INTEGRITY DUE DILIGENCE GUIDELINES FOR LENDING TRANSACTIONS

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1 INTEGRITY DUE DILIGENCE GUIDELINES FOR LENDING TRANSACTIONS Introduction The Bank's mandate is to promote sustainable growth of its member countries by providing longterm financing to projects that strengthen the competitiveness and enhance the environment. As part of sustainability the Bank puts great emphasis on integrity and good governance. All the Bank's lending must be done applying sound banking principles. This way the Bank can also protect its reputation. Developments in the corporate sector in the early 2000's and more recently in the financial sector show the severe consequences non-compliance, poor governance and lack of transparency may have on the market. In the global environment the incidents have effects far beyond the places where they originally occur or are detected. The International Financial Institutions (IFIs), among them NIB, have already for many years addressed issues relating to fraud, corruption, money laundering and counter terrorist financing. They have stated that corruption is one of the major factors undermining sustainable growth and a serious obstacle to reduce poverty. In 2000 NIB approved its first resolution on anti-corruption which has been updated several times to bring it in line with market standards and the practice of other IFIs. The joint actions by the IFIs to combat fraud and corruption are set forth in a Uniform Framework for Preventing and Combating Fraud and Corruption (IFI-Framework) which NIB has also endorsed. The IFI -Framework calls for harmonised definitions of fraudulent and corrupt practices which are included in the Bank's policies and implemented in, or referred to, the Bank's loan documents. The IFI-Framework also sets out recommendations on general principles to guide in analysing integrity issues in lending and investment decisions. The IFI-Framework recommends the following general principles for IDD: adequate "know your customer" procedures to ensure identification of beneficial ownership close scrutiny of o parties convicted of or under investigation for serious crimes and sanctioned by regulatory body or appearing on recognised sanctions list o parties subject to civil litigation concerning allegations of financial misconduct o Politically Exposed Persons (PEPs) consistent with FATF-recommendations 1 identification of mitigants and enforcement of covenants that address integrity risks ongoing monitoring of integrity risks through portfolio management With reference to the Uniform Framework and other market standard and practices 2 and as part of its efforts to promote sustainability and compliance, the Bank has decided to embark on a consistent process to assess integrity matters in relation to its lending in formalising an Integrity Due Diligence Process (IDD-Process). 1 Financial Action Task Force Recommendations 2003/ Examples of market standards are Directive 2005/60/EC, FATF Recommendations 2003/2004, FSA Review of private banks' anti-money laundering systems and controls, Basel Committee on Banking Supervision: Customer Due Diligence for Banks, UN and EU Sanction Lists and the policies and practices of other IFIs. 1

2 From June 2014 the Integrity Due Diligence Guidelines have included a Non-Compliant Jurisdictions Policy (NCJ-Policy). The NCJ-Policy establishes the Bank s standpoint towards Non- Compliant Jurisdictions (NCJs). Objectives The IDD-process will not secure elimination of fraudulent behaviour and corrupt practices or integrity risk in the Bank's operations, nor will it safe-guard the reputation of the Bank in all circumstances. However, the IDD-process consistently applied will raise the awareness among staff and the Bank's customers about the importance of these issues and contribute to the Bank's commitment and accountability to its shareholders and other stakeholders. The IDD guidelines will help the persons responsible to carry out the IDD in providing guidance on principles to be applied in the process. The process itself is further described in detail in the IDDprocedures and the questionnaires or check-lists. The aim is to ensure conformity and consistency and the guidelines and procedures will hopefully facilitate and expedite the whole IDD-process. However, in addition, sound judgment and full disclosure of integrity issues are required. Also a project with integrity concerns can be financed if the integrity risk can be mitigated to an acceptable level in particular when the mandate impact is high or the Bank's participation can contribute to improved governance and transparency. The IDD-process is designed to be an integral part of the credit process. The Originator as leader of the transaction team will be responsible for the carrying out of the IDD. The transaction teams are best suited for this since they are familiar with the Clients and are in close contact with them on a continuous basis. Save for the persons mentioned in the IDD-procedures and assistance with information services, involvement of other persons will be limited as integrity issues often are sensitive and the Bank has committed itself to protect bank secrecy and to maintain confidentiality at all levels to protect the Client and the project under consideration. Although high integrity risk may cause financial loss, the main objective is to protect the Bank from loss of reputation. Therefore it is paramount that the integrity risks are assessed and dealt with as early as possible in the project cycle and the credit process. Guidelines Scope of the IDD The scope of the IDD will depend on the type of Client and of the project to be financed. The procedure should be targeted at least on the Borrower and the Guarantor in the private sector, in the public sector mainly on the implementing agency. For public sector entities a due diligence evidencing that the procurement process is in accordance with NIB's Procurement Policy must be performed. In complex, structured project finance cases, in certain business sectors and in cases where enhanced IDD is required, the IDD may, as deemed appropriate, be extended also to main beneficiaries, licensors and agents as the case may be. The IDD-questionnaire's definition of Client covers the shareholders, board members and senior management in general and all the other parties mentioned above as applicable. 2

3 The IDD includes the screening of Clients for NCJ-links. How much time and resources, i.e. how deep and broad, the IDD needs to be will depend in particular on how well the Client is known by the transaction team. If well known, the IDD may be performed without resorting to any research with external sources of information. However, this can in practice only be applied for counterparties within the member countries. The IDD will be depend also upon the complexity of the transaction and various parties involved, where the transaction is carried out, upon the business sector and finally upon the findings when filling in the questionnaire, i.e. are there any red flags requiring further checking and perhaps engaging an external investigator. If a Client is following acknowledged corporate governance codes, supervised by a competent entity, the process will normally not require any checking in depth. Listed companies within the Bank's member countries are for instance subject to such supervision, even if standards still might vary somewhat between the countries. If the Client is a Financial Intermediary (FI), the Bank has to make sure that the FI also applies prudent KYC - principles and procedures to detect any fraudulent or corrupt behaviour among its clients and in particular that it has relevant and sufficient controls to prevent money laundering and to suppress terrorist financing Sources & Tools for IDD-process Besides the team's own previous knowledge of the Client and acquired information during the transaction's early evaluation process, information important for the IDD can be sought directly from the Client, from freely available "search engines" on the internet and, additionally from a number of internet information services NIB is subscribing to. The list of such services and persons designated to have access to such information is attached to the IDD-procedures. In some cases the Bank may decide to use the services of external investigators. See further the IDD-procedures. In order to help the transaction team in performing a structured and coherent IDD, two questionnaires have been developed, one general to be filled in for all transactions and, in addition, one to be filled in by FIs. They are both annexed to the IDD-procedures. Basic prerequisites for lending The four basic principles presented below would normally be cases where the Bank has to abstain from lending and they would thereby constitute project blockers. 1. The Bank will not lend if it does not know who the beneficial owner is It is important that the Bank has knowledge of all shareholders, including beneficial owners 3, of the Client who are able to exercise substantial control or influence. The Bank will usually not proceed with a transaction if the beneficial owner is not known. 3 Beneficial owner refers to specific rights ("use and title") in equity belonging to a person even though the legal title of the property belongs to another person. For more guidance see Directive 2005/60/EC 3

4 Through applying pertinent KYC - principles (Know Your Customer) preferably before starting to analyse any transaction, the Bank should satisfy itself as to the identity of the beneficial owner and in some cases also from where the source of wealth is derived. This is also a way for the Bank to promote transparency of ownership and control. 2. The Bank will normally not engage in transactions involving individual and legal persons convicted of, or under investigation for, a serious criminal offence. If investigations are on-going, the Bank should try to postpone its involvement until the investigations are concluded. The principle applies also to persons who have been found, or charged with, having violated UN sanctions. Although court proceedings and convictions in certain jurisdictions might be politically motivated, the Bank may still in these cases be subject to substantial reputational risk. Therefore the Bank should exercise particular care if it proceeds with the transaction in question. 3. The Bank will as a rule not lend to a Client currently on any recognised black list There are a number of widely recognised black-lists 4 of which the UN is perhaps the most important to check. The easiest way to check these lists is through the internet based information sources that the Bank is subscribing to. In line with the NCJ-Policy the bank will not lend to a Client incorporated in a black listed jurisdiction or if a controlling owner is incorporated in a black listed jurisdiction as defined in the NCJ-Policy. 4. The Bank will not lend to a Client with evident links to organised crime The ties and connections with organised crime, save for convictions, are often difficult to establish with certainty. Credible evidence includes information provided by several independent sources. A mitigating factor could be that the links relate to a time well in the past and no credible evidence of continuous activity has been provided. Enhanced IDD and Red Flags Certain circumstances as the ones listed below would constitute red flags in the questionnaire and hence be subject to enhanced IDD. In these cases the transaction can go forward if mitigating factors and measures are presented to the satisfaction of the Credit Committee. 1. Transactions involving Politically Exposed Persons (PEPs) 5 As is imminent from the definition mostly prudent persons are among PEPs. In relation to transactions they nevertheless comprise of persons who are in a position where they may exert undue influence on decision-making and have access to state funds. They may also be vulnerable in 4 UN Security Council, US Dept. of Treasury, FBI, financial market regulators such as SEC, FSA, OFAC, Central Banks, EU Travel Ban, World Bank, Interpol 5 Politically Exposed Persons means natural persons who are or have been entrusted with prominent public functions and immediate family members, or persons known to be close associates with such persons. (EU-directive). Examples include Central and local government officials, MPs senior executives of state owned enterprises and of international organisations and high ranking political party officials. 4

5 a situation of regime change. Therefore enhanced due diligence should be carried out and disclosure of the existence of PEPs should be made to Credit Committee. 2. Transactions involving extractive industries and real estate Industries and business sectors which rely on licenses or permits are particularly vulnerable to corrupt practices and would therefore warrant enhanced due diligence. 3. Abuse of generally accepted corporate governance practices Examples of this would include asset stripping, forced bankruptcies, hostile take-over practices or abuse of minority shareholders rights. 4. The use of unnecessarily complicated company structures, NCJs and off-shore vehicles. Special attention should be paid in these circumstances as the reasons might be unacceptable business practices or tax evasion. It is often difficult to determine if a tax practice is considered illegal tax evasion or fraud or merely tax mitigation or avoidance of tax. However, transactions which are clearly tax driven or involve tax havens should be assessed more in detail in relation to local tax laws and the business purpose of the transaction. Mitigating factors and measures In many cases the existence of a red flag or other serious integrity concern would not in itself prevent the Bank from engaging in a transaction. It is expected that when integrity issues are revealed and disclosed also mitigating factors are identified and measures recommended. Some examples of mitigating factors would include Ability to undertake reforms Time Track record Sound management Mitigating measures could be included in the documentation as conditions precedent to disbursement or as covenants to properly reflect the level of risk. In appropriate cases, a special communication strategy could be considered. Follow-up Integrity issues should be considered at all times not only when financing is decided upon. The IFI- Framework also calls for on-going monitoring of integrity risks in the loan portfolio. When particular covenants are included, they should be monitored but in addition, the regular review of the transaction should include also matters of integrity in particular on loans which are otherwise subject to closer follow-up. 5