The role of private debt in sustainable infrastructure
Sponsored commentary from Macquarie
Infrastructure represents $1.1 trillion of the annual investment required to address the UN Sustainable Development Goals (SDGs), according to the McKinsey Global Institute, making sustainable infrastructure one of the most important components in addressing the challenges and risks posed by climate change. Dillon Anderiesz from Macquarie Infrastructure Debt Investment Solutions (MIDIS) explores the role of private capital in infrastructure and how infrastructure debt is poised to be an important part of the solution.
In his 2015 speech “Breaking the Tragedy of the Horizon – Climate Change and Financial Stability”, Bank of England Governor Mark Carney explained that since the true cost of climate change will be imposed on future generations, the current generation has no direct incentive to fix it. He also added, “Once climate change becomes a defining issue for financial stability, it may already be too late”.
There are some institutions led by managers who have an interest, or a fiduciary mandate, to manage capital with a long-term investment horizon. These investors have recognised the role of private capital to preserve the health and stability of financial mar- kets and the potential impacts of climate change on society. Investors have also realised that asset classes like sustainable infrastructure meet return targets and are more resilient to the impacts of climate change.
In a recent letter, 95 investors overseeing more than $11 trillion of assets urged European utilities to set timelines for eliminating coal-fired generation in the EU and industrialised nations. Similarly, a $2 trillion investor-led initiative including the Church of England Pensions Board and Swedish Pension Fund AP7, urged 55 high-carbon European companies to better align their lobbying stance with the goals of the Paris Agreement. Both examples illustrate that environmental, social and governance (ESG) considerations and sustainable investing are high on the agenda for some of the world’s largest investors.
More recently, governments and regulators have also been responding to the challenge. Numerous consultation papers and reports have been published on these topics by the Financial Conduct Authority, EU High-Level Expert Group (HLEG) on Sustainable Finance and the Bank of England alongside several others, with the intention of providing solutions to some of the challenges of investing in solutions for climate change.
The role of infrastructure debt
At its core, infrastructure provides essential services supporting the community and has a long operational life. As a result of the stable cash flows and historically high recovery rates in the rare instances of default, infrastructure assets can typically support significant amounts of debt - often more than 75 per cent of the project capital.
In a report published by New Climate Economy “Better Growth, Better Climate”, it estimated that from 2015-30, the projected global demand required for infrastructure would be $89 trillion. An additional $8.8 trillion of investment in low carbon technology and energy efficiency is required to meet the 2°C, goal of the 2015 Paris Accord. If we assume that projected demand is met with 75 per cent debt, infrastructure debt represents nearly a $75 trillion-dollar opportunity. Within this enormous demand, McKinsey define sustainable infrastructure as any infrastructure asset that is socially inclusive, low carbon and climate resilient.
There are several characteristics of infrastructure debt which make it an appealing asset class for investors seeking opportunities to make a positive contribution to the environment. These include the size of the opportunity, visibility of the use of proceeds, measurement of impacts and the ability to incorporate ESG factors in risk management.
Offshore Wind Project
Offshore Wind Farms have positive environmental impacts when compared to fossil fuels-based energy production. The example below outlines the considerations and highlights the difference between ESG risk management and tracking proactive sustainability outcomes in the context of the UN SDGs.
An analysis of ESG risks goes beyond what is immediately apparent. The project might be assessed as a Category B project under the Equator Principles but our review would ad- dress a wide range of considerations including (but not limited to):
- the contractors’ compliance with welfare, health and safety standards and other regulatory requirements
- the reputation of the parties involved, including financial and tax history
- the impact on the marine environment and any disruptions to migration pattern and aquatic habitats, which is typically captured in compliance with licenses and permits
Direct engagement with borrowers as well as with technical, legal, financial and insurance consultants enables us as an asset manager to identify and appropriately mitigate a wide range of risks, including ESG risks, prior to in- vestment.
The GIG have indicated how an offshore wind project has the potential to contribute to the following SDGs:
- Reduction of harmful air pollutants (e.g. NOx, SOx and particulate matter) through the avoidance of fossil fuels combustion to generate electricity.
- Provision of electricity generation from a renewable source.
- Development of sustainable and resilient infrastructure.
- Efficient use of natural resources through the avoidance of fossil fuels consumption to generate electricity.
- Improves human and institutional capacity on climate change mitigation
ESG and sustainability in the investment process
Understanding the ESG and sustainability profile of investments and their relationship to fiduciary duties is becoming increasingly topical, not least prompted by the EC Action Plan on Sustainable Finance and the IORP II Directive in Europe. Sustainability-orient- ed investors look for projects with
- direct visibility on the use of proceeds,
- access to due diligence reports on salient ESG issues,
- ongoing transparency and reporting on non-financial elements of project operations, and the opportunity to negotiate directly with the borrower,
- detailed information including due diligence reports on a range of ESG risks and identify positive ESG outcomes.
It is important that lenders have ongoing engagement and dialogue with asset owners throughout the investment lifecycle. There will undoubtedly be developments in ESG considerations as the knowledge and understanding of these factors by investors and operators matures. In the context of long dated loans, managers need to make sure that they have terms in the loan agreements which provides reporting to investors and the rights to take action when necessary. This is enhanced by close relation- ships with the borrower and with sponsors.
The importance of measurement
The ability to measure sustainability performance is considerable as both measurement and taxonomy are high on the agenda of regulators seeking to en- able investment in combating climate change. This is important as there are challenges relating to accepted definitions, consistency and comparability of standards.
There is no shortage of frameworks for assessing the sustainability qualities and risks associated with investments. From the Green Bond and Green Loan Principles, UN SDGs, and recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), to Impact Management Project (IMP) and GIIN’s IRIS, these frameworks each offer something different and are often complementary. Perhaps the most recognisable of these, the SDGs has been increasing in popularity with managers as a way of targeting sustainable investments and tracking non-financial impacts. Macquarie’s Green Investment Group (GIG) also offer a proprietary Green Impact Reporting service to demonstrate how climate investments are aligned with decarbonisation objectives and SDGs. The approach is based on the harmonised carbon accounting framework developed in partnership with development banks including International Finance Corporation (IFC), European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB).
This document has been prepared solely for general information purposes. It should not be construed as investment advice nor an offer or recommendation to buy/sell any securities or to participate in any investment strategy.
In early 2012 Macquarie established the Macquarie Infrastructure Debt Investment Solutions (MIDIS) platform to leverage the infrastructure expertise within Macquarie into an investor-aligned global infrastructure debt investment management business. The MIDIS platform has been successful in securing mandates with insurer and pension scheme clients.
Across the portfolio, MIDIS has invested over €1.8 billion in renewable energy and over €600 million in social infrastructure which have contributed towards the generation of over 6GW of renewable energy, financing over 5,000 hospital beds, 25,000 affordable housing units and providing over 140,000 students with school facilities.