Member Article

Environmental laws should not be understood as a limit to economic growth and development but as a crucial part of economy: the wise use of natural resources means greater benefit from raw materials and lower costs for inputs. At the same time, the quality of life for Brazilian citizens should be enhanced by an effective program of environmental sustainability. Thus, environmental law has always operated on a win–win equation, although that is certainly not the way it is understood by most political leaders or even by the population. So how does Brazil deal with environmental liability directives for the financial sector, and what are the consequences?

Civil environmental liability rules

The main concern with respect to environmental liability is how far the liability chain could extend, considering the “indirect polluter” and strict, joint, and several liability concepts expressed in Articles 3 and 14 of the Brazilian Environmental Policy (BEP).

In theory, if almost all individuals and entities connected to environmental damage, directly or indirectly, can be held liable, companies are left with a tremendous risk of being harmed by events that are completely out of their control. And what about financial institutions? Can they also be included in the liability chain if they make funds available to companies but have no control on how those companies develop their activities, nor on whether they comply with environmental laws?

Although only a single article in the BEP states that before lending, public financial institutions should check whether borrowers have valid environmental licenses and are in compliance with federal technical rules issued by the Brazilian Environmental Counsel, the existence of broad liability rules in a developing economy has led to serious consideration of the idea that financial institutions should be held liable for environmental damages caused by borrowers.

Such an interpretation could cause lenders to become so frightened of potential penalties that lines of credit vanish from the Brazilian market.

Financial institutions have always been key players in deciding which sectors will benefit from credit, and the Brazilian legal environmental system should instead take advantage of their key role. Environmental agencies should work closely with banks to inspect and control borrowers’ activities.

If potential non-compliance is detected, the bank should be informed immediately and the credit line suspended – or even cancelled or channeled to remediation of damages in worst-case scenarios.

Voluntary commitments and principles

Voluntary commitments undertaken by some financial institutions are also part of the equation, namely,

• the Green Protocol signed by Brazilian banks in 1995, a voluntary public policy that commits signatory banks to promoting sustainable development
• the Principles for Responsible Investment within the United Nations Environmental Program
• the Equator Principles signed by banks worldwide in 2002.

All three documents have evolved a great deal over the last decade. In 2008, new banks signed on to the Green Protocol, and more and more banks have committed themselves to the Equator Principles, which have been revised to introduce stricter application. The threshold for project finance deals that are subject to the principles has been lowered from US$50,000 to US$10,000.

The United Nations principles have also been revised and are becoming broadly applicable.

Environmental case law

As for Brazilian case law, although public (and also some private) financial institutions have been figuring as defendants in environmental lawsuits, no financial institution has so far been convicted for damages caused by borrowers. Brazil does nevertheless have an important 2009 precedent from the Superior Court of Justice, concluding that liability for environmental damage lies with those who

cause the damage

should prevent the damage from occurring but do not

let third parties cause the damage

finance third parties that cause the damage

benefit from the damage caused by third parties.

That decision has played a key role in environmental decisions since its publication, and more and more financial institutions have become defendants in environmental lawsuits. In addition, the Public Attorney’s Office has been using the decision to pressure the financial sector to better evaluate or even restrict credit for projects with high environmental sensitivity.

The 2014 ruling

Legally speaking, private financial institutions are used to working within a voluntary framework: those committed to the various protocols have subjected themselves to environmental policies when delivering credit. As for public financial institutions, once a license is valid and compliance with technical rules is confirmed, the credit line has been ready to go.

Since 2012, however, financial institutions have known that the environmental normative scenario was about to change. In June, the Central Bank of Brazil released drafts of two socio-environmental rules for public consultation. They encompass corporate governance for financial institutions, evaluation and mitigation of risks in projects, and publication of socio-environmental reports. Consequently, interested parties have been discussing this topic with the Brazilian government for some time.

As a result, the voluntary scenario has recently been slightly revised. On 25 April 2014, the Central Bank published Resolution No. 4,327, providing guidelines for financial institutions – and other institutions authorized to operate by the bank – for drafting and implementing a Socio-Environmental Responsibility Policy (SERP).

The outlines of SERP

The resolution provides guidelines covering the internal activities of these institutions, as well as their projects and deals. The guidelines recognize that the SERP must accommodate both proportionality and relevance principles: it has to take into account the degree of risk exposure

involved for the institution, the nature of the institution, and the complexity of its activities and projects.

The resolution also stipulates that institutions should establish an internal structure in order to implement the SERP, stating that potential stakeholders should be encouraged to take part in the drafting of the SERP itself.

The corporate governance structure could include a socio-environmental committee linked to the board of directors or, if there is no board of directors, to a board of officers. The committee would have consultancy powers and would monitor and evaluate the SERP.

To manage the socio-environmental risk of their own activities and projects, according to the resolution, financial institutions should establish or refer to the following:

systems, routines, and processes that identify, classify, evaluate, monitor, mitigate, and control the socio environmental risks inherent in its activities and projects

databanks on effective losses derived from environmental damage, covering at least five years, including the amounts involved, and the type, location, and economic sector of the project

previous evaluations of potential negative socio-environment impacts from new products and services, including reputational damage

procedures to ensure adequate management of socio-environmental risks in terms of legal and market changes.

The risk evaluation departments of institutions would be entitled to manage socio-environmental risks. Further, for projects related to economic sectors with higher potential to cause environmental damage, institutions should establish specific criteria and mechanisms to evaluate the socio-environmental risks.

In order to implement the SERP, institutions should draft an action plan on a defined schedule. Both the SERP and the action plan have to be approved by the board of officers and, when existing, by the board of directors. These approvals are intended to ensure that the SERP will integrate other policies from the institution, such as its credit policy, human resources management policy, and risk management policy.

Considering that the resolution is extremely recent, it is not yet clear how it will be interpreted by the Public Attorney’s Office, NGOs, and other stakeholders . Potential ancillary impacts – such stakeholder willingness to discuss drafts of SERPs, stronger positioning by the Public Attorney’s Office on the potential liabilities of financial institutions, and the behavior of the press – are still unknown.

Brazil still has a long path ahead as it decides whether environmental rules constitute a strong instrument to enhance the economy and lead to sustainable development, or an economic obstacle that is causing the country to retreat from development. Financial institutions that are subject to risks related to potential environmental liability are caught between the horns of this dilemma.