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01 June 2023
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5 minutes

Delivering ESG in emerging markets

Project finance

In recent years, ESG-driven demands in project finance have been changing not only the financing approach but also the underlying projects themselves. Financiers and project sponsor companies need to meet a seemingly ceaseless array of new global standards that require new policies and reporting.

The pressures of increasingly stringent ESG requirements are also coming from all stakeholders. Intra-national regulators and domestic governments are adopting tighter ESG standards – not just for the underlying projects themselves, but also for the project supply chain and the construction companies involved.

Meanwhile, project sponsors need to attract investors and meet tougher contractual requirements, as well as responding to pressure from employees and shareholders – while also appealing to future employees too. Investors too need to ensure deals qualify for ESG-designated funds, to be able to deploy new sources of liquidity into projects. And other financing partners, such as banks, multilateral development banks and export credit agencies, all are demanding baselines that evolving benchmarks, such as those sustainable finance standards that are being developed by the EU, are adopted by all financing parties. The EBRD is focused on aligning projects to climate goals.

And if that wasn’t enough, external stakeholders – such as analysts and the financial media – are demanding more ESG-related information across a range of new areas as they too seek to embrace the ever-evolving ESG agenda.

ESG standards in the context of emerging markets

Many of these standards are being developed internationally. Even regional standards – such as those being created in Europe – are soon set as industry benchmarks, albeit informally. There is an understandable desire for harmonisation of ESG rules and regulations, to create a unified benchmark that will facilitate the transfer of capital and risk throughout the project finance world. However, the reality remains that in many emerging markets simply implementing global standards without any customisation is problematic.

The environmental aspect of ESG can be particularly complicated when it comes to the adoption of European-led standards within emerging markets. For example, while emerging market regulations seek to advance renewable energy, almost to the point of excluding of any fossil-fuelled power generation – this ignores the national reality of countries such as South Africa, which has an electricity grid that is powered by almost 90% carbon-emitting sources. And while the government has committed to eradicate this use by 2050 – and the private sector is supporting this ambition – practical realities suggest that simply pulling the plug on anything that is designated renewable in terms of primary generation, its supply chains or transmission is dangerously short sighted.

The emerging market context is also incomparable in terms of the social aspects of ESG. Gender inequality in regions such as Latin America is of a hugely different nature and scale to that in Europe. That isn’t to suggest that the social element of ESG in this region is less ambitious: if anything, companies and financiers are demanding greater change in terms of gender equality than that in Europe. But it is to admit that the journey ahead of Latin America is a longer one and even moving rapidly means that European-style KPIs aren’t suitable for many emerging markets.

As in developed markets, the governance aspect of ESG is also vital – perhaps even more so. But, again, the reporting requirements must make sense within the context of individual countries’ existing reporting and transparency practices. ESG-led stipulations should be focused on encouraging the evolution of governance in these countries, but demanding an immediate leap to international best practices would be futile. Perhaps worse – it would simply discourage any engagement with international ESG communities.

Long-term harmonisation

In emerging markets it’s often the projects themselves that are ESG compliant. For example, Metro Line 4 in Brazil’s São Paulo, was project managed by TMF Group and was constructed in line with ESG requirements. Perhaps more importantly, the outcome itself was itself ESG aligned across the full spectrum, resulting in lower gasoline usage, reduced pollution, increased social mobility, economic growth and benefits that target lower socio-economic groups, in terms of mobility and productivity. The ‘big picture’ should also be kept in mind and, while ESG standards throughout projects are important, compliance-led rejection of international parties due to minor weaknesses should be avoided.

In some project finance cases it is not even clear which regulations are relevant – sometimes there is a case to be made for ‘choosing regulations’. This is clearly a delicate decision, and parties need to balance the overall needs for the project, while also being aware of any ‘greenwashing’, should some regulations be set aside.

In the long term, the international alignment of ESG standards will be positive for a variety of stakeholders, from issuers and investors, to other service providers. However, while the industry strives for this harmonisation there will need to be an evolutionary phase when practical realities of markets mean that a ‘one-size-fits-all’ approach won’t be helpful and may, in fact, delay many needed environmentally and socially aligned projects.

Project finance

TMF Group’s global capital markets practice offers a range of administrative, agency, issuer/SPV and trustee services, across industries and clients. Our unique footprint ensures we can provide clients and transaction parties with real time assistance from our local experts. We have substantial experience helping clients with new and refinanced securities, syndicated loans, secured transactions and multi-jurisdictional transactions. Make an enquiry.

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