Schydlowsky Not Your Problem?

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FUTURE OF FINANCE 2018

Not your problem?
Why you neglect socio-economic risks at your own peril

Prof. Daniel Schydlowsky | CEO, Boston Developing Economies, Ltd.

Prior to his current position, Daniel Schydlowsky spent four years as Banks superintendent for Peru. That experience left him convinced that banks must better recognize and quantify the true costs of socio-environmental conflicts. With partners, they can develop more effective frameworks to minimise and deal with them.

The very first day Daniel Schydlowsky began his new role in Peru, he was confronted by what he describes as ‘mayhem’. Farmers and other locals rose up in protest against the Conga mining project, concerned about its perceived impact on the local water supply and ecosystem. The president gave the armed forces temporary extra powers; the conflict led to ministers resigning and several deaths. What you might call a lose-lose situation.

Dr. Schydlowsky then puts up a map showing the huge numbers of E&S-related conflicts worldwide. These include many biomass conflicts, not an industry you’d expect to trigger much controversy, and even protests in more authoritarian states. His message: this not only can, but does happen pretty much everywhere, and it can happen to your project, too.


Use your nose

Schydlowsky says in the absence of any scientific tools for predicting such conflicts, you have to use your nose. Be sensitive and empathetic to how communities are likely to feel about a project. He cites an excavation project where 1,000 employees and their families were due to move into the local town of only 15,000. That’s likely to worry the locals.

Fears arise particularly when worry is about something unspecified which means, argues Schydlowsky, transparency helps. If you know what’s coming, you can think about how you’re going to deal with it, which immediately moves most people into a more constructive mindset. But there will still be different reactions. On the one hand, a project brings change, which many don’t welcome; on the other, it brings likely prosperity. That mix of emotions and views is also a cocktail for local instability.

Also look at that bigger picture. While irrigation projects produce gains where they’re carried out, they often raise the water table lower down the valley, creating problems for those communities. There are also what Schydlowsky calls waves of conviction, as projects go through different phases, politicians enter and leave office, etcetera. Keep that nose fine-tuned.


The hidden hand

The cynic might at this point ask: why bother? Schydlowsky’s answer is simple: risk.

First, don’t be complacent about government’s ability to deal with a conflict effectively. If things start to go wrong, the costs of neglect hit the project itself, the financiers and third parties. And as Schydlowsky wryly observes, when multiple debtors have problems, it becomes the problem of the creditors.

Investors tend not to centralise a project’s various costs of neglect, which are spread through various departments and costs centres. As a result, Schydlowsky says, the hiding hand principle comes into play: what you don’t know doesn’t get calculated and costs are ignored. In a socio-environmental project, these include the macroeconomic costs to the country in terms of increased debt, and loss of equity and tax revenue. Banks don’t tabulate provisions made against losses. And, of course, there are the hidden losses to local MSMEs.

For a financier, says Schydlowsky, the risks are very real. Be aware of them and work with your operating companies to make sure they are aware of them, too. You need to formalize how you measure socio-environmental costs, counting both costs incurred and costs avoided (including, in both cases, reputational cost). Provisioning effectively says that you accept the costs but that, says Schydlowsky, is something you don’t want to do.

Equator principle with teeth

For the financial regulator there are challenges. It’s very difficult to predict contagion, when and where anger is going to suddenly spring up about a project. What you need, argues Schydlowsky, is equator principles with teeth – that is, compulsory.  That way everyone has to abide by the rules and you have a level playing field. Moreover, when something is compulsory banks know where they stand, and certainty is something which helps everyone feel more comfortable.

Schydlowsky closes by saying Peru is the only country in the world to make the Equator Principles compulsory. In the three years since there have been no conflicts. That may be a coincidence, Daniel Schydlowsky acknowledges with a grin; but then again, it may not.