Unmanaged Environmental and Social Risks are credit Risks

CHEMICALS WAREHOUSE EXPANSION

Background Chemical company involved in the importation and trade of chemicals for the printing and paint manufacturing industries. Started out as a small warehouse in a mixed residential area. Company has had an account with the bank since its first trading days. Experienced rapid growth and sought a medium term loan (6 years) of LKR 150 million. Financing was used to purchase adjoining blocks of land and expanding the warehouse infrastructure.

E&S Due DILIGENCE E&S due diligence checks included: Check of business registration and local authority approvals √ yes they did Check to see if chemical warehouses require Environmental Protection Licenses E&S DD report indicated that chemical warehouses are not a prescribed activity requiring an EIA A site visit to check fire safety equipment √ report noted that company had installed portable fire extinguishers and a hydrant system Was this an adequate E&S DD for a chemicals warehouse undergoing a large expansion in a mixed residential area?

SOME Missed issues – can you think of any others? CEA require site clearances for chemicals storage. Other regulatory compliance checks such as: Import restrictions under the Pesticides Act, Imports and Exports Act and Import License requirements; Occupational Health & Safety; Hazardous Waste Management. Check of chemicals stocked and whether they were being safely stored & handled: Availability of Safety Data Sheets; Labelling; Safe quantities; Safe distances between stocks with incompatible properties; Aisle spaces; First aid, wash stations; Emergency preparedness and response systems; Worker health and safety. Assessment of community health and safety risk and whether an expanded operation was compatible with a mixed residential area.

The Reality ... Not so Rosy The reality on the ground which wasn’t articulated in the E&S DD was more concerning. There were large quantities of poorly stored and managed hazardous substances with a mix of toxic, flammable, combustible and chemically reactive properties. Furthermore, chemical were stored right up to the boundaries and there was little buffer between the operation and family homes. The Bank’s credit appraisal was inadequate for a business that should be categorized as high E&S risk, due to the inherent hazardous properties of the substances being stored and traded.

A matter of time A fire broke out at the warehouse damaging the stocks, warehouse infrastructure as well as releasing a plume of toxic vapour across the neighbouring community. Over 50 residents were hospitalized with breathing difficulties and eye irritations. The incident made headlines of the local media and the facility was closed for six months pending outcome of court proceedings. The company was subsequently ordered to relocate to an industrial zone. Cash flows were hit hard both from loss of business while closed, site clean up costs and warehouse relocation. Company failed to commit to its loan repayment schedule.

Reflections Business approvals and licenses are just one small part of an E&S due diligence. They are not a guarantee of operational compliance. A Bank’s E&S risk management system must not rely on whether or not a client requires an environmental protection license (EPL). Do some research on the business activity! Good practice guidelines on chemical warehouse operations, storage and handling practices would have given ideas on what to look for during the site visit. If in doubt bring on expert opinion. The client was handling substances with hazardous properties. It would have been prudent to bring in someone experienced with such substances. Your E&S risk management system should allow for the immediate flagging of concerns before too much work is undertaken on a credit proposal. Just a few photos (it didn’t look like this picture) from the first site visit should have alerted the credit team to the potential risk exposure. This would have prompted an immediate discussion how to progress with the facility application. Was there a way to support the client and turn them into a safer enterprise.

Metal plating Plant

BackGround A small-scale metal plating company manufacturing zinc plated fasteners with a growing market. Company approached bank for a LKR 300 million to finance the construction of a new factory in a new location to expand production capacity. As part of its credit appraisal the bank undertook an E&S risk assessment as metal plating operations have the potential for impacts from unmanaged effluent discharges, air emissions and hazardous working environments. The E&S risk assessment was concerned with the new production facility as financing was for the new factory.

E&S Due DILIGENCE scope BE SMART ABOUT WHAT you ASSESS Do you think the scope of the Bank’s E&S due diligence assessment was adequate? Should the scope of the E&S due diligence have also included the existing operation and existing capacity and commitment of the client to manage their E&S impacts? At no point did the Bank consider assessing the existing operation even though the existing operations would continue until the new facility was operational. The new facility was expected to take 12 – 18 months to build.

A Lot can happen in a year and a half! Two months before the facility was due to commence operations the community neighbouring the existing operation raised a complaint against the company. The community was concerned with a deterioration in the water quality in their dug wells. An investigation found that effluent discharges from the metal plating company were responsible for the ground water contamination. It was further established that rinsing water and spent water from the acid/alkali baths had been discharged directly onto the ground instead by a new employee of the gully bowsers. The company accepted responsibility. The company had to close operations, clean-up the contamination, fund the construction of a new piped water supply and bowser in water supplies. The company incurred heavy costs from the clean-up, project delays (the new facility completion was set back by 6 months and lost revenue from 8 months on non-production.

Reflection Determining the scope of the E&S DD is critical. As a Bank you need to understand all aspects of your client’s operations and where the material risks may arise. Taking an approach that only considers E&S risks associated with the specific project/activity that is being financed maybe inadequate. Don’t forget to assess your client’s environmental controls and management practices and how well they have been integrated into standard operating procedures (SOPs) and training. For example, Were there clear and well communicated SOPs on how rinse water and spent water from acid/alkali baths were to be managed? How were new employees briefed on how to manage effluents? Finally, how prepared was the client to respond to an unintentional release? Incidents do happen and clients should be prepared to respond. Photo by Pahala Basuki on Unsplash

Textile Finishing Company

BackGround A medium sized textile finishing company is looking to install a new production line to cater for increasing demand. The company dyes and prints fabrics on contract to several large-scale branded apparel manufacturers. The company sought part financing of LKR 100 million for the new line. The bank visited the company and noted that the factory bordered a wetland and enquired about effluent management. The team was informed that the company had an effluent treatment plant and had to meet stringent wastewater quality standards.

DIG a bit deeper….. Whilst the credit team correctly noted the proximity to a wetland and potential impact from effluent discharges. No documentation or further investigation was undertaken to verify that the company was in fact complying with the “stringent” regulatory requirements. Checking compliance – means accessing supporting documentation, test results that verify compliance. Furthermore, no enquiry was made as to whether the new production line would increase quantities of effluent and whether the effluent treatment plant had the capacity to handle an increase.

IF YOU don’t…… Shortly after the first disbursement the community observed dead fish floating in the wetland and approached the company as they suspected the effluent discharges. The community launched a public protest when the company ignored their concerns, which triggered an investigation by the regulatory authorities. It was established that the quality of the effluent discharges fluctuated because the treatment plant was unable to adequately process the wastewater when large volumes were generated by the production process. If the effluent treatment plant couldn’t handle current wastewater volumes how would it cope with an additional production line? It also emerged that the company had not obtained environmental clearance for the factory expansion from the CEA.

THIS May COMES TO PASS…… The company was ordered to immediately stop expansion and to relocate. Some of the company’s customers ended their contracts. The impact of the relocation and lost revenue strained the company’s cash flow and their ability to meet loan repayments. The Bank decided to stop any further loan disbursements.

Reflections Compliance checks are essential. These checks must be supported by demonstrable evidence of compliance. There can be a wide variety of E&S regulatory requirements to follow up on ranging from effluent discharges, air emissions, hazardous substances permits, occupational health and safety to labour laws. It is more than just checking for Environmental Protection Licenses and Site Clearance Certificates. These are important but not the only regulations to check. Expansions – don’t lose sight of the potential for increased volumes of waste streams or the opportunity to introduce more efficient production technologies and reduce volumes of waste generated per quantity of finished product.

Business risk for client Credit risk for the bank. Poorly managed impact = Business risk for client Credit risk for the bank. summary