How we apply our investment process
How we apply our investment process
Our investment process consists of the following stages. Through case studies we illustrate how ESG is an integral part of this process.
Step 1 | Investment selection
We identify investment opportunities within our markets that contribute to our three SDGs. We check geographic limitations, the exclusion list, the viability of the investment plan and the business itself. We also check if our investment is additional.
FMO was approached to consider a company that focuses on non-timber forest products. As we have limited experience in this sector, a pre-clearance in principle (CiP) meeting was set up to discuss potential ESG risks and whether FMO was equipped to not only onboard the risks but also support this customer in managing them. This resulted in engagement with civil society organizations (CSOs), an early visit to the customer premises and project sites for the CiP. We looked at labor issues, particularly worker conditions, child labor, and early identification of potential risks to establish synergies with local and international stakeholders to manage areas with high biodiversity values and even foster changes at the sectorial level.
Step 2 | Clearance in principle
We make an initial assessment of risks and opportunities, define the terms of our engagement, and scope any further assessment needs. We conduct a KYC assessment to ensure that the customer complies with anti-money laundering, anti- corruption and anti-terrorist financing regulations. We also screen potential effects on environmental, social, governance and human rights issues. We document this in a CiP proposal, informing our decision to continue preparing for a final investment decision.
FMO worked with a pan-African generalist fund to support it in the process of greening the investment portfolio and aligning the fund’s investment strategy with the Paris Agreement. Key principles to maintain were: 1) investments should contribute to a genuine improvement in energy efficiency or greenhouse gas reduction, and 2) investments should not contribute to a long-term lock-in of high carbon infrastructure. During this process, the fund manager developed a climate change policy attesting their commitment to the 1.5-degree pathway in all their funds and direct investments and agreed on an ESG-based incentive structure.
Step 3 | Due diligence
We carry out a detailed project assessment. We document the results in a finance proposal informing our final decision to invest. For high-risk investments, we perform a site visit and meet with stakeholders. Where needed, we engage external experts. We define and negotiate further ESG requirements and conduct further human rights risk assessments. This may include on-the-ground research and consultation with local civil society.
An African bank presented high E&S as well as corporate governance risks during due diligence. We changed the E&S and corporate governance risk category of this existing customer in response to its growing corporate portfolio as well as changes in the board and governance structure. The decision to change the risk category translated into the involvement of an E&S specialist and corporate governance officer for the first time since the bank's relationship with FMO started almost a decade ago. Due to low ESG standards and regulatory requirements across the market and the fact that this had never been raised with the bank in previous transactions with FMO or other DFIs, there was initial pushback on the ESG actions proposed. The E&S specialist and deal team took time to visit with the customer on-site twice to discuss the requirements and expectations. This helped to build trust and ensure the customer fully understood the importance of implementing the ESG changes proposed. By doing so, we were able to agree on a rigorous E&S plan and corporate governance recommendations that will help the bank manage the E&S risks in their corporate portfolio and improve the structure and functioning of its Board of Directors.
Step 4 | Decision to invest
Our Credit department evaluates all Financial Proposals (FPs) and writes a credit advice in support of a final investment decision. After approval, we disclose proposed investments that fall within our Customer Disclosure Policy, for 30 days prior to contracting. This enables (local) stakeholders to provide feedback or additional information, thus helping FMO increase the quality of our investments and make better investment decisions.
As part of our investment decision in a generalist fund, we engaged the fund manager regarding an ESG-based incentive structure for the fund manager and a green investment target. We also extended capacity development funding related to climate risk and energy efficiency, to assist the fund manager in reaching the targets. Based on the current pipeline, the portfolio is expected to meet the 50 percent qualifying level to be eligible for our Green label. To mitigate the risk of greenwashing and of the fund’s climate strategy not being implemented due to pressure to meet commercial return expectations, the fund will provide annual audited reporting on this, and we will review their eligibility to the Green label based on this outcome annually. The fund manager’s strong commitment buttressed our decision to invest.
Step 5 | Contracting and investment disclosure
FMO includes ESG requirements and conditions in its agreements with customers to make them legally binding. We disclose a summary of the proposed and contracted investments during the full tenor of our engagement on the World Map page on our website.
FMO decided to invest in an on-grid renewable energy project that involved resettlements and livelihood restoration of untitled land users. Due diligence revealed a legacy of mistrust of developers among local stakeholders, which had led to politicization of the land discussions. While most affected parties supported the project and were seeing it as beneficial, some influential individuals remained opposed despite the company’s best efforts to address concerns and bring about community cohesion. As lead lender, we undertook additional checks on broad community support prior to financial close and disbursement of funds, to ensure the company was incentivized to maintain the momentum of social cohesion efforts. Efforts have led to an exemplary resettlement approach in which the company assisted every project affected person and some 80 households to purchase a piece of land of their choosing, ensured security of tenure for both the male and female head of household, provided compensation for the construction of the replacement houses (all families opted for cash compensation) in instalments to ensure no one was worse off. This tailor-made approach greatly contributed to a relationship of trust with the local communities and can be seen as an excellent example of implementation of IFC Performance Standard 5 in a highly socially complex environment (featuring various tribes and marginalized groups).
Step 6 | Disbursement
Disbursement of funds can take place upon fulfilment of the conditions, ESG and other, as set out in the legal agreement.
In 2017, FMO invested in a hydropower fund in a region characterized by ecological and social challenges, in a country with limited E&S expertise. We assigned a specialist consultant under a four-year technical assistance contract, offering training and coaching to the fund manager and the project developers, co-funded through our technical assistance facility. Five years later, the E&S performance was evaluated in an independent audit. The technical assistance program contributed to improved design and management of fish passage and ecological flow, and the achievement of a social license to operate through meaningful engagement with communities and civil society organizations. Overall, the audit indicated that the fund’s investment process was conducive to sustainable value creation. Audit recommendations were made toward an exit strategy where the non-financial value proposition is equally represented.
Step 7 | Monitoring and value creation
Throughout the lifetime of the investment, we monitor its performance 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, including, where applicable, a check whether the affected community still supports the investment.
FMO supports an aquaculture customer in Africa that produces fish in cages for the local market and sources fish feed locally, which helps increase regional food security. Through our capacity development facility, we supported this customer in developing a resource efficiency plan that will contribute towards them becoming more climate change resilient and supporting climate mitigation efforts. This plan will include the procurement of energy and water monitoring technology to establish efficiency improvement baselines, the use of biodigesters, and the use of solar lighting around site to reduce demand for grid-based energy.