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Due Diligence Checklist Devaluation by mikeholy


									Red Flags:
A Due Diligence Checklist

Environmental and social controversies can be the source of downside risks that ultimately may
adversely impact the financial viability of exploration and development (E&D) projects. While
many risks can be mitigated by satisfying environmental/ social concerns or managing exposure
though contracts or credit enhancements, a project that raises numerous Red Flags may indicate
that it is unbankable. For example, some force majeure risks that stem from significant and
sustained political opposition cannot be easily diversified away in limited recourse transactions.

Therefore, Amazon Financial Information Service encourages potential financiers and project
developers to take the following three steps when performing socia l and environmental due

1. Check for Social and Environmental Red Flags (e.g. impact on national parks, lack of local
   consultation, militarization)
2. Perform Due Diligence on Social and Environmental Risks (e.g. protests, opposition to
   permits, lawsuits)
3. Assess Financial Risks (e.g. delays, cost overruns, decreased revenues)

1. Check for Social and Environmental Red Flags

The following project characteristics raise Red Flags, and potential financiers should ensure
thorough due diligence on the following items:

Environmental Red Flags
   - Project is located in or will affect pristine, sensitive, biodiverse or unique ecosystems
       (See maps of biodiversity hotspots,
       forest frontiers, and unique ecoregions
   - Project is located in or will affect protected or recognized areas (e.g. national parks,
       World Heritage sites, etc.)
   - Project will affect unique, rare, endangered or protected species
   - Activity is environmentally sensitive in nature (e.g. mining, oil development, large
       infrastructure) or will create irreparable impact
   - Project has significant secondary or cumulative environmental impacts

Social or Political Red Flags
   - Project is located in indigenous territory or areas with land titling disputes
   - Project will affect indigenous, marginalized or uncontacted peoples
   - Project will require resettlement of local populations
   - Local populations believe that the project will generate limited local benefits
   - Project involves militarization, or is located in areas with guerrilla activity
   - Project is sponsored by or will generate revenue for corrupt, repressive or undemocratic
   - Affected populations have not given their full, prior and informed consent
   -   Project sponsor has not adequately disclosed information to the public and/or financiers
       about the proposed project, including environmental and social analyses
   -   Project sponsor has not conducted adequate or culturally appropriate public consultation
   -   Project company or consortium members have a history of poor environmental and social
       management or performance

2. Perform Due Diligence on Social and Environmental Risks

General opposition to project: Has the project or its related components or counterparties (e.g.
fuel supply sources, transportation infrastructure, contractual offtaker) been the target of protests
by communities, labor unions or environmental organizations? How widespread or militant is
the opposition? How could opposition politicize or decrease popular/governmental support for
the project?

Regulatory compliance: Has the project passed required environmental review and has it
received proper licenses and permits? Is the project in compliance with national civil rights and
internationally accepted indigenous, labor and human rights laws? Does the project comply with
internationally recognized (e.g. World Bank) environmental standards? To what extent does
regulatory compliance mitigate political opposition?

Reputational capital: What are the potential public relations costs of the investment? Could
financiers face negative publicity due to these controversies? Have local or international
organizations issued statements supporting or opposing the project, sector, project company,
sponsor or host country government? To what extent are internationally-known pressure groups

Siting issues: Does the project impact indigenous reserves or lands for which indigenous land
claims remain unresolved? Does the government face legal challenges in land rights disputes?
What kinds of sovereignty or rights are provided to indigenous peoples in national or
international law? Have proper procedures been followed for the acquisition of permits,
particularly for projects that are sited in environmentally sensitive areas?

Legal liability: Have environmental or social controversies led to current or impending legal
proceedings or negotiations that seek to delay, mitigate or stop the project? To what extent could
financiers be exposed to these liabilities, in both home and host country jurisdictions?

Environmental liability: What is the liability regime for environmental accidents and/or
emergencies? Have project sponsors provided adequate monitoring systems, response plans, and
debt service reserves/insurance?

Governmental capacity: What unknown risks may financiers be exposed to due to lack of
governmental transparency, oversight and enforcement? To what extent does legal compliance
and contracts (e.g. the successful acquisition of pertinent permits, concession agreements,
contracts of work, etc.) mitigate opposition/ social risks, particularly in undemocratic, repressive,
or unstable regimes?
Project company capacity: Does the project company or consortium members have the
experience and financial capacity to successfully manage technical environmental challenges as
well as "soft" issues such as community relations? How strong are the project company's
governance regime, disclosure mechanisms, and corporate culture?

3. Assess Financial Risks and Expos ure

Cost overruns: Will the cost of politically acceptable environmental and social mitigation plans
increase costs and erode margins?

Liquidity risk: Could environmental or social issues result in unforeseen costs in the operation
& maintenance (O&M) phase, such as environmental capital expenditures, legal fees associated
with potential litigation, major fines, or environmental remediation?

Project delays and down time: Could opposition create delays in the design, siting, permitting,
and construction of the project? Could the project be the target of work stoppages, sabotage or
guerrilla activity that might force operations to halt or declare force majeure? What affect would
this have on project costs, projected revenues and/or debt repayment schedules?

Devaluation of assets: For shareholders, how might opposition to the project or increasing
sovereign risk devaluate a company's assets and affect shareholder value? For creditors, how
could devaluation of key assets affect the client's credit risk or collateral?

Contract violations/penalties: Could a project company's poor environmental and social risk
management violate contracts, such as loan covenants specifying compliance with applicable
laws, or with multilateral development bank environmental/social policies? Could opposition to
a project lead to schedule slippages and ultimately create contract penalties?

Increased compliance costs: Will impending environmental regulations create unforeseen
regulatory burdens, particularly for projects that only meet current minimum performance

Increased cost of capital: Will higher financial risks increase the cost of capital for the
borrower? How will these risks be managed?

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