FMO (Netherlands Development Finance Company) (2019)

Introduction

In 2005, the Netherlands Development Finance Company (FMO) adopted the Equator Principles (EP) to create a risk management framework for determining, assessing and managing environmental and social risks in projects.

FMO believes that good economic, environmental and social (E&S) management, and corporate governance, are interrelated. Therefore, we are convinced that there is a strong business case for the incorporation of ESG issues in business strategies. As a consequence, FMO recognizes the value of considering environmental and social criteria when financing and therefore decided to endorse the Equator Principles. The main objective is to express our commitment to mainstreaming sustainability considerations in financial best practice throughout the sector and effectively apply environmental and social criteria in all financing transactions that FMO concludes.

As stipulated by our Sustainability Policy, FMO has been using the Safeguard Policies / IFC Performance Standards (IFC PS) since the year 2000. Due to the new reporting requirements requested in the third generation of EP (EPIII) to further breakdown the categorized investments by sector, region, and independent review, we have simplified our quantitative reporting to cover the exact scope of the EP III.

Additionally, FMO applies the safeguard policies and the IFC PS to all its financing, including financing under US$10 million and not only our project finance transactions but corporate finance as well. Although indirect investments are not within the scope of Equator Principles, we still work with our financial institution (FI) clients and private equity funds (PEF) in which we invest, to improve how they handle the environmental and social risk in their portfolios. This ensures that these investments meet (or over time become compliant with) FMO’s requirements. Through this, we identify potential value creation that can be achieved with these clients. Therefore, FMO goes further than the Equator Principles’ requirements.

FMO’s Sustainability Policy

Minimum Requirements
FMO can work with a broad array of privately owned companies, financial institutions (FI) and private equity funds (PEF). It chooses not to select clients which are part of our Exclusion List. The Exclusion List relates to activities that are not supported by development banks such as FMO due to their unacceptable nature (i.e. child labor). See FMO’s website for the full list https://www.fmo.nl/policies-and-position-statements, under Exclusion list. Moreover, FMO also requires its FI and PEF clients to apply this Exclusion List to the clients they select in their portfolio.

ESG Integration into Investment Process
FMO considers ESG issues integrated into the organisation. Almost all departments involved in the credit process have ESG expertise or exposure to ESG issues. Investment managers are responsible for addressing ESG issue with low risk clients and work together with E&S and Corporate Governance officers on high risk clients. The same applies to the credit analysts in the credit department. Legal counsels work together with deal teams to incorporate ESG clauses in the contracts and our portfolio management departments work on monitoring ESG actions and reporting that clients have to undertake.

FMO evaluates (on a risk-based approach) all of its financing against the IFC Performance Standards regardless of asset class and amount of investment. Should ESG gaps be identified at our clients we work with them to develop an Environmental and Social Action Plan (ESAP) and/or Corporate Governance Plan to close these gaps according to the IFC PS and our Corporate Governance Policy. Within our investment directorate there are ESG officers who participate in the deal teams together with the investment officers to carry this out. On a transaction level, commercial managers remain responsible for the implementation of the Sustainability Policy in the transactions. ESG staff report directly to department specific ESG Managers. The purpose of the ESG manager layer is to ensure clear accountability for meeting ESG targets and enable integrated steering of performance. In 2019, FMO reorganized its ESG and impact management governance. This is the IESG MT (Impact and ESG Management Team) with a director, 3 sector ESG managers, 1 Capacity development manager, Impact manager and the Impact MT (IMIR (impact measurement and integrated reporting), IESG director, Impact Manager, Knowledge Management and Learning and development manager and Strategy manager). This change was made to deepen expertise, improve local stakeholder management, and drive effective and consistent implementation of ESG policies and guidelines, including human rights. This is under the director of Impact and ESG. Ultimately, the Management and Supervisory Boards are responsible for FMO’s ESG targets. FMO currently has an organisation wide target where we aim to achieve an implementation of at least 90% of our high/medium ESG risks at amber/green performance level in the reporting year. This is tracked in an internal IT system called the ESG Performance Tracker. This is one of FMO’s non-financial targets, which is included in the annual report.

In 2017, as part of revised Sustainability Framework, FMO has issued position statements that further reinforce ESG issues into the organization. These position statements include Human Rights, Gender, and Land Governance. FMO also published its path to becoming a leader in this space, from compliance to value add. The path reflects FMO’s ambition to become a leading bank in financing the transition to a more inclusive and greener economy. This entails the conscious build-up of a portfolio of projects that target sectors that support people that are in need of access to basic services, e.g. finance, energy and food, and achieve an optimal use of scarce resources and a reduction of harmful emissions. These can be found at https://www.fmo.nl/policies-and-position-statements.

Direct Investment

All our direct investment clients (including those in which we take equity) are required to comply with national E&S law as a minimum standard, and with the Environmental and Social Performance Standards, as developed by the International Finance Corporation (IFC), member of the World Bank Group, whichever stricter. To help our direct investment clients establish sound ESG practices, we use a practical framework. The framework comprises of four parts: (1) Risk Categorization of clients, (2) Establishing applicable requirements, (3) Environmental and Social Action Plans and (4) pricing incentives.

(1) Risk Categorization of Clients
All new and existing clients are subject to a Risk Categorization of their (potential) Environmental and Social impacts. There are four risk categories A, B+, B and C: A = high risk: Projects / clients with potential significant adverse social or environmental impacts which are diverse, irreversible or unprecedented. B+ = medium high risk: Clients with potential adverse social or environmental impacts that are generally beyond the site boundaries, largely reversible and can be addressed through relevant mitigation measures. B = medium risk: Clients with potential limited adverse social or environmental impacts that are few in number, generally site-specific, largely reversible and readily addressed through mitigation measures. C = low risk: Projects with minimal or no adverse social or environmental Impacts. The categorization of clients into the A, B+, B, or C category is largely based on an assessment against the applicable IFC Environmental and Social Performance Standards. At the same time, we cooperate closely with the European Development Finance Institutions (EDFI’s) with the purpose to harmonize our definitions and requirements.

(2) Establishing applicable requirements
FMO requires that all clients and equity investments comply with applicable environmental, social and human rights laws in their home and host countries. Applicable environmental, social and human rights laws are both applicable national and international law to which the client is subject In addition, FMO upholds a set of (inter)national standards, as specified in Chapter 4 of the FMO Sustainability Policy. With respect to the management of environmental and social impact, the primary standards that guide FMO’s relationship with clients are the IFC Environmental and Social Performance Standards and the associated World Bank Group Environmental Health and Safety Guidelines.

(3) Environmental and Social Action Plans
Based on the outcomes of the assessment carried out, an Environmental and Social Action Plan (ESAP) is to be agreed upon as necessary, with clear and practical milestones to be achieved within a certain period. The ESAP would normally allow clients a reasonable time period (ca. three-year period) and at a minimum within the period of investment to reach full compliance with the requirements. For clients in category B and C, no in-depth assessment is required. However, on a voluntary basis we try to identify potential value creation that can be achieved with these clients. The ESAP is, in cooperation with the client, made “SMART”, i.e. Specific, Measurable, Achievable, Realistic and Time-Bound, and included in the loan documentation. Non-compliance with key milestones of the ESAP constitutes an event of default under the loan documentation. For FMO’s direct equity transactions, the ESAP shall be firmly agreed and under implementation before disbursement of FMO’s funds and the E&S principles applied by the company shall be firmly constituted in the Shareholders Agreement. Effective implementation of the ESAP adds value to the client, it mitigates E&S risks and it contributes to E&S development impact that FMO achieves through its financing.

(4) Pricing Incentives/Penalties
FMO can support the E&S business case in structuring its financial products. From a risk-return perspective, FMO can support implementation of major milestones of the ESAP by offering pricing incentives and/or requiring pricing penalties (in case of non-compliance with the Environmental and Social Action Plan) and by providing capacity development grants for technical assistance.