How we apply ESG standards in our investment process
In the following overview, we explain the different stages in our investment process, pre-COVID-19, and how ESG is integrated into that process. By means of examples, we show how this works in practice.
Step 1 | Customer selection
We identify investment opportunities within our key markets that contribute to our three SDGs. In our selection, we check country limits, the exclusion list, the viability of the investment plan and the business itself. We also check if our investment is ‘additional’. This means that we can provide resources and share best practices that are critical for sustainable development and that otherwise would not have been available to the company or project.
High level of ecological importance requiring further assessment
FMO considered investing in a company that aimed to expand their industrial commercial wood plantations from a medium to a large plantation to promote higher volumes of CO2-eq sequestration. This plan required the acquisition of extensive areas of land, and the conversion of grassland and tropical savannah (degraded, and intervened) into monocrop plantations. After an analysis of the geographical location, and type of ecosystem, it was concluded the region where the expansion was planned had a high level of ecological importance, which required further assessment. The transaction was put on hold while the company completed a comprehensive Environmental and Social Impact Assessment, High Conservation Value assessment and Land Use Cover Change Assessment to define targets for remediation and measurable conservation outcomes for biodiversity.
Step 2 | Clearance in principle
We perform an initial assessment of risks and opportunities, define the key terms of customer engagement, and scope any further assessment needs. We document this in a ‘clearance in principle’ (CiP) proposal, informing our decision to continue preparing for a final investment decision. We conduct a Know Your Customer assessment to ensure that the customer complies with anti-money laundering, anti-corruption and anti-terrorist financing regulations. The financing opportunity is also assessed against potential effects on environmental, social and human rights conditions, as well as governance structures.
Performing contextual risk analysis with a human rights lens
For a potential investment in a large agri-commodity facility in a tropical forest, we applied a human rights due diligence guidance and undertook a contextual risk assessment. The analysis discovered potential risks around legacy land issues, recognition of Indigenous Peoples by the State and dilemmas facing the communities with respect to forest protection versus deforestation for family farming and survival. Over the course of a year, the investment team worked with the customer to strengthen its environmental and social practices. This required the customer to commit to zero deforestation and net biodiversity gains, no physical resettlement and Livelihood Restoration Planning and Implementation and protecting Indigenous Peoples. The latter requirement further includes conducting human rights assessments, acknowledging the identity of Indigenous Peoples and undertaking processes around free, prior and informed consent (FPIC). Since then, the customer has followed up by engaging with third-party experts to conduct site assessments in areas with indigenous communities, human rights issues and/or high risk of biodiversity impacts. Seeing the customer’s commitment and progress made, FMO felt comfortable to proceed to the next stage of the investment process.
Dealing with legacy issues and engaging with the community and NGOs
FMO is considering investing in a portfolio of renewable energy projects. Prior to seeking CiP, an early Environmental & Social (E&S) review flagged that some of the customer’s assets have received community and NGO complaints related to community water supplies for indigenous groups. The FMO deal team suspended the CiP process to visit the sponsor’s existing assets and assess the situation on the ground. The site visit gave the deal team a chance to ascertain whether the sponsor’s approach to dealing with the legacy issues and engaging with the community and NGOs met FMO's expectations. This also gave an indication of how the customer would handle any ESG and Human Rights issues that may come up in the projects FMO considers financing. We agreed on a set of steps to be completed by the sponsor before FMO would prepare and submit a CiP.
Step 3 | Due diligence
We carry out a detailed project assessment. We document the results in a finance proposal informing FMO’s final decision to invest. We perform a site visit, including visits to key stakeholders. Where needed, we engage consultant support in various fields. We define and negotiate further ESG requirements and conduct further human rights contextual risk assessment as informed by the CiP. This includes on-the-ground research and consultation with local civil society.
Improving the ESMS and overall E&S performance
A key customer has activities and initiatives strongly aligned with FMO’s strategic objectives, such as financing women-owned MSMEs and green products. During the Environmental & Social Due Diligence process (and during subsequent monitoring) FMO recognized the need to upgrade the Environmental and Social Management System (ESMS). However, the organizational structures did not support an integrated approach. The concerted efforts by FMO’s deal-team, consultants and the bank’s internal sustainability team improved the ESMS and the bank's overall E&S performance.
Step 4 | Decision to invest
Our Credit Department evaluates all finance proposals and writes a credit advice in support of a final investment decision by the Investment Committee. After approval, FMO discloses proposed investments for 30 days prior to contracting. This gives stakeholders the opportunity to share their concerns and feedback with us.
Conditional to taking gender-related action
E&S due diligence on a renewable energy project revealed that the project site is in an area with significant social and economic inequality between men and women, with cultural and traditional roots. Women’s freedoms and safety were perceived to be threatened by the project bringing men from other parts of the country to live and work in the area. These sensitivities were further investigated and characterized in a gender impact assessment, and the decision to invest was conditional to the customer’s formal commitment to taking gender-related action. Furthermore, when COVID-19 posed the question of whether the worker camp should become a restricted access camp, the earlier gender assessment indicated that a more regulated camp was more gender sensitive, as this would minimize any interaction between migrant workers and vulnerable local women.
Step 5 | Contracting & investment disclosure
FMO includes ESG requirements and conditions in its agreements with customers to ensure that they are legally binding. We disclose contracted investments during the full tenor of our engagement in the 'World Map' on our website.
Onboarding E&S manager to oversee local activities
FMO recently invested in a renewable energy project. Due diligence revealed that the tense security and human rights context requires a high degree of sensitivity to all typical environmental and social management aspects. This includes sharing cleared wood with communities, housing labor in local villages, traffic management and the grievance collection and redress mechanism in particular. FMO required the customer to onboard a highly qualified in-house E&S Manager at corporate level, prior to contracting, rather than continuing to rely on consultants to design and operate the E&S management systems.
Step 6 | Disbursement
Disbursement can take place upon achievement of the conditions, ESG and other, set out in the legal agreement.
Conditional to making governance improvements
A potential FMO customer was headquartered in a country with an underdeveloped culture of corporate governance, especially in relation to privately-held companies. The company had no Board of Directors, and the founder was the sole decision-maker. While considering a long-term engagement with the company, FMO emphasized the need for a Board of Directors with independent members to provide countervailing power to the dominant founder. The disbursement of the facility was conditional on the establishment of the Board and achievement of several milestones. The requirements have been met and FMO continues to work with this customer and support it on further governance improvements.
Step 7 | Monitoring & value creation
Throughout the lifetime of the investment, we monitor performance and progress and look for opportunities to add value. We continue to work with our customers to ensure implementation of our ESG requirements. We review the customer’s and consultant’s ESG monitoring, accident and incident reports. We conduct customer visits and perform an annual customer credit review. We also conduct an ongoing community support check.
Addressing root cause of health and safety incidents
During monitoring of a generalist Private Equity fund that targets SMEs, a significant number of health and safety incidents were recorded in the portfolio. Engagement with the fund manager revealed that this was due to insufficient health and safety measures and inadequate protections for workers’ rights in some of the fund’s portfolio companies. Further engagement and support led to a commitment by the fund manager to address the root causes of the incidents, corrective actions, training, inspections, workplace risk assessments and audits, while regularly updating the investors on progress. In cooperation with other DFIs/ investors FMO and the fund manager agreed an action plan including strengthening of the team’s E&S capacity. The interaction with the fund manager and their strong commitment to E&S gave FMO the confidence to continue investing in future funds raised by the fund manager.