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2004 October Report of the Auditor General of Canada

Main Points

1. We found that the Environmental Review Directive and other environmental review processes used by Export Development Canada include most elements of a suitably designed environmental review procedure. We identified these key design elements based on a review of the documented policies of similar institutions. EDC's current review policies meet more standard design elements than its previous policy.

2. We found major improvements in the manner in which EDC implemented its environmental review processes, including the Directive, over a similar audit conducted in 2001. Overall, we concluded that the Directive and EDC's other environmental review processes were operating as designed.

3. EDC designed the Directive to allow it to exercise discretion in the many steps involved in its implementation. We were satisfied that EDC was careful in exercising its professional judgment in categorizing transactions and in making its determinations under the Directive. At the same time, we noted areas for improvement in documenting how it exercises this discretion in its review of environmental impact assessment reports and public consultation.

4. Increased expectations for greater accountability in both the private and public sectors impose on EDC a greater responsibility to demonstrate that it exercises its discretion wisely. In our view, the counterbalance to the broad discretion in EDC's environmental review policies is greater transparency. Although EDC filled some of the transparency gaps we noted previously, our Report recommends additional steps that EDC needs to take to enhance transparency and to assure Parliament and Canadians that EDC's environmental review processes uphold high standards of environmental protection and sustainable development.

5. In our 2001 Report, we found that EDC was a leader among its counterparts. Now, EDC has designed its environmental review policies to be in line with the Recommendation on Common Approaches on Environment and Officially Supported Export Credits of the Organisation for Economic Co-operation and Development (OECD). While EDC is ahead of its counterparts in requiring third party review of environmental impact assessment reports, other export credit agencies show leadership by exceeding the OECD Common Approaches for disclosure and public consultation elements. These are the two areas we highlighted in our last Report and that EDC still needs to improve. In our view, EDC should decide whether it wishes to show leadership among export credit agencies by enhancing its Directive and other review processes.

Background

6. Amendments in 2001 to the Export Development Act imposed a legal obligation on EDC to carry out environmental reviews of project-related transactions. EDC adopted a new Environmental Review Directive in 2001 and established supplementary environmental review processes for certain transactions not covered by the Directive. Our audit examined the design and implementation of these environmental review processes.

7. This is our second Report on EDC's environmental review processes. Our first Report in May 2001 found that EDC's Environmental Review Framework had most elements of a suitably designed environmental review process, although there were important gaps in public consultation and disclosure. We also found significant differences between the Framework's design and its operation and concluded that the Framework was not operating effectively.

8. EDC and other export credit agencies do business in a climate of escalating expectations regarding transparency, public trust, and accountability. Their role in international finance, particularly in the developing world, has brought increased pressure from stakeholders to develop more stringent standards for carrying out environmental and social reviews of projects that they finance. In 2003, members of the OECD adopted the Organisation's Recommendation on Common Approaches on Environment and Officially Supported Export Credits. This document promotes a level playing field for officially supported export credits by establishing common procedures and processes for environmental reviews of projects while respecting the primary role of export credit agencies to promote trade in a competitive environment.

Export Development Canada has responded. Export Development Canada has accepted, and agreed to take action on, all our recommendations. It has provided a response for each recommendation as well as an overall comment. Each response includes a statement of actions either taken or planned.

Introduction

Overview of Export Development Canada

9. Export Development Canada (EDC) is a Crown corporation whose mandate is to support and develop Canada's export trade and Canadian capacity to engage in that trade, and to respond to international business opportunities. EDC operates as a commercial financial institution to provide trade finance and risk-mitigation services to Canadian exporters and investors (Exhibit 1).

10. EDC has developed tools, practices, and policies to manage risk in the export transactions it considers. EDC has also adopted environmental review processes to meet its legal obligation under its legislation, to manage environmental risk, and to ensure that the transactions it supports are justified after consideration of environmental issues.

Our 2001 Report

11. In May 2001, we released our Report on the design and implementation of the environmental review policy and procedures EDC used at the time. This policy was known as the Environmental Review Framework.

12. We reported that while the Framework had most elements of a suitably designed environmental review process, there were important gaps in public consultation and disclosure. We also found significant differences between the Framework's design and its operation and concluded that the Framework was not operating effectively. The Report contained recommendations for improvements to both the design and implementation of the Framework. EDC undertook to address these recommendations.

Changes since May 2001

13. Consultation. In response to our Report, EDC consulted with business and civil society groups from across Canada in 2001 on revisions to its environmental review process. EDC used three documents for these initial consultations: a draft document from the Organisation for Economic Co-operation and Development (OECD), a guidance document prepared by the Department of Foreign Affairs and International Trade, and a consultant's paper focussing on broad issues relating to environmental review.

14. New legal obligation. In the meantime, Parliament amended the Export Development Act. The amendments, which came into effect on 21 December 2001, established a legal requirement for EDC's board of directors to issue a directive to assess the environmental effects of project transactions. EDC released its new Environmental Review Directive the same day.

15. Additional consultation. In 2002, EDC gave the public an opportunity to comment on the Directive and a draft policy on prior disclosure of environmental and social impact information. After a 60-day consultation period, EDC made minor changes to the Directive, but substantially altered its draft prior disclosure policy. It dropped the proposed 45-day period for disclosing information and the condition making consent for disclosure from Canadian project sponsors a requirement for EDC support. EDC made these changes in response to concerns from the business community that EDC maintain a level playing field with other export credit agencies. The amended Directive and new prior disclosure policy both came into effect on 1 May 2002.

16. Other changes. EDC made other operational changes in response, among other things, to our Report. It created supplementary processes to review the environmental impacts of certain transactions not subject to the Directive. It hired a Chief Environmental Advisor to direct a team of in-house environmental specialists to review transactions under the new Directive and its other environmental review processes. And in 2002, EDC established a new position of Compliance Officer. This officer responds directly to public inquiries and oversees issues and policies on transparency and disclosure practices, human rights, business ethics, and the environment.

Evolving international and domestic context

17. External pressure. Export credit agencies such as EDC play a key role in international trade and finance in developing countries. Collectively, they represent a large source of public international finance and provide an important tool for large-scale infrastructure and resource extraction projects in the developing world.

18. This prominent role has brought increased scrutiny from civil society groups concerned about the potential significant environmental and social impacts of these investments. These groups have demanded that export credit agencies develop more stringent standards for carrying out environmental and social reviews of projects and that they make their reviews more transparent. Two initiatives in particular show the response of export credit agencies and the private banking sector to the call for enhanced standards and greater transparency in their application.

19. Organisation for Economic Co-operation and Development. The Working Party on Export Credits and Credit Guarantees has operated under the auspices of the OECD to create coherence among the environmental risk assessment practices of export credit agencies. In December 2003, Canada and other OECD member countries adopted the OECD Recommendation on Common Approaches on Environment and Officially Supported Export Credits. This document promotes a level playing field for officially supported export credits by establishing common procedures and processes for environmental reviews of projects. The OECD Common Approaches aims to promote good environmental practices with a view to achieving a high level of environmental protection. It recommends that members seek to foster transparency, predictability, and responsibility in decision-making by encouraging disclosure of relevant environmental information while taking into consideration business confidentiality and other competitive concerns. Although OECD recommendations are not legally binding, there is an expectation that OECD member countries will act in good faith to fully implement them.

20. Equator Principles. In 2003, the private banking sector developed the Equator Principles, a set of voluntary guidelines to help the banking industry address environmental and social risks in large-scale project financing. Based on policies and guidelines of the World Bank and the International Finance Corporation, the Principles apply to projects with a total capital cost of US$50 million or more in all industry sectors throughout the world.

21. As at 15 April 2004, 21 banks (including 2 Canadian banks) had adopted the Principles. Banks, like export credit agencies, are a source of project finance. Market analysts calculate that the banks adopting the Principles represented approximately 75 percent of the project loan market volume in 2003. In May 2004, Denmark's Eksport Kredit Fonden became the first export credit agency to adopt the Principles.

22. EDC's actions in adopting the Directive and in making the changes noted above are consistent with the trend toward enhanced accountability and transparency of financial institutions in Canada and abroad. Exhibit 2 shows some of the developments over the past few years in Canada and internationally that have influenced changes in the environmental review policies of export credit agencies.

EDC's Environmental Review Directive and other environmental review processes

23. Key elements. EDC's environmental risk management process has two components:

• the Environmental Review Directive to respond to EDC's legal obligation to carry out environmental reviews of transactions in accordance with the Export Development Act, and
• supplemental processes to conduct environmental reviews of transactions that do not fall within the scope of the Directive.

24. The Directive. The Directive establishes the scope of EDC's legal obligation to carry out environmental reviews of project-related transactions. It requires EDC to categorize projects on the basis of their potential adverse environmental effects. It also requires EDC to determine whether a project is likely to have adverse environmental effects despite mitigation measures and then whether EDC is nonetheless justified in entering into the transaction. No such determination is required for lower risk projects. Nor is one required for projects in Canada or the United States, provided EDC receives confirmation that such projects are designed to meet host country environmental requirements.

25. The Directive is publicly available on EDC's Web site and a copy is set out in the Appendix. Exhibit 3 sets out the steps EDC follows in applying its Directive.

26. When does the Directive apply? The Directive only applies to a small percentage of EDC's business volume—1.2 percent in 2003 (Exhibit 4). First, it only applies to project-related transactions. In 2003, project-related transactions represented less than 1.5 percent of EDC's business volume. However, the Directive only covers those transactions with a repayment term or coverage period of two years or more. This project focus and two-year threshold exclude EDC's short-term accounts receivable insurance, which in 2003 represented approximately 70 percent of its business volume. This exclusion is common business practice in all export credit agencies we reviewed.

27. Second, the Directive applies to those medium- and long-term financial services that are financing, political risk insurance, or equity transactions. This excludes contract and insurance bonding. The scope of the Directive narrows this further to support for project-related transactions with a value greater than SDR10 million, which is the equivalent of about C$20 million.

28. In the first two years of its operation, the Directive applied to eight completed project-related transactions per year. EDC's remaining project-related transactions are covered by the processes described below.

29. Other environmental review processes. EDC extends its environmental risk management beyond the scope of the Directive to three supplemental review process streams. No public document describes these processes. Rather, EDC relies on its internal corporate manual on environmental review practices to guide application of its supplemental reviews. Together, the Directive and the supplemental review processes form a complex system for determining which transactions will be subject to environmental review (Exhibit 5).

30. The first supplemental process deals with project-related transactions that are less than the Directive's monetary threshold but over US$5 million. EDC subjects higher risk projects in this review stream to a categorization and review process similar to the one it conducts under the Directive.

31. The second process is an environmental reputation review. EDC applies this to higher risk project-related transactions below the US$5 million threshold as well as to non-project transactions above US$5 million. EDC establishes an environmental reputation risk rating by assessing various factors, including country, sector of activity, size of operations, site characteristics, and the environmental policies and track record of the company involved.

32. The third process screens non-project related transactions below US$5 million for environmental risks. Financial service managers and underwriters carry out this type of screening. EDC's Environmental Advisory Services group oversees the application of the Directive and the first two supplemental processes.

33. Case Studies. EDC publishes only limited information about its environmental reviews, primarily with respect to its higher risk (Category A) project transactions. The six case studies in Exhibit 6 help illustrate the application of EDC's Directive and other environmental review processes. They include examples of signed and declined transactions. We omitted names of parties, exact geographic locations, and, in certain cases, the precise international standards applied to comply with EDC's disclosure policy.

Focus of the audit

34. The Export Development Act. The Act mandates the Auditor General of Canada to audit the design and implementation of EDC's Environmental Review Directive on a regular basis and to submit her report to the board of directors of EDC, the Minister of International Trade and to both houses of Parliament. At the request of the Minister of International Trade, we undertook this audit two years after implementation of EDC's new Directive and other environmental review processes.

35. In conducting our audit, we identified key elements of a suitably designed environmental review process similar to those used for our 2001 Report. These elements are based on a comparative review of the documented policies of international financial institutions, including export credit agencies, private sector commercial banks, and multilateral development banks. We compared them with EDC's Environmental Review Directive and other environmental review processes.

36. We assessed whether EDC was applying its Environmental Review Directive and other environmental review processes as designed and reviewed the manner in which EDC responded to the recommendations in our 2001 Report. Further details about our scope and approach can be found in About the Audit at the end of this Report.

Observations and Recommendations

Design suitable for a financial institution

The Environmental Review Directive has most elements of a suitably designed environmental review policy

37. Our comparative review of the policies of export credit agencies, private sector commercial banks, and multilateral development banks identified key elements of an environmental review policy suitable for an international financial institution (Exhibit 7). We found that EDC's current environmental review processes include most (34 of 37) of the elements included in the policies of a majority of the institutions we reviewed. These are referred to as standard elements. The Directive meets more standard elements than EDC's previous policy. While designed to be in line with the OECD Common Approaches, the Directive also includes one element that is not yet common practice for export credit agencies: requiring third party review of environmental impact assessment reports.

38. The Directive omits three standard elements: ensuring due regard for international environmental agreements, co-ordination of review efforts with other financial institutions, and notification of stakeholders for public consultation. In our file review, we did find evidence that, in practice, EDC takes international environmental agreements into consideration and co-ordinates its review efforts with other financial institutions. Public consultation is addressed later in the Report.

39. Missing policy elements. Notwithstanding EDC's attention, in practice, to international environmental agreements, in our view a Crown corporation that implements Canadian government policy should explicitly state its commitment to take into account Canada's international environmental obligations. Most financial institutions in our comparative review now take into account international environmental agreements as a standard element of their environmental review policy. EDC is among the export credit agencies that do not have this policy element.

40. Recommendation. EDC's environmental review policies should include a requirement that EDC take into account Canada's international environmental commitments when considering support for projects.

EDC's response. EDC believes that taking Canada's international environmental commitments into account is an important aspect of its environmental review processes and is pleased that the Office of the Auditor General has recognized our current practices in this regard. EDC will respond to this recommendation by working with the appropriate government department(s) to increase the exchange of information and identify the international environmental agreements relevant to EDC's environmental reviews and establish a commitment within our policies reflecting this practice.

41. EDC's Directive eliminated two elements found in its former policy: emergency response procedures and the need to consider cumulative effects. This occurred when EDC substituted the list of elements required for an environmental impact assessment report used in the OECD Common Approaches for what it previously used. We consider this approach to be a step backward for EDC. In our view, EDC should not eliminate elements from its environmental review policy to conform to a level playing field.

The Environmental Review Directive's narrow scope

42. Objective. Our 2001 Report recommended that EDC clarify the objective of its Environmental Review Framework. EDC responded by identifying the purpose of the Directive as establishing the process required to make a determination regarding EDC's justification in entering into transactions. This objective restates EDC's legal obligation to carry out environmental reviews. It is framed in terms of legal risk rather than, as suggested in our 2001 Report, the intended results of an environmental review—namely that the projects EDC approves are environmentally sound and sustainable

43. Environmental review policies generally contain statements of objectives or purpose intended to guide their application and interpretation. For example, the OECD Common Approaches is based on principles that include the promotion of good environmental practices and consistent processes with a view to achieving a high level of environmental protection. EDC's environmental review policies are not governed by any similar over-arching principle. We believe that EDC, as a Crown corporation, should frame its objectives for environmental review based on principles of environmental protection and sustainability. Such principles serve to complement its legal objective.

44. Recommendation. EDC should amend its Directive and other policies to establish general principles to guide its interpretation and application with a view to supporting projects that are environmentally sound and sustainable.

EDC's response. EDC believes that general principles can be useful in guiding the interpretation and application of environmental review policies and practices. EDC has already taken this approach in establishing an environmental commitment in its Code of Business Ethics and by identifying the environment as a key pillar of EDC's Statement of Commitment on Corporate Social Responsibility. In light of this recommendation, EDC will consider amending the Environmental Review Directive and other policies to incorporate the principles underlying this environmental commitment.

45. Exclusion of short-term transactions. The Directive and other review processes do not apply to short-term accounts receivable insurance. Although noting this exclusion is a practice common to many export credit agencies, our 2001 Report recommended that EDC conduct an environmental risk analysis to determine whether such exclusion is justified. It has not done so.

46. Recommendation. EDC should conduct a risk analysis to determine what risks, if any, it is open to by excluding short-term insurance from environmental review.

EDC's response. In response to the 2001 audit recommendation on the exclusion of EDC's short-term business from the former Environmental Review Framework, EDC conducted an analysis of its short-term business portfolio which considered the business and environmental considerations related to this exclusion from environmental review. The Corporation will consider a further elaboration of this analysis. As a further mitigating effort, EDC has provided training to all short-term insurance underwriters to improve their ability to identify situations that may require guidance, and they are encouraged to contact the Environmental Advisory Services Group to discuss any environmental concerns arising from the short-term business transactions they encounter.

47. Other coverage restrictions. The Directive clearly states that its environmental review procedures apply only to transactions related to a project. The Directive defines a project as a physical development that is industrial, commercial, or infrastructure-related on a greenfield site or a facility undergoing major extension or modification. Additional definitions in the Directive further narrow its application to project-related transactions where EDC or the exporter is dealing with persons in a position to influence the design and direction of a project. The Directive does not apply to the establishment of corporate loan facilities, such as lines of credit, where there is no identified project; however, it applies if a client requests an advance under a line of credit for a particular project.

48. Although its enabling legislation allows EDC discretion to establish definitions for its Directive, it has chosen some criteria in these definitions that are based on factors other than potential environmental risk. Notions of ownership, control, and influence are not indicators of risk.

49. Monetary thresholds. The Directive sorts transactions according to their monetary value. However, a monetary threshold is not an indicator of environmental risk. Since our 2001 Report, most of the export credit agencies we reviewed have adopted some form of thresholds. EDC uses the same threshold that the OECD Common Approaches recommends.

50. The OECD Common Approaches applies no financial thresholds when it considers projects in sensitive areas (defined as including parks, protected areas, and wetlands). EDC plans to bring its review policy for sensitive areas into line with OECD policy. Projects in sensitive areas would be subject to EDC's first supplemental environmental review process, as described earlier.

51. Project splitting During the consultation period on the Directive, civil society groups raised concerns that applicants would split projects to avoid a monetary threshold that would otherwise subject projects to a detailed environmental review. We found no evidence of project splitting in our audit work.

52. Increased burden for supplementary review processes. The Directive's restrictions narrow its scope to the point that it captured eight completed project-related transactions per year since its adoption. This increases the burden on the supplementary environmental review processes to ensure that risks are identified and properly assessed in cases where a full environmental impact assessment may not be otherwise warranted. For example, transactions that don't qualify under the Directive may nonetheless involve activity with potential adverse environmental impacts. In such cases, even a minor contribution to an environmentally unsound operation has the potential to cause severe reputation damage to EDC and to reflect negatively on the Government of Canada.

53. EDC has chosen to manage the environmental risks associated with its mandate to promote trade by focussing much of its environmental review efforts on project-related transactions. However, it also established a procedure for environmental reputation reviews for non-project transactions.

54. There is no standard practice among financial institutions for conducting environmental reputation reviews. It remains a highly subjective exercise. As this area evolves, EDC needs to update its methods to apply objective, practical criteria to ensure that its environmental reputation reviews are working effectively.

Implemented as designed

Major improvements in implementation

55. We reviewed whether EDC implements its environmental review processes as designed. In doing so, we looked at how EDC's processes meet key design elements, including the steps set out in the Directive.

56. In our 2001 audit of EDC's previous Environmental Review Framework, we found significant differences between the Framework's design and its operation. We reported finding gaps at each stage of the environmental review process and we concluded that the Framework was not operating effectively.

57. In our current audit, we found that EDC has made major improvements to the way it implements its environmental review processes, including the Directive. Overall, we found that the Directive operated as designed. When we compared implementation against the design elements of the Directive, we generally found that EDC

• screened and categorized transactions appropriately;
• reviewed environmental assessment reports or other information. EDC requested additional information when warranted and, in certain instances, made filling information gaps a requirement of financing;
• identified which international standards to apply;
• based decisions to support transactions on sufficient information. EDC declined support when adequate information was unavailable;
• took decisions at the appropriate level of authority; and
• included environmental covenants and monitoring requirements in transaction documentation when appropriate.

58. We found that EDC generally applied its other environmental review processes, including its review of projects not subject to the Directive and its environmental reputation review process, in accordance with its internal procedures manual.

59. Applying EDC's Directive and other review processes has been a learning experience for EDC staff and clients. EDC clients interviewed by us confirmed that EDC staff were very professional in dealing with issues that arose during the review process. There was also general consensus that the Directive neither imposed an undue financial burden nor caused unexpected delays in processing transactions.

Internal procedures and accountability

60. Our 2001 Report recommended a more systematic approach to review processes. Our current audit found that EDC made significant improvements in staff training and in strengthening its own control systems.

61. Staff are trained in the new processes. EDC went to considerable effort to hire experienced staff. It hired a senior environmental specialist who supervises the six-member team that applies the Directive and other environmental review processes. It organized extensive staff training after the new Directive came into effect and trains all new employees on the environmental review processes.

62. Monitoring procedures. In 2001, we reported finding limited evidence of systematic monitoring of transactions. EDC has since developed new internal procedures and systems to ensure appropriate monitoring. Staff track reporting requirements on an automated system and follow new procedures to verify late or incomplete reports or incidences of non-compliance. EDC's environmental specialists assess these reports.

63. In the transactions with monitoring requirements we reviewed, we found that EDC followed its internal procedures. When monitoring reports were late, EDC followed up to ensure that they would be provided. When EDC found non-compliance with negotiated environmental covenants, staff requested further information on the problems and the actions taken to rectify the non-compliance. EDC's ability to carry out effective monitoring is constrained in those transactions where it is one of many lenders in a loan syndicate.

64. Enhanced mechanisms to improve supervision. Since our 2001 audit, EDC strengthened its accountability mechanisms to monitor all environmental review processes. These mechanisms include the following:

• an automated system for tracking medium- and long-term transactions that uses a series of check points to ensure that transactions follow all required environmental review steps;
• an Environmental Advisory Services team that reviews the environmental impacts of project and non-project transactions;
• internal audits of how staff use EDC's automated transaction system and its disclosure policy. The audits identify process deficiencies and recommend measures to correct them;
• enhanced approval levels appropriate to the size of the transaction to ensure that required opinions and other documentation have been obtained;
• the Audit Committee of the Board of Directors overseeing issues to do with the Directive and the disclosure policy; and
• a Compliance Officer whose mandate is to provide additional assurance to the public that EDC is complying with its policies on transparency and disclosure, environmental review, human rights, and business ethics (see case study, EDC's compliance officer mechanism: The first test).

EDC has broad discretion in applying the Directive

65. Discretion. The legally binding nature of the Directive influenced its design. EDC was concerned that a legal obligation to carry out environmental reviews would open up its decisions to judicial review, so it used the broad discretion given to it under the Export Development Act to restrict the scope of the Directive's application and to build a considerable amount of flexibility into its design. The policies of other export credit agencies we reviewed also provide for discretion in their application.

66. This discretion allows EDC to exercise professional judgment at various steps in the application of the Directive:

• categorizing projects,
• analyzing environmental impact assessment reports to determine what information is required and whether information gaps are justified,
• selecting which international standards to use,
• determining the significance of environmental impacts, and
• determining justifications for entering into transactions.

67. We are satisfied that EDC takes care in exercising its professional judgment to categorize transactions and make determinations on higher risk projects. At the same time, we noted areas for improvement in documenting how EDC exercises this discretion: analysis of environmental impact assessment reports and public consultations.

68. Contents of environmental impact assessment reports. The Directive establishes different information requirements and formats for environmental impact assessment data in accordance with the risk category of a project. Annex 3 of the Directive lists the aspects normally covered by environmental impact assessment reports for higher risk projects. But the Annex also notes that every element need not be covered for the report to be complete. Still, EDC needs to carefully consider relying on reports that don't cover every element and should consistently document those cases where it decides to do so. Although it did address in some form gaps it identified in environmental impact assessment information provided, EDC's documentation in some cases was weak.

69. Recommendation. EDC should ensure that it adequately documents the circumstances that justify its decision to accept information gaps in environmental impact assessment reports in its environmental review of project-related transactions.

EDC's response. EDC views any material gaps in environmental impact assessment information very seriously and has refused to support projects on this basis (as outlined in EDC's Chief Environmental Advisor's Annual report and in this Report). EDC believes that all information gaps in environmental impact assessment reports should be documented and the decisions to accept these gaps need to be justified. It is standard practice for all Environmental Advisory Services project opinions to address Environmental Impact Assessment elements and, if elements are not fully addressed, to note justifications where appropriate. EDC will review the consistency of its documentation of this aspect and will make modifications as appropriate.

70. Public Consultation. Public consultation under the Directive is discretionary. The Directive states that EDC "expects," rather than requires, public consultation on Category A projects. This matches the OECD Common Approaches and the practices of many other export credit agencies. The Directive builds in additional flexibility for the public consultation elements by allowing for adaptation to the various political, cultural, and legal contexts in the countries where EDC carries on business. Like its export credit agency counterparts, EDC does not explicitly define the type of public consultation expected.

71. However, multilateral banks, such as the International Finance Corporation, require consultation for Category A projects. These institutions use public consultation to identify and resolve potential problems early on by bringing additional expertise, information, and viewpoints into the project process. There is no standard methodology for public consultations. But the International Finance Corporation prepared a guidance document, Doing Better Business through Effective Public Consultation and Disclosure. It believes that "consulting with the public makes good business sense."

72. EDC could use this guidance to help accomplish the basic purpose of public consultation, namely to identify and consider the concerns of affected people in the host country. The policies of some international financial institutions, including that of EDC, require, at a minimum, compliance with the public consultation requirements of the host country. There may, however, be situations where going beyond a strict adherence to legal requirements is warranted to adequately manage environmental risk and reputation issues.

73. We found EDC's assessment of the adequacy of public consultation was not consistent. EDC did not always receive sufficient information to determine the adequacy of the consultation. Nor was it always clear from available documentation what influence, if any, consultation had on the projects. A more recent transaction reviewed by us indicated that EDC exercised greater due diligence about the nature and extent of host country requirements on public consultation.

74. In some instances, EDC's clients become involved in a project after consultation has taken place and may not have access to public consultation records. In other cases, circumstances regarding the host country culture and laws or the nature of the project itself may lead EDC to support a transaction without full information on public consultation. However, in all circumstances justification for proceeding without full information on public consultation needs to be fully documented in the files. We did not always find this to be the case.

75. Our audit found that EDC did not meet the standard design element for notification about public consultation. Although the policies of a majority of the export credit agencies we reviewed included this element, the OECD Common Approaches does not. There is no uniform practice for public consultation notification among export credit agencies because it is the project sponsors, not the agencies, that carry out this consultation. In our view, EDC's policies should encourage appropriate notification for public consultations in the projects they support.

76. Recommendation. EDC should be diligent in confirming that public consultations are, at a minimum, in accordance with the requirements of the host country. In cases where EDC decides to proceed with a transaction despite the absence of full information on public consultation, EDC should document its justification for that decision. Where warranted, EDC should go beyond a strict adherence to host country public consultation requirements, in order to adequately manage environmental risk and reputation issues.

EDC's response. EDC's Environmental Review Directive requires compliance with host country requirements as per Paragraph 22 of the Directive which states "the project in respect of which EDC is conducting a review has been designed to comply with host country environmental requirements, such as any applicable provisions for local consultation..." Where information related to public consultations is not comprehensive, EDC carefully considers whether the absence of this information is a key concern with respect to the support of the project. EDC will review the consistency of its documentation of this aspect and will make modifications as appropriate.

77. Transparency. The discretion built into the different stages of application of EDC's environmental review processes makes it difficult for Parliament and the public to understand how EDC applied, interpreted, and oversaw its environmental reviews. In our view, the counterbalance to this discretion is greater transparency.

78. Without greater transparency, Parliament and Canadians lack information about what impact, if any, EDC's environmental review processes have had to ensure that EDC upholds high standards of environmental protection and sustainable development. Internal controls and safeguards alone do not provide this assurance to the public. EDC needs to demonstrate that its exercise of discretion under its environmental review policies upholds these high standards. Our comments below discuss steps EDC could take to enhance transparency.

Other observations

Disclosure is an essential element for a credible environmental review process

79. EDC acknowledges that disclosure of environmental information is emerging as an essential element of a credible environmental review process. Prior disclosure of information for projects with potentially significant environmental impacts (Category A projects) has, in recent years, become a regular policy in most export credit agencies we reviewed. It allows important information to be brought forward from other sources and taken into consideration in project review. In EDC's case, the information disclosed both prior to and after signing a transaction needs to enhance public trust in the manner in which it carries out its legislated duty to conduct environmental reviews.

80. Since our 2001 Report, EDC has developed a that includes EDC's commitment to disclose, with client consent, that it is considering support for a Category A project under its Directive.

81. EDC discloses environmental and individual transaction information on a voluntary basis with the consent of its clients. It is not legally obliged to provide information under access to information legislation. Nor does EDC's current disclosure policy fall under the same legal obligation as its Directive.

82. EDC must balance commercial competitiveness and client confidentiality with its need to demonstrate accountability and assure public confidence in the execution of its mandate. These considerations led EDC to include the following information for release under its prior disclosure policy: date of posting, country of the transaction, a general description of the project, the project name, the project sponsor, and the project contact.

83. EDC also took its client concerns about competitiveness into account and did not make consent for prior disclosure a precondition for EDC support. However, at the time it consulted on its draft policy, there was no information on the number of transactions to which this policy would apply.

84. To date, EDC has experienced few problems obtaining consent to disclose what has amounted to minimal information. From the time it came into effect until 31 December 2003, the prior disclosure policy has applied to eight completed Category A projects. Clients granted consent for disclosure in seven of those projects. EDC officials informed us that they received comments from the public on only one of those disclosures.

85. In our view, EDC needs to consider taking a leadership position in making prior disclosure a precondition of EDC support. This would demonstrate a greater commitment to transparency with limited effect on competitiveness in the few transactions to which it applies.

86. Additional disclosure. EDC released its first annual Chief Environmental Advisor's report on its Web site in September 2003. This report covers projects reviewed during 2002 and includes information on

• the number of projects in each category,
• the number of signed projects in each sector and in each region,
• the name and location of signed Category A projects, and
• whether EDC refused project proposals on environmental grounds during the same period.

This report provides information in addition to what EDC discloses under its policy. This initiative shows promise for greater commitment to transparency in EDC disclosure.

87. International standards. EDC responded to our 2001 recommendation to identify the standards it uses in its review of projects. Annex 5 of the Directive lists examples of internationally recognized good practices, standards, and guidelines to use as benchmarks in reviewing projects. The list gives EDC the flexibility to select the standard most appropriate for any project.

88. EDC does not disclose the standard that it uses for any particular project. Revealing the specific international standard upon which it has based its determination would give the public and Parliament a greater measure of confidence that EDC is applying appropriate standards when it supports exports.

89. At the time EDC adopted the prior disclosure component of its policy, it agreed to amend its individual transaction reporting to refer to the international standards that were met or exceeded for Category A projects. It did so by referring to the catalogue of standards from its "Illustrative list of internationally recognized good practices, standards and guidelines" (Annex 5 of the Directive). This list adds no new information to its disclosure efforts and does not identify the specific standards it has used in carrying out its environmental review for those projects.

90. Recommendation EDC should disclose the specific standards it used in carrying out its environmental review of Category A projects.

91. Evolving disclosure practices. EDC has undertaken to amend its disclosure policy as practices of other credit agencies evolve. We have noted the following enhanced disclosure practices among the agencies we reviewed:

• Prior notice period— The period for advance disclosure for export credit agencies varies from none to 45 days. This contrasts with 60 to 120 days for multilateral development banks. The OECD Common Approaches recommends that its members should seek to disclose environmental information about a Category A project 30 days before commitment.
• Information disclosed after signing— Some export credit agencies enhance transparency by releasing additional information on environmental reviews of projects after signing. This information can include
  • the standards used for evaluating high-risk projects;
  • a list of signed projects with their environmental categorization, published on a yearly or quarterly basis; and
  • reference to the mitigation measures and monitoring requirements for signed projects.

92. EDC is considering revisions to its prior disclosure policy to align with the OECD 30-day period. In our view, EDC needs to consider at the same time whether it wishes to keep pace in making other transparency enhancements to its policy.

93. Recommendation. EDC should amend its disclosure policy and practices to take into account evolving best practices and to enhance corporate transparency by

• at a minimum, reflecting the 30-day prior disclosure recommended in the OECD Common Approaches;
• listing all signed projects with their environmental categorization on a yearly basis; and
• indicating whether mitigation measures or monitoring requirements were imposed.

EDC's response to the recommendations in paragraphs 90 and 93. EDC ensures that it operates in accordance with the OECD Common Approaches and, as such, is already applying the 30-day prior disclosure provision recently added to the OECD's Common Approaches agreement. It is important to note that EDC was part of the initial group of export credit agencies that developed an ex-ante disclosure policy, and that EDC continues to support the inclusion of this element at the OECD level.

EDC will address the further recommendations by considering appropriate enhancements to the Chief Environmental Advisor's Annual Report among its options.

Project-related social impacts

94. The Directive looks at one aspect of social impacts: project-related social impacts. The Directive defines this as "any instance of involuntary resettlement or any other adverse change that the project imposes on indigenous or vulnerable groups or on cultural heritage." The Directive is not designed to address broader social aspects such as human rights and labour conventions. This is consistent with the approach of other export credit agencies.

95. The review of project-related social impacts under the Directive helps protect EDC's reputation from serious damage by guiding it away from supporting transactions that may bring public disapproval; for example, those allegedly involving human rights abuses. It is important that EDC meets the highest standards when it puts a Canadian face on exports.

96. EDC's environmental review policy is part of a larger suite of business ethics practices that EDC states are "integral to its processes when analyzing finance and insurance transactions." EDC has taken steps to enhance its ability to obtain and analyze relevant social information. It has a memorandum of understanding with Foreign Affairs Canada to share information on the human rights policies and records of various countries with EDC's Political Risk Assessment Department.

97. We found that EDC's Environmental Advisory Services team reviewed social assessment information for certain transactions; EDC's Political Risk Assessment Department dealt with human rights issues in other cases. However, the broad nature of social issues can make it difficult to determine where the responsibility lies to review these issues. EDC has no over-arching policy to co-ordinate the activities undertaken in its various departments to address broader social issues in a coherent fashion and to ensure that no significant risks are overlooked.

98. Recommendation. EDC should adopt a policy to ensure that risk analysis of the social impacts of transactions is co-ordinated among its various departments.

EDC's response. EDC believes that it is important to consider the environmental and related social effects of the projects it is asked to support. The Environmental Review Directive defines "environmental effect" as "any change in the environment, including any project-related social impact...". More specifically, the Directive reflects the precept of the OECD's Common Approaches agreement that "any instance of involuntary resettlement or any other adverse change that the project imposes on indigenous or vulnerable groups or on cultural heritage" comprises a potential "social impact" which might be caused by a project.

EDC considers human rights as a regular part of its due diligence, through mechanisms which are additional to those processes dedicated to environmental and social impact review. For example, exchanges between EDC and the Department of Foreign Affairs on human rights issues internationally are separate from the Directive and the mechanics are managed by country experts in EDC's Political Risk Assessment Department (PRAD). PRAD's assessments are documented in the Memorandum of Authorization required to proceed with transactions and are considered part of EDC's overall risk assessment process. As recommended by the Office of the Auditor General, EDC will review its current approach to ensure maximum efficiency in these mutually supportive processes.

Conclusion

99. We found that EDC's Environmental Review Directive and other environmental review processes contain most (34 of 37) elements of a suitably designed environmental review policy. EDC has designed its environmental review policies to be in line with the OECD Recommendation on Common Approaches on Environment and Officially Supported Export Credits.

100. We found that EDC has made major improvements to the manner in which it implemented its environmental review processes, including the Directive. Overall, we concluded that the Directive and other review processes were operating as designed.

101. EDC has built considerable discretion into its Directive and other environmental review processes. While we found EDC was careful in exercising its professional judgment, we noted areas for improvement in documenting how it exercises this discretion: analysis of environmental impact assessment reports and public consultation.

102. Increased expectations for greater accountability in both the private and public sectors impose on EDC a greater responsibility to demonstrate that it exercises its discretion wisely. In our view, the counterbalance to the broad discretion in EDC's environmental review policies is greater transparency. Although EDC filled some of the transparency gaps we noted previously, our Report recommends additional steps that EDC needs to take to enhance transparency and to assure Parliament and Canadians that EDC's environmental review processes uphold high standards of environmental protection and sustainable development.

103. In our last audit, we found that EDC was a leader among the G-8 export credit agencies in terms of environmental policies despite criticisms about lack of consultation or public disclosure. Today many other export credit agencies have caught up, particularly with respect to transparency aspects. In our view, EDC should decide whether it wishes to show leadership among export credit agencies by enhancing its Directive and other review processes.

EDC's overall response. EDC is pleased to receive the findings of the Office of the Auditor General's (OAG) Report, which acknowledge EDC's significant efforts and achievements in designing and implementing its Environmental Review Directive and associated processes. The key audit findings confirm both the suitability of the design of the Directive and associated processes and that these have been implemented as designed. The improvements noted in the findings have been achieved in a short period of only two years since the previous OAG audit in this area, attesting to EDC's commitment to environmental review, and its dedication to continually improve its practices.

EDC agrees with the OAG that EDC and other export credit agencies operate in a climate of escalating expectations regarding transparency, public trust, and accountability. It is equally true, however, that these agencies operate in a world of escalating global competition in which exporters and investors are demanding effective global trade tools and increasingly need a sophisticated suite of export development programs and risk management products. One of EDC's fundamental responsibilities in fulfilling its mandate is to strike a balance between the needs of Canada's exporters and the expectations that exist around environmental review.

With respect to international leadership, EDC believes that it continues to play a leading role among export credit agencies in many areas of environmental review and related disclosure practices. These are areas of rapid evolution, and in many areas international norms are still emerging. No single agency has established a leadership position on all of the many elements of environmental review. Moreover over the past few years, agencies have demonstrated their commitment to on-going co-operation and co-ordination at the OECD level to develop a consistent and appropriate global playing field for their respective exporters with respect to environmental review and disclosure. As the yardsticks continue to move, EDC is of the view that leadership is most appropriate in the context of the OECD discussions and that the Corporation should continue to play a leadership role in this forum.

The OAG's Report emphasizes the importance of accountability and transparency. EDC's Disclosure Policy has been effective in encouraging project sponsors to release environmental information on projects. Since the last OAG Report in 2001, EDC has created the position of Chief Environmental Advisor and a stand-alone Environmental Advisory Services Group with an extensive role in conducting environmental reviews and risk assessments and in identifying appropriate mitigation measures related to transactions for which EDC's support has been sought. The Chief Environmental Advisor also has a broader role in engaging with stakeholders and reports quarterly to the Audit Committee of the Board of Directors on various matters including specific transactions reviewed. Further, the Chief Environmental Advisor reports publicly through an annual report, which provides additional information on environmental review at EDC. Together with the reports by EDC's Compliance Officer to the Board of Directors and to the public on EDC's compliance with its environmental and disclosure policies, EDC has created regular channels for promoting accountability and transparency in these areas.

Given EDC's mandate to support and develop export trade, and the heightened public expectations around environmental review, EDC has regularly met with a range of stakeholders on environmental review matters. These stakeholders include exporters, business associations, and a broad range of non-governmental organizations interested in environmental and corporate social responsibility issues. These exchanges, along with the proactive dissemination of information on environmental and other corporate social responsibility practices, as well as active participation in conferences and forums focussing on these issues, round out EDC's approach to transparency of, and accountability on, its conduct.

About the Audit

Scope and approach

We used a two-phase approach similar to our 2001 audit of EDC's environmental review processes.

Design suitability. First, we looked at whether Export Development Canada's Environmental Review Directive and other review processes were suitably designed. We based our review on the criteria for a suitably designed environmental review process that we used for our 2001 audit. These criteria were developed using the following steps:

• We examined the findings from a study on the environmental and social requirements of international financial institutions carried out under the guidance of the World Bank Group's International Finance Corporation. Export credit agencies were among the 42 institutions that participated in this study, which defined minimum requirements of good practice that international financial institutions should adopt to ensure that the projects they support are environmentally and socially responsible. These minimum requirements correspond to the main elements of our audit criteria.
• We developed sub-elements based on our Office's 1998 audit of environmental assessment (May 1998 Report of the Commissioner of the Environment and Sustainable Development, Chapter 6, Environmental Assessment—A Critical Tool for Sustainable Development). The criteria we used in our 1998 audit defined good environmental assessment practice.
• We categorized our sub-elements into standard or emerging elements. Standard elements are used by a majority of institutions; emerging elements are used only by a minority of institutions. To validate our categorization, we examined the environmental review policies of several organizations, including the export credit agencies of Canada's main trade competitors. We focussed on documented policies but did not examine how they were put into practice.

We updated the information used in our previous benchmarking exercise by examining the most recent environmental review policies and procedures of 18 institutions, including export credit agencies that are EDC's competitors, multilateral and bilateral organizations engaged in international project support, and one Canadian and one foreign commercial bank with international lending practices. We used publicly available information for our work to compare policies. We are not in a position to verify the accuracy of this information nor to audit the application by other institutions of their environmental review policies.

To determine whether EDC's Environmental Review Directive and other environmental practices were suitably designed, we applied the standard elements as our audit criteria. We applied the emerging elements to indicate the steps EDC could take to strengthen its Directive and other environmental review processes.

Implementation. In the second phase, we assessed the extent to which the Directive and other procedures were implemented as designed. We developed a checklist of the key features of the Environmental Review Directive and other review processes used by EDC and applied it to a series of transactions reviewed by EDC during the period from 21 December 2001 to 31 December 2003 as follows:

• a sample of 11 (of 17) transactions classified as Category A, B, and C projects under the Environmental Review Directive;
• a sample of 8 (of 33) transactions classified as Category A and B projects that EDC reviewed under other environmental procedures;
• a sample of 21 (of over 3000) transactions not related to a project, with a focus on higher risk industrial sectors; and
• a sample of 10 (of 29) transactions subject to monitoring obligations.

We interviewed EDC staff and corporate officials, including financial services managers involved in the selected transactions, the Environmental Advisory Services team, and members of Internal Audit and Evaluation. We also interviewed clients of Export Development Canada as well as representatives from other export credit agencies and civil society organizations.

Audit team

Assistant Auditor General: Richard Flageole
Commissioner of the Environment and Sustainable Development: Johanne Gélinas
Principal: Stuart Barr
Director: Darlene Pearson

Pierre Fréchette

For more information, please contact Communications at (613) 995-3708 or
1-888-761-5953 (toll-free).

Definitions:

Civil society groups—Non-profit associations that operate independent of the government. They can include universities, environmental movements, indigenous peoples' groups, communities and trade unions. (Back)

Terms used in EDC's Environmental Review Directive:

Financing transaction—Can include a loan, a purchase of receivables, a lease, or a financing guarantee entered into by EDC.
Political risk insurance transaction—Insurance coverage to protect against political risks such as foreign exchange transfer difficulties, expropriation by a host government, or war, revolution, and insurrection.
Equity transaction—The acquisition by EDC of an interest in an entity, other than by way of the taking or realization of security.
SDR—Special drawing rights, which is an artificial currency unit defined as a basket of national currencies established by the International Monetary Fund. (Back)

Greenfield—A site on which there is no previous development. (Back)