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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 diligence: 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 http://www.conservation.org/hotspots/where.htm), forest frontiers www.globalforestwatch.org, and unique ecoregions http://www.nationalgeographic.com/wildworld/global.html) - Project is located in or will affect protected or recognized areas (e.g. national parks, World Heritage sites http://www.unesco.org/whc/nwhc/pages/sites/main.htm, 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 government(s) - 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 involved? 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 standards? 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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