Legg Mason Investment Counsel - Going For the Gold: Best Practices in Project Development

Social Research Reporter
Monthly commentary from our Social Research Analysts November-December 2012 

Imagine thousands of men, women and children gathered around a lake on open grassland.  It’s a warm day:  the sun is high, the wind is blowing.  In the background, are construction vehicles – backhoes, large dump trucks, and stacks of chain link fencing waiting to go up.  Some of the people are holding signs, some are just raising their arms, but they are all shouting: “Stop this Project! Save our water!”  Off to the side, armed security guards and anti-riot police are standing ready to open fire.  What may have been a peaceful protest could now turn violent at any moment.

This scenario is an example of the conflict that often surrounds the development and operation of extractive resource or resource-intensive projects.  While the global population grows and becomes wealthier, the planet’s natural resources continue to present constraints.  Companies have picked the low-hanging fruit – now, around the world, companies are seeking to exploit areas that are more remote or which contain resources that are more difficult to extract in order to meet the growing demand.  Countries with resources but limited economies are seeking companies to help their people benefit from the inherent values of the resources.  However, in these cases, the potential impacts on the environment and local communities tend to be relatively greater, and therefore, the center of public concerns.  The potential for conflict is real when different stakeholders’ interests collide:  community, company, government – where does the power lay?

The controversies that companies face present tangible financial and reputational risks.  To minimize those risks, special interest groups, responsible investors, and multilateral development agencies have been advocating that companies obtain the Free, Prior and Informed Consent (FPIC) of local communities in order to minimize the impacts that their operations have on the lands and lifestyles of the people living nearby.  Considered to be the gold standard, FPIC seeks to ensure that communities have a meaningful role in evaluating development projects and benefit from project-related activities that may help them fulfill their aspirations for economic and social development.

At its core, FPIC is a process through which communities are allowed the right to accept or reject a project.  Further, the process aids the company in question in obtaining legitimacy and support for a project thereby reducing the risks involved.  FPIC goes beyond typical consultation or community outreach.  Specific tenets of the process are crucial to implementation.  Firstly, the process of engaging relevant stakeholders must be free of coercion, intimidation, and manipulation.  In order for community consent for a project to be real, that consent must be sought early on, before the project becomes an economic or political inevitability.  All parties must be adequately informed about the project, including the potential risks and consequences, in a timely manner.  This means that the information must be in a form and language that the communities understand.  Further, they must have the legal and technical expertise to understand all of the implications.  Finally, to obtain consent, communities must be allowed to make decisions in their own time according to their own decision-making process.  Consent can only be achieved after meaningful participation in all aspects of the project.

“Circumstances Requiring Free, Prior, and Informed Consent…If the client proposes to locate a project on, or commercially develop natural resources on lands traditionally owned by, or under the customary use of, Indigenous Peoples, and adverse impacts can be expected…”
Source:  Standard #7 of the International Finance Corporation’s Performance Standards on Environmental and Social Sustainability, Effective January 1, 2012

Even with this guidance, challenges remain.  For example:  How do you determine the communities from which you need consent?  The obvious answer is those communities that are living near the project or on the land where the project will be constructed.  There could, however, be other communities that are located further downstream from the project that would be affected by it.  Which individual(s) in any given community can give consent and on behalf of whom?  Determining who speaks for a community that has a complex mix of multiple leaders with varying degrees of official authority and money, and, subgroups with conflicting interests, can be tough.  How do you know when consent has been given?  Unfortunately, there is no broad agreement on what consent looks like or means.  When should you seek consent?  There is no agreed upon time; however, given the significant amount of time and money that is often invested at the exploration stage, many believe it should occur prior to exploration.  These activities also have the potential to negatively impact the environment and local communities.  Can the consent be taken away?  FPIC is not a one-time seal of approval, but, rather, a dynamic process which occurs throughout a project’s lifetime.  It is important for a company to maintain community support; failure to include the affected communities in decision-making and in the benefits throughout the project could impact relations and lead to actions that block or shut down the company’s operations.

FPIC is a best practice for the sustainable development of any oil, gas, or mining project.  While companies are encouraged to implement this principle for all extractive projects, FPIC has already been recognized as a right for Indigenous People by the International Labor Organization (ILO), the Inter-American Court of Human Rights, and the United Nations (UN).  The concept continues to gain momentum.  Earlier this year, the International Finance Committee (IFC), the World Bank’s private sector lending arm and the largest global development institution focused on the private sector in the developing world, strengthened its sustainability framework to require that companies obtain the FPIC of indigenous communities as a condition for receiving financing.  The principles of FPIC are also being recognized by development agencies like the International Fund for Agricultural Development, and by industry bodies, such as the Round Table for Sustainable Palm Oil (RSPO) and, to some extent, the International Council on Mining and Metals (ICMM).

Many social investors believe companies have a moral obligation to respect the rights of the people living in the communities surrounding their operations.  It is also argued that respect for communities makes good business sense and is necessary to reduce the risks of a project.  Companies operating without FPIC are subject to a number of risks including operational delays due to road blockades, legal actions, or permit appeals, increased security costs due to vandalism and threats to employees, and lawsuits for alleged complicity in human rights violations.  All of these affect a company’s reputation and its access to business partners and financing.  Many extractive projects take place in countries that lack the strong institutions and governance systems needed to ensure that they do not adversely affect local communities and the environment.  Companies cannot rely on governments to protect the rights of the local people or the environment.  In order for companies to fulfill their obligation to respect rights and minimize risk, they need to have strong policies and programs in place that allow them to identify, prevent and address the adverse human rights impacts of their operations.

Many companies have made some type of commitment to securing community support in advance of launching projects.  However, despite the strong business case for implementing FPIC, some companies have been reluctant to fully commit to it.  One reason is that communities can reject a project that has the potential to be very profitable for the company.  The process also requires a significant investment of time, which could delay the project longer than the company would like.  The challenges and uncertainties surrounding the implementation of FPIC have also contributed to companies’ lack of full commitment.  However, it has been suggested that the benefits associated with adopting a FPIC policy may outweigh the challenges of securing consent.

Consider the opening scenario.  It is easy to see how the company could continue to face protests; perhaps those would even lead to a shutdown of the company’s operations.  Any action by the security guards could cause more problems and result in legal action.  People all over the world will hear about the protests and the company’s business and reputation will suffer.  The impacts could be great.  Might FPIC make a difference?

Legg Mason Investment Counsel                                                                                     www.lmicglobal.com/sri

The views expressed are subject to change and do not necessarily reflect the views of all Legg Mason Investment Counsel personnel.  Any mention of a company or sector should not be construed as investment advice and should not serve as the sole basis for an investment decision.  Any data cited have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed.