to questions such as: Who will be affected by the project? How will they be affected? What can be done to mitigate or reduce these effects? Public consultation with the affected local community has allowed sponsors to obtain answers to these questions and has proven to be an effective way to improve projects. Furthermore, to the extent that some sponsors might have an industrialcountry focus, these early interactions allow for better identification and analyses of key issues. Lesson 2: The Sponsor’s Role Is Critical. The sponsor’s role is critical in all IFC investments. While IFC and other cofinanciers (including the sponsor) provide the necessary capital, the sponsor is the one ultimately responsible for the actual working of the project from construction to operation.
Box 4.4 Other Lessons Related to Sponsors As noted, the sponsor is ultimately in charge of the actual working of the project. Three additional lessons regarding project sponsors emerged during the interviews with IFC project teams conducted as background for this report, namely: ■ It is important not to underestimate sponsors’ interest in E&S issues. Often IFC’s clients are more aware than IFC of emerging trends and risks in the market. ■ Many project sponsors recognize and value IFC’s contributions to and role in enhancing their environmental performance. ■ Sponsors tend to see value in addressing E&S issues, such as specific standards and reporting requirements, when they are presented clearly and cogently up-front, that is, during appraisal and structuring, and by reflecting such specific requirements in investment agreements. No one benefits when these issues are avoided in the beginning, because they will have to be dealt with ultimately. As noted earlier, late consideration of such issues typically results in potentially greater disruption to the project, its sponsors, and affected communities, ultimately leading to higher costs and suboptimal choices.
LESSONS LEARNED
51
Notwithstanding legal agreements, the sponsor’s capacity to deal with E&S issues does make a difference. IFC has learned through experience that determining sponsors’ capacity and attitude as soon as possible is important (for other lessons pertinent to sponsors see box 4.4). IFC’s experience with sponsors, while varied, has been good-to-excellent for the most part. Sponsors appear to fall in four broad categories. A first group of sponsors, usually international companies, is familiar with E&S issues and knowledgeable about best practices. These sponsors incorporate such issues in their thinking on a regular basis and often possess the requisite capacity to address such issues in-house. A second, fairly large, set of sponsors tends not have formal E&S guidelines or procedures (or at least not as detailed as IFC’s), but does not object to IFC’s requirements, and typically sees the net advantages of adhering
to them. Such sponsors are usually smaller international firms or large, successful, domestic firms. Their capacity to address E&S issues is usually adequate, and they are receptive to building such capacity when it is deficient. Many are eager for training and assistance in capacity building, such as setting up in-house procedures for compliance. In cases where sponsors are less familiar with international best practices, IFC has encouraged such sponsors not to take a checklist approach to compliance, but to deal with the fundamentals of the issues involved. A third set of sponsors, noticeably in the minority, are often local firms that are usually relatively small even when compared with other firms in the host country. They are often unfamiliar with the need to address many of the E&S issues involved and lack the capacity to do so. Moreover, some find IFC’s E&S approach unwarranted and the requirements unnecessary or onerous.
Box 4.5 The Costs of Inadequate Public Consultation and Disclosure Avoidable Delay Relationships rapidly became strained when the residents of a rural community observed bulldozers clearing a corridor for a pipeline through a forested area of communal land. The community was not expecting these disturbances and knew nothing about the developer’s intentions. This led community leaders to plead for intervention by the central government, which ordered the developer to cease work and begin negotiating compensation. Had the developer informed the community about the project from the outset and negotiated its own compensation, the government would have had little reason to get involved and the resulting eight-month delay would probably not have occurred. Weakened Negotiating Position For one manufacturing project the government retained responsibility for acquiring land from a number of families farming the area of the proposed site. The developer remained uninvolved, leaving this sensitive issue to others. However, because of the government’s inadequate resources and rigid pricing criteria for compensating the families for their lost land and crops, the acquisition process soon ground to a halt (with the developer unaware of the problem). One week before construction was scheduled to start, the developer found itself agreeing to highly inflated compensation claims. This level of compensation might well have been unnecessary if the developer had taken a more active role in consulting and negotiating with the local people from the beginning. Tarnished Reputation Late and culturally inappropriate consultation with the local population over proposed involuntary resettlement left one energy company’s plans for a power station in disarray. Because they had not been consulted, local NGOs and elected leaders worked together to create opposition to the project. The resulting media attention generated negative publicity for the project sponsor and left the company with a tarnished reputation. Despite a rapidly growing market for the power sector, four years later the company found that it was still unable to win another government contract. A culturally appropriate program of public consultation that maximized the involvement of the affected population in planning their own future would have helped allay local hostility. Source: IFC 1999.
52
LESSONS OF EXPERIENCE
A fourth set of sponsors consists of FIs, many of whom have little or no awareness or capacity to manage E&S issues. IFC delegates E&S review responsibilities to FIs and provides training and technical assistance to help them strengthen their capacity. Evaluations indicate that prior to training most FIs believe that such issues are not relevant to them. However, subsequent to training most have come to see that such issues are relevant to their institution, and begin to build up appropriate capacity and systems. Lesson 3: Disclosure and Transparency Up Front Are Necessary to Build and Maintain Credibility. Public consultation and disclosure can generate positive financial and commercial benefits for project sponsors in the form of reduced financial risk, direct cost savings, and reputational gains. Moreover, public consultation and disclosure can generate more effective and sustainable approaches toward projects. Gaining and maintaining local public and government support for a project is critical. Political opposition, legal action, or local social unrest can delay a project and be extremely costly. Consultation can open the lines of communication and help resolve issues before they lead to conflict, thereby reducing financial losses caused by delays. Local know-how, shared through public consultation, can often help a project sponsor identify cost-effective mitigation measures. For example, using consultation to identify potential job opportunities on the project for local people not only satisfies local economic and social interests, but can lead to significant savings in accommodation, transport, and expatriate costs for project sponsors. Public consultation can play a key role in building a positive image for a company. Effective public consultation demonstrates a company’s commitment to the project, the local area, and the country and can help project sponsors respond to the public’s concerns about project-related issues. If done properly, such efforts can have an impact beyond the local area and enhance the company’s reputation with the government, as well as with consumers nationally and even internationally (if relevant). Consultation can help make corporate invest-
ments more effective by identifying the community’s priority needs and designing responses that are locally appropriate. This too can enhance the company’s reputation. Gains often go beyond building a loyal customer base or greater market share. On occasion, the goodwill generated by such behavior can build strong local support, which can be helpful if unanticipated problems occur. Sometimes political factors, such as host government involvement and preferences, or commercial factors, such as competition or fixed financial arrangements with tight constraints, can influence a sponsor’s ability to carry out public consultation and disclosure in the most optimal manner. However, IFC believes that sponsors should neither consider political and commercial factors to be insurmountable obstacles, nor should they use them as excuses for failing to consult with locally affected people. Competitors or interest groups may try to exploit the consultation and disclosure process for their own ends; however, on balance, IFC’s experience has been that the risks of failing to engage in adequate consultation outweigh the risks of consultation and disclosure. Poor public consultation has its own costs, which can readily exceed any of the direct costs and risks of good public consultation (box 4.5). Private businesses must build trust in the local communities where they operate. To do so they must be perceived as credible, accountable, and transparent. IFC has worked hard to help sponsors build such trust, concentrating on front-end disclosure, such as public consultation with local communities and disclosure of project documents before Board approval. Specifically, ■ For all category A projects the full environmental impact assessment is disclosed no later than 60 days prior to Board consideration. ■ For all category B projects the environmental review summary is disclosed no later than 30 days prior to Board consideration. ■ For all projects the summary of project information is released no later than 30 days prior to the Board date for projects processed by regular procedure, and the closing date for projects processed by streamlined procedure.
LESSONS LEARNED
53
IFC is currently studying the disclosure of information on E&S issues for existing projects to see if ongoing project monitoring information might be shared in some fashion that both protects confidential client information while providing greater information to the public. Lesson 4: Close and Tailored IFC Engagement in E&S Issues throughout the Project Improves Outcomes. IFC’s ability to implement its E&S policy is due largely to the extensive in-house capability that it has built up in recent years. This has also enabled IFC to play a sig-
nificant role in helping its clients enhance the quality of their environmental performance. IFC takes an integrated approach consisting of three main components. First, IFC started with World Bank Group guidelines and then tailored them to meet its requirements, based on its experience in developing projects in countries around the world.9 These guidelines are specific to particular industries, sectors, or types of projects. During the appraisal process, IFC identifies which of these guidelines are applicable to a project. If IFC invests in the project, the project’s per-
Box 4.6 IFC's E&S Risk Monitoring System To better identify projects that warrant more attention to E&S issues, and to highlight specific issues on which to focus within each project, IFC has developed a dynamic risk monitoring system, called the Environmental and Social Risk Rating (ESRR) system. This tool enables IFC to track and communicate how specific investments are performing in meeting the E&S requirements defined during appraisal and as specified in the investment agreements. Given that IFC’s regional and sectoral departments range across a broad set of disciplines, the ESRR provides a common framework for these various groups. The ESRR provides a simple numerical score for all category A and B investments, which are scored in one of four bands: band 1 (good), band 2 (average), band 3 (watch), and band 4 (substandard). The grading system aims to quickly and clearly identify those investments that require attention. For example, a rating of band 4 indicates that active intervention is required. The score is derived by the responsible project manager using a special score sheet. Typically IFC’s Environmental and Social Development Department‘s quality project management system defines certain trigger events. The investment is scored after review of the annual monitoring report; supervision travel; or the exchange of other significant information, such as press coverage. The score sheet poses 12 questions for each of three categories: risk factors, management factors, and performance factors. Each of the 12 questions has three options. ■ Option 1. Yes, the project’s annual monitoring report is adequate and the Environmental and Social Department is able to assess performance against all stated requirements for the project; or Not Applicable, no annual monitoring reports are required of the investment. ■ Option 2. Partial, the Environmental and Social Department is able to assess performance against certain requirements, but the picture is incomplete and follow-up will be required. ■ Option 3: No, information submitted is of negligible value to assess performance; or No Information has been submitted to IFC. Each answer is weighted according to its significance. All 12 questions are similarly scored. The scores are then totaled automatically and the bands are assigned as follows: ■ Band 1: good (ESRR score 0–15) ■ Band 2: average (ESRR score 16–41) ■ Band 3: watch (ESRR score 42–67) ■ Band 4: substandard (ESRR score 68–82). IFC has approximately 700 scores to date and is satisfied that the tool is representative. Source: IFC’s Environment & Social Development Department.
54
LESSONS OF EXPERIENCE
formance is monitored against these guidelines. Compliance with IFC’s guidelines is the expected standard, in addition to compliance with applicable local, national, and international laws. IFC guidelines encourage project sponsors to improve their enviromental management system, or where none exists, to establish one. This helps project sponsors avoid mistakes, reduce development costs, and improve project sustainability. Second, IFC’s E&S requirements are integrated into its legal documents. IFC has learned that establishing policies, guidelines, and procedures was necessary, but was insufficient without proper implementation. This generated the need to create a contractual basis for IFC to enforce compliance with its rules. IFC also learned that having a good environmental impact assessment process was not enough, particularly in cases where those responsible for the project’s financial and operational aspects did not fully appreciate or understand the implications from an assessment point of view. IFC’s objective of making the negotiation and documentation process multidisciplinary is so that E&S issues can be considered alongside financial, operational, legal, and technical issues. IFC’s approach to the documentation of E&S issues in contracts varies depending on the complexity of the project. For category A projects IFC documents specific requirements in detail to create leverage and to ensure that the project team gives full consideration to the relevant issues. The process is time consuming, but it is worth the effort, because it results in clear written commitments and fuller awareness of issues on the part of the sponsor.10 For category B projects IFC tends to rely on a standard set of E&S provisions, making modifications where necessary. In all cases IFC uses standard project financing clauses that cover conditions of disbursement, covenants, events of default, and project completion tests, applying them to E&S issues (for IFC’s standard set of legal provisions see http://www.ifc.org). However, not all IFC projects fit neatly into a standard project finance model. For example, IFC makes equity investments, provides guarantees and trade financing, and deals with innovative financial products. For these kinds of projects creating leverage for E&S issues is a challenging task for IFC’s environmental lawyers.
Third, IFC places significant emphasis on project supervision. This begins with the first disbursement of funds. The investment staff carry out supervision visits at least once a year for all greenfield projects and expansion projects under construction. For projects under implementation, supervision includes at least one fieldvisit a year by technical staff. Depending on the type of project, representatives of the Environment and Social Development Department and/or the Insurance Unit also make site visits. For all category A projects an external, independent consultant must either prepare or verify an annual environmental monitoring report. Furthermore, the relevant investment staff prepare annual project supervision reports for every IFC client that are submitted for management review. Based on the reports’ findings and recommendations for action, follow-up is completed as required. Each year between 80 and 100 supervision reports also include an evaluation finding, which examines the projects’ development outcomes and IFC’s effectiveness in implementing the projects more closely. IFC has found that close project supervision at all stages of the project cycle allows staff to address issues as they arise, thereby improving project outcomes. In addition to the supervision of E&S issues as part of IFC’s general supervision, IFC’s Environmental and Social Development Department has developed a dynamic risk-rating system to evaluate which projects might benefit from supplementary supervision (box4.6). Lesson 5: Adequate Internal Capacity Is Essential for Project Evaluation. As discussed in chapter 3, for the past decade IFC has focused on creating and enhancing its internal capacity to analyze E&S issues. This has allowed IFC not only to assess the relevant issues independently, but also to internalize these issues into its project financing processes and procedures. This capacity resides not only in the Environment and Social Development Department, but also in the Technical Department, with nearly 40 highly experienced industry specialists, more than half of whom are engineers. IFC also has inhouse insurance specialists, as well as lawyers who specialize in E&S issues. The result of this enhanced internal capacity has been that projects are more carefully designed and structured
LESSONS LEARNED
55
with respect to E&S issues, thereby reducing project risk and enhancing project sustainability. This independent internal capacity is a source of strength, particularly when sponsors either lack familiarity with or are misinformed about E&S issues pertaining to the project. Lesson 6: Strict Adherence to Sound E&S Standards Is Necessary, Although Some Flexibility Is Warranted. An important element in the success of any set of standards is that they be used in a fair, sensible, and consistent manner. IFC pays particular attention to ensuring that it follows these principles. While greenfield project companies must meet all E&S requirements by the time of disbursement, for existing operations (modernizations, privatizations, and corporate investment programs), IFC may require a corrective action plan that addresses the remediation or corrective actions that will bring facilities into compliance with its requirements.11 The corrective action plan sets out the implementation schedule and costs, and is typically structured to allow companies to reach full E&S compliance with some flexibility in terms of timing provided that they meet specific targets along the way. The flexibility of these plans allows projects to contribute to economic growth while simultaneously improving the environment. Lesson 7: SMEs Do Not Need Separate Procedures but Benefit from Field-Based E&S Expertise. IFC’s experience in working with Small and Medium Enterprises (SMEs) has been that, with a few exceptions, they do not have a problem in accepting or incorporating IFC’s E&S requirements.12 SME projects tend to require a good deal of IFC-client interaction. Dealing with such clients from IFC headquarters raises transaction costs substantially, making the presence of field-based staff extremely effective. Field-based E&S staff act as a vital resource by exposing SME clients to, and educating them about, E&S issues, often intervening in problem areas early on to find simple, cost-efficient solutions. Other factors may require IFC to spend additional time working with SMEs. First, SMEs possess limited resources and tend to lack the broad management skills that larger corporations possess. This, coupled with the
difficulties of doing business in countries with a poor enabling environment, leads to financial pressures for many SMEs. Thus such SMEs often give lower priority to E&S issues than might otherwise be the case. Second, in many frontier regions inadequate government capabilities and interest in E&S issues make it difficult for IFC to require compliance, because clients do not feel any pressure to comply from the government. Third, insisting that a noncompliant sponsor rectify the situation immediately would, in many cases, close the SME down, which is not to anyone’s advantage. Taken together, these factors can require IFC to spend a considerable amount of time with many client SMEs (particularly when viewed in the context of project size), trying to gradually bring projects into compliance with E&S requirements while at the same time preventing further damage to already weak financial fundamentals. While this approach leads to better outcomes, it raises the already significant costs of working with individual SMEs. This has led IFC to de-emphasize direct lending to SMEs and to do more of its SME work through Financial Intermediaries (FIs). Lesson 8: Large Projects Are Fundamentally Different from Other IFC Projects. IFC usually becomes involved in one or two large projects every year.13 Each is unique, and the relatively small sample of projects precludes drawing any broad conclusions. However, two main lessons have emerged from the few large projects IFC carried out during 1993–99. First, when involved in large projects IFC has moved from working with the private sector alone to working jointly with the private sector, other parts of the World Bank Group, and country governments because of such projects’ significant impact on the economies where they are based and the consequent country government interest and involvement. In countries where the enabling environment is weak or nonexistent, an issue both private sector sponsors and NGOs often raise is whether the revenues generated by these large projects will be channeled to the people who need them the most, or whether the revenues will remain unaccounted for. The frequency with which such issues arise has spurred IFC to work more closely with all parties involved to structure the management of the project’s revenue stream appropriately, a difficult
56
LESSONS OF EXPERIENCE
process that requires careful attention. The role of the private sector sponsor and of advocacy NGOs becomes particularly important in helping IFC devise a fair revenue management plan given countries’ influence on IFC’s Board of Directors. Second, many of IFC’s large projects are situated in one-company towns. The absence of a diversified economic base often leads local, and sometimes regional, governments to become dependent on the company for revenues. Compounding the problem is the fact that local businesses are rarely in a position to comply with either national or IFC’s E&S requirements. In several of these large projects IFC investee companies typically provide the town with social services. For example, one of IFC’s investee companies provides the town with heating and hot water, another provides social services in the form of health facilities, and a third has set up a school for its employees’ children and for children from surrounding villages. The risk here is that the local or regional government could become perpetually dependent on the company for funds. The solution to such problems is to work with local and regional entrepreneurs and help them grow so that they can improve their production and delivery systems, raise internal standards, and develop into more mainstream and independent companies. The focus behind such activities is to ensure that the local and regional economies become more diversified, thereby broadening their economic and tax bases. Lesson 9: Capacity Building for Financial Intermediaries Is Vital. Like many other IFIs, IFC uses FIs to reach a wider set of private sector firms. IFC invests in FIs, which are either local lending institutions or funds, both of which either on-lend to subprojects or invest in local firms as well as in firms in other developing countries. The FI that directly receives IFC funds is IFC’s client, and the ultimate recipients of IFC’s investments are clients of the relevant FI. Using such locally based FIs is more efficient than direct IFC involvement, as these institutions typically have lower transaction costs and possess knowledge specific to the area. Moreover, in most cases they are physically close to the private sector firms they are working with,
which permits easy and ongoing interaction and exchange of information between the lender and the client. In addition, the FIs are an effective mechanism for transferring new ideas and knowledge to their clients. However, widespread use of FIs places IFC in a predicament. FIs typically have little or no E&S management capability. Furthermore, for IFC to know how effective the FIs are in ensuring that its E&S standards are being met is difficult. IFC’s response has been to build up E&S capacity in the FIs with which it works. This is a high-priority goal for IFC, because, ultimately, this is the only effective way to ensure that all projects consider E&S issues at every stage. To this end, IFC runs formal training programs with all its FI clients and provides follow-up support to the highest priority FIs. Training appears to be most successful when it is casebased and aimed at communicating that E&S issues are bottomline issues that affect FIs’ creditworthiness and reputation. IFC has learned that spending sufficient time at the onset to determine an FI’s capacity is important, and superior to a “one size fits all” approach. This is crucial, given that IFC’s FI operations are diverse in terms of sector, location, types of arrangements, and institution size. Over the years IFC’s portfolio of FI projects has changed in composition with the inclusion of a number of investment funds, and the total number of FIs IFC works with now numbers over a 100, a few of which specialize in funding large or very large projects. Often the equity position this subgroup of FIs takes is a small portion of total financing. Time constraints and relatively small equity stakes reduce the leverage fund managers have in ensuring that companies implement appraisal requirements properly. Thus IFC is forced to grapple with such issues as how to ensure that the enterprises receiving funding from IFC’s FIs and investment funds are in full E&S compliance. While IFC must clear all category A subprojects, and while it conducts site visits to most category A subprojects, for IFC to conduct full reviews of all category A subprojects being financed by FIs is neither possible nor practical. IFC’s approach in such cases has been to put the fund manager in direct contact with IFC’s E&S specialists, who sometimes participate in appraisal missions, thereby providing limited on-the-job training. This is still not entirely satisfactory, but does
LESSONS LEARNED
57
provide fund managers with a better understanding of IFC’s policies, procedures, and guidelines and concrete examples of how IFC interprets those policies and guidelines. Even this approach is resource intensive, because fund managers review many projects before deciding to finance only a handful of them. For example, for one FI, IFC has reviewed about 20 subprojects, but the FI has yet to invest in a single one of them. When IFC determines that one or more subprojects in an FI investment are in violation of the relevant E&S guidelines, the first step is to try to work with the FI and help it fix the problem. If this approach turns out to be ineffective, IFC seeks to exit from the investment, taking into account liquidity, market constraints, and fiduciary responsibilities. In practice, selling IFC’s stake, particularly in privately held companies, can be difficult and takes time.
While at the outset many client FIs are not adequately aware of the E&S issues involved, and thus do not fully understand the implications, overall they tend to be receptive to incorporating E&S issues as they become increasingly aware of them through IFC’s capacitybuilding exercises. IFC fully realizes that a lot more work is needed in this context, and will continue to devote resources to this end.
CONCLUSIONS IFC first began addressing environmental issues in its projects in 1988. Since that time it has systematically put in place formal requirements and rules, built up capacity, introduced checks and balances, established guidelines for public disclosure, and instituted internal accountability mechanisms. IFC views its E&S management system as a dynamic system that it continually improves so as to further its mission.