Infrastructure investors making ESG a priority

Growing awareness of responsible investing, which considers environmental, social and governance factors, has transformed the conversation in the infrastructure sector

Environmental, social and governance (ESG) factors exist to make the job of the responsible investor easy, in theory. The reality, for infrastructure, is less simple.

ESG is not a number, it is a living, breathing process to influence tangible change for the better, while reducing risk and achieving sustainable financial gains

Rising uptake of ESG means infrastructure is increasingly required to consider the context in which it operates, says Professor David Hart, director of sustainable energy specialists E4tech.

“The sector is having to take account of its own ESG priorities, as well as those of others, as it provides infrastructure to support initiatives which meet wider goals,” he says.

ESG is the new normal for the responsible investor

Investment is also gearing up, says Tim Clare, ESG director at Anthesis Group. “As with wider private equity, infrastructure funds are starting to put in place internal ESG teams, policies and procedures, set meaningful management and improvement key performance indicators at asset level, and beginning to report. GRESB [global real estate sustainability benchmark], in particular, is driving action,” he says.

GRESB assesses ESG performance. Its data and analytical tools are used by more than 75 institutional investors, collectively representing over $18 trillion in capital. In 2018, GRESB assessed 903 real estate funds and property companies, 75 infrastructure funds, 280 infrastructure assets and 25 debt portfolios.

ESG is effectively the new normal, says Marissa Szczepaniak, investment director at Vantage Infrastructure. “Growing awareness has completely changed the conversation in the infrastructure community,” she says. “Nowadays, investors expect integration of ESG.”

For the responsible investor, Environmental, social and governance (ESG) factors with long-term liabilities. There is a natural fit with ESG factors, focused on returns over time, as well as alignment on reputational risk.

So a nationally critical infrastructure asset that scored poorly on ESG might still secure funding, but come with conditions attached, says Ms Szczepaniak. “The responsible investor would need to have a clear ESG turnaround plan, to optimise it for current and future customers,” she says. “Continued poor performance would attract public scrutiny and lead to ever-increasing fines, decreased subsidies, early retirement or even public ownership.”

It pays to get ESG management right

The consequences of getting it wrong can be serious, even fatal, says Emma Arnold, technical director of environmental due diligence at WYG. “Poor management of ESG in capital projects is a major reputational and financial risk. It can mean projects getting delayed or even not getting off the ground,” she says.

The responsible investor also makes demands of fund managers, adds Mr Clare. “Poorly performing funds are going to have to work harder, although ultimately there is still a lot of cash needing a home,” he says. “Vital infrastructure will get funding, but marginal schemes, particularly in democracies with heightened environmental and social concerns, will increasingly struggle.”

The responsible investor is not short of infrastructure options. The World Bank Beyond the Gap report estimates investments of 4.5 per cent of gross domestic product will enable developing countries to achieve their infrastructure-related sustainable development goals. Identifying a huge global infrastructure gap, the bank issues the stark reminder that 940 million people still live without electricity, 663 million lack improved drinking water, 2.4 billion need improved sanitation, one billion live more than two kilometres from an all-season road and four billion have no internet.

Development finance institutions can, however, lend concessional capital to infrastructure projects in non-Organisation for Economic Co-operation Development countries at interest rates well below the usual. Such cut-rate financing has potential to substantially speed renewable-energy transition in developing economies, for instance, according to Bloomberg New Energy Finance, reporting for the $5.4-billion Clean Technology Fund.

Regulation and standards make projects attractive to responsible investor

On environmental issues, of course, the carrots and sticks of policy, regulation and standards are nothing new for infrastructure players.

In 2013, the UK Treasury published an Infrastructure Carbon Review, recognising the opportunity for value-chain participants to co-operate on low-carbon development. To help turn aspiration into reality, the PAS 2080:2016 standard, a consultative document based on the British Standard model, was then commissioned, explains Guy Thompson, head of architecture, housing and sustainability at MPA (Mineral Products Association) The Concrete Centre.

“This PAS promotes reduced carbon, reduced-cost infrastructure delivery, more collaborative ways of working and a culture of challenge essential for innovation. It includes requirements for all value-chain members to show leadership and establish effective governance systems for reducing whole-life carbon,” he says.

Greater awareness still needed around ESG

With the social dimension coming more to the fore, though, ESG is emerging in a new light, beyond mere compliance, as a value-generative way to win projects. The primary reasons are twofold, argues Adrian Walker, infrastructure partner at law firm Hogan Lovells and head of its Business Integrity Group. “On the one hand, you have public sector procurement law focused on social value and ESG, which is going to cross-fertilise by jurisdiction and into the private sector,” he says.

“Then you also have the multi-trillion-dollar flight of private equity and funds to ESG, which is lowering the cost of capital with a deeper liquidity pool. So ESG is going to be key in price competition, too.”

The issue for infrastructure, however, is understanding what actually constitutes ESG in practice, argues Ms Arnold. “There is still very little awareness and much confusion about ESG across the sector,” she says. “Asset managers are continually asked for conflicting sets of data from investors and ratings agencies are increasingly trying to shoehorn ESG into a metric.”

Ultimately, ESG must not become a tick-box exercise or greenwash. Ms Arnold concludes: “ESG is not a number, it is a living, breathing process to influence tangible change for the better, while reducing risk and achieving sustainable financial gains.”