Foreign direct investment in Latin America has risen strongly over the last decade, exceeding traditional sources of funding from governments and multilateral development banks. With the private sector playing an increasingly critical role in the region, environmental advocates are demanding that financial institutions adopt codes of conduct to promote environmentally sustainable development. Many within the private financial sector remain skeptical of these demands, and, even if they agree that environmental criteria should be taken into account in lending and underwriting decisions, they often disagree about specifics. Recent events suggest, however, that these debates are likely to intensify in the coming years.

The environmental effects of growth in the region are creating new challenges for business. A recent study by the Economic Commission for Latin America and the Caribbean confirmed a steep decline in most environmental indicators during the last two decades. These impacts go beyond the much-publicized destruction of rainforests. Industrial pollution has increased significantly. Air pollution and inadequate access to safe water and sanitation have severe human costs. In Mexico, for example, thousands of children living in a community surrounding the Met-Mex Penoles smelter in Torreón were found to have blood lead levels well above international standards, prompting toxic tort lawsuits. The company has reportedly spent millions for cleanup and compensation to affected families.

Some who do business in the region still labor under the common misperception that environmental issues are not significant risk factors in Latin America. That misperception is rapidly yielding to a new reality. As a result of, among other things, democratization and the Internet, the days of environmental impunity in the region are numbered. Opposition political parties, the media, local and international non-governmental organizations (NGOs), and indigenous groups are effectively shining the spotlight on companies and projects with significant environmental impacts.

It is no longer possible for major projects to be approved and to operate in the quiet manner that was customary for so many years. Legal reforms implemented during the 1990s enable private citizens in many Latin American countries to participate in project reviews and to bring private legal actions seeking redress of environmental violations. Prodded by these citizen efforts, environmental agencies and the courts are developing both the capacity and the political will to take independent action. While government enforcement remains uneven, it is rising and – above all – is unpredictable. It is not uncommon to see project denials, plant closures, major fines, and even criminal prosecutions arising from serious environmental incidents.

Argentina enacted a strict hazardous waste law in 1993 that imposes criminal liability on plant operators. At least two people – a plant manager and an engineer – were convicted under the law. In 1994, Argentina amended its constitution to create specific environmental rights, and these rights have been enforced by private litigants.

An environmental crimes law in Brazil implemented through stringent regulations in 1999 has substantially strengthened the hand of government regulators. It is now common to see fines in the hundreds of thousands and millions of dollars. Government regulators in Brazil also have formed task forces with Greenpeace to identify and combat environmental violations.

A framework environmental law enacted by Chile in 1994 and environmental impact regulations promulgated in 1997 have opened project reviews and approvals to public scrutiny. Litigation by project opponents has become commonplace. Regulators often attach significant environmental conditions to their approvals. The newly appointed head of Chile’s national environmental commission, a prominent environmentalist, has pledged strict enforcement of such conditions.

In Colombia, public interest organizations specialize in class action litigation alleging environmental violations. In Mexico, citizen litigation is less of a factor, but the federal environmental agency inspects most major facilities at least once every two years. The EPA and its Mexican counterpart, Profepa, are stepping up joint enforcement activities along the US-Mexico border. The EPA recently issued its first-ever fine to a Mexican company for illegally shipping hazardous waste into the United States.

In a number of instances during the last three years, major companies and projects have run into significant environmental difficulties. These cases illustrate the challenges faced by companies operating in the region.

In Brazil, the state-owned oil company, Petrobras, was fined $28 million by the federal environmental agency after a 340,000 gallon oil spill in January in Rio de Janeiro’s Guanabara bay. After a second million gallon spill from its Repar refinery in Paraná state in July (the worst spill in 25 years), Petrobras was fined $118 million by federal and state authorities. These fines are a direct result of law reforms that increased penalties for serious environmental violations, and represent the highest fines ever recorded in Latin America.

Local opposition thwarted efforts by Metalclad, the US waste disposal company, to reopen a hazardous waste facility in the Mexican state of San Luis Potosí, prompting the company to file a $90 million arbitration claim under the investor protection provisions of NAFTA. Metalclad purchased the site and obtained all of its federal permits to reopen the facility, but the state government prevented the reopening by declaring the site part of a special ecological zone. Metalclad asserts that these actions amounted to an expropriation of the company’s investment and future profits. The claim is pending before a special tribunal in Washington, DC.

In Mexico, for the first time ever, environmental prosecutors in the federal attorney general’s office arrested and jailed two managers of state-owned Pemex during a criminal investigation of alleged illegal disposal of hazardous waste into a river in Veracruz.

Risks Abound
These developments represent serious bottom line risks for financial institutions operating in Latin America. Environmental opposition can increase project completion risk. Major fines can impair a borrower’s ability to repay. Foreclosure on contaminated property can create a risk of lender liability. In Colombia, the environmental ministry held a private bank, Banco de Colombia, responsible for cleanup after the bank received a 108-acre site from the National Federation of Cotton Growers in payment of a loan. The property was contaminated with agrochemicals. Under an agreement with the ministry, the bank committed to clean up onsite contamination and monitor the remedy for 20 years. The ministry also ordered the bank to suspend financing for affordable housing near the site.

In addition to bottom-line risks, financial institutions also should anticipate reputational risk arising from public scrutiny of their lending and underwriting practices. Environmental advocates are planning and executing campaigns directed specifically at the financial sector. According to Francis Grant-Suttie, director of private sector initiatives at the World Wildlife Fund US in Washington, “the financial services sector is the next target. It’s not just the resource companies of the world, but also their financial backers, who will be in our cross-hairs.”

Those efforts are becoming more systematic. In 1998, the National Wildlife Federation (NWF) and Friends of the Earth launched project Quantum Leap, which trains environmental NGOs to expand their focus to include private banks on Wall Street. “The unprecedented level of private capital flowing to developing countries through financial institutions necessitates a shift in advocacy to protect natural habitats,” adds Julie Tanner, manager of the NWF’s Finance and the Environment program. Training sessions have been held in Washington, Chile, and Thailand. Tactics include discussions with bank officials, shareholder resolutions and consumer boycotts. There is already evidence of such efforts in connection with Latin American projects.

Fidelity Investments, one of the largest mutual fund groups in the world, was targeted by demonstrations by Amazon Watch and others seeking divestment of Fidelity’s shares in Occidental Petroleum as a result of Occidental’s activities in Colombia.

Banks are Targets
Environmental advocates targeted Dresdner Bank in connection with its financing for hydroelectric projects proposed by Endesa along the Bío Bío river in Chile. These efforts arose out of protests initially directed at the International Finance Corporation, the World Bank’s financing arm for the private sector. When Endesa sought private funding from Dresdner in lieu of IFC funding, advocates redirected their efforts toward Dresdner.

As a result of these developments, some financial institutions are considering steps to manage environmental risk in the region more effectively. These steps can include development of regional or country-specific risk protocols, environmental training for bank officers and in-house counsel, adoption of environmental management systems, and closer review of environmentally sensitive loans and projects.

Some financial institutions, including Bank of America, joined the United Nations Environment Program’s Financial Institutions Initiative, which promotes sustainable development efforts among the world’s banks. Others endorsed environmental management principles established by other organizations, such as the Coalition for Environmentally Responsible Economies (CERES). The precise contours of each financial institution’s approach will vary depending on business objectives, internal structure, and strategic objectives. It seems likely, however, that proper management of environmental issues in Latin America will become increasingly important. Those financial institutions that are prepared to meet these environmental challenges will be more effective than those that are not.

Jeffrey Gracer is a partner in the environmental and Latin American practice groups at Torys, an international law firm with offices in New York, Toronto and Beijing.