BNP Paribas on why now is the time to step up on sustainability

With governments cash-strapped as a result of the pandemic, private capital must play a pivotal role in creating a more sustainable future, says Stéphanie Passet, investment director at BNP Paribas Asset Management.

This article is sponsored by BNP Paribas Asset Management

How has the global focus on sustainability changed over the past 18 months and what has been driving that?

Stéphanie Passet
Stéphanie Passet

Sustainability and the energy transition have certainly remained at the forefront of government and public agendas, despite the pandemic. This is particularly true in Europe. It is also true that we’re seeing an increasing emphasis on ESG from institutional investors.

In addition to a long-term trend that has seen investors ever more focused on driving sustainability, an evolving regulatory framework, particularly with the EU Sustainable Financial Disclosure Regulation and the EU taxonomy, has accelerated that journey over the past 18 months.

That regulation represents a new challenge for the industry because it impacts institutional investors in multiple ways, from the selection of assets through to reporting.

Governments are unable to foot the ESG bill themselves. What does this mean in terms of how sustainability goals will be financed?

Public spending is primarily being targeted towards public health at the moment – coping with the pandemic and supporting the subsequent recovery. The government purse cannot be infinitely extended, so the private sector is having to take up the baton in the mission to create a more sustainable world.

An increasing proportion of infrastructure funds will need to be dedicated towards supporting ESG and sustainability goals and private markets will need to co-operate with government regimes if we are to meet 2050 targets.

The most explicit form of that co-operation we’ve seen, historically, involves PPPs, which have been in decline in many markets. Do you expect to see a resurgence in those structures?

No, I don’t think so. The role of government will be to provide the necessary regulatory support or subsidies that will act as a catalyst for private capital, which can then take over. So, private capital will serve to leverage public funds, rather than through PPPs.

What opportunities is this creating on the debt side, particularly in terms of investment in renewables?

Climate change awareness is certainly supporting the development of low-impact energy production based on renewable energy technologies, especially in Europe, where renewable energy accounted for around 34 percent of total generation in 2019. Meanwhile, although the US has lagged other countries in this transition, there are positive signs ahead with the Biden administration announcing a $2.25 billion infrastructure plan to focus on green energy and decarbonisation.

Therefore, the traditional renewables sector – solar and wind – is continuing to develop rapidly, with countries announcing ambitious targets in terms of additional renewable energy production. We expect to see a lot of new capacity come online by 2030.

However, we are also observing a scarcity in the number of renewables assets available for financing. This is because renewable assets are environmentally friendly by nature and therefore represent an obvious sector to invest in for any organisation looking to boost its sustainability credentials. That means strong competition among debt providers and, consequently, a significant compression on returns. It’s a challenging sector for those reasons, but we continue to seek and identify the right assets, offering the right risk-adjusted returns.

When will hydrogen become a bankable proposition?

Hydrogen is a great example of the type of asset that currently requires government support.

Both the US and EU governments are currently considering the nature of the subsidies and political support they are going to provide to that sector, in order to serve as a catalyst for project development.

While we do see a lot of projects at the work-in-progress stage, these are primarily equity opportunities, right now.

However, I believe they will become bankable in the future, but we’ve not yet reached that stage.

What about opportunities in the telecoms sector?

Clearly, the onset of covid has highlighted the importance of connectivity as home working has become more prevalent. The fibre optic roll-out was already a major source of financing opportunities pre-pandemic, but we’ve seen a marked increase in dealflow and now expect that to last for the foreseeable future.

In terms of ESG, fibre primarily has a social impact, bringing internet connections and high-speed broadband to rural communities across Europe, bridging the internet divide, and helping to meet social development goals identified by the EU.

“Private markets will need to co-operate with government regimes if we are to meet 2050 targets”

Furthermore, although there is some expectation of a return to working norms, as vaccination programmes continue to make progress, many companies are likely to allow a mix of home and office working. This would not only reduce the commercial rent burden of the business, but also offer individuals a lifestyle away from urban areas, if they desire, thus providing an additional economic boost for rural communities – all facilitated by investment in telecoms infrastructure.

Elsewhere, we see opportunities in the data centre sector for those assets powered by renewable energy.

Are you also seeing opportunities to support utilities in their energy transition?

There are opportunities to support utilities in their energy transition – for example, through the phasing out of coal generation and a shift towards more sustainable capacity. There are also opportunities around the addition of battery storage to renewables plants, taking that intermittent generation and turning it into a baseload power supply.

In the longer term, we anticipate that green hydrogen will reach a stage where it can replace the gas that is currently being used as an interim source of energy. But first, the cost of producing that green hydrogen will need to become more competitive, because currently it’s still too expensive.

Digitisation has been another prominent theme in recent years. What are the sustainability angles there?

Digitalisation is providing opportunities around smart meters and smart grids, which can then enable the optimisation of networks and of base load capacity to provide greater energy efficiency and, therefore, to reduce carbon footprint. The same is true of smart cities, which can help reduce the carbon footprint of a whole neighbourhood.

“There are opportunities to support utilities in their energy transition – for example, through the phasing out of coal generation”

Digitalisation is also an important tool for EV charging stations, which rely on smart data and apps that are made available to EV owners.

Meanwhile, for the infrastructure asset class overall, digital transformation enables managers to collect and process large volumes of data in order to optimise assets from an ESG perspective, while simultaneously reducing operational and maintenance costs.

What role can lenders play in driving sustainability through their deployment activities, as well as their terms and conditions?

Lenders have less direct influence than equity investors because they don’t have voting power. But lenders are still able to exert influence through their investment selection, which dictates the level of liquidity available for a specific sector or project. For example, more liquidity may be available for a renewable asset today than for a hydrocarbon storage facility.

Lenders can also insist on specific ESG due diligence on an asset and include reporting requirements as part of the financing documentation. So, certainly, lenders have a role to play in creating a more sustainable world.

You mentioned that sustainability sectors command strong competition among lenders. How can you avoid the most hotly contested areas?

The market is highly competitive, so lenders need to broaden their investment horizon and move towards new frontiers. Being a first mover in a new sector puts you in a position to capture a premium. If you want to invest behind sustainability themes and maintain your returns, the answer is to explore the next wave of opportunities.

How do you manage risk when you move into a new sector?

We rely heavily on due diligence. As a lender, we don’t take the same kind of risks that an equity investor does, but we would structure more protective terms in a new sector than we might in a sector that is better known and understood. So, it’s a mix of risk-sharing with the equity provider and the structuring of the financing.

How can lenders differentiate themselves as a sustainable partner of choice?

Fully embed ESG into investment processes on an asset-by-asset basis. We’ve done this since launching the private debt and real asset team in 2017 because we believe that ESG will impact performance in the long term.

What that means in practice is that we carry out a full ESG analysis, in just the same way that we do technical and financial due diligence. We have an in-house sustainability centre, but we also use an external consultant that provides quantitative analysis on every asset in terms of carbon footprint and alignment with a two-degree trajectory. That consultant scores the net environmental contribution of the asset and benchmarks it against its peers. Therefore, we have a strong ESG ethos and that’s attractive to many of our investors.

What do you think the future holds for private capital’s role in creating a more sustainable future?

Private capital is an important source of liquidity and, therefore, is a strong contributor to the acceleration of the energy transition and digital transformation going forward. We rely on government to put the right regulatory framework and incentives in place. But private capital must step up to leverage that public funding in order to create a more sustainable world.