This article is sponsored by Edmond de Rothschild
Where are the most interesting energy transition opportunities from an infrastructure debt perspective?
The opportunities are everywhere. It is a global play. The energy transition is a global phenomenon and the technologies to support that transition are proliferating at a remarkable rate. The real question, for me, is whether an asset manager can capture those opportunities. We believe we are thanks to our deep industrial knowledge.
To do so, you need to understand the changing regulatory environment in each country, and you need to understand the industrial and technological evolutions that are taking place. That means understanding newer technologies, such as floating offshore wind, hydrogen and battery storage, for example. It is also about assessing accurately if evolutions within existing technologies, such as the increasing size of blades for onshore windfarms, still make them reliable assets that are easy to operate and maintain, as we wish to keep the risk profile acceptable to our investors.
When I talk about understanding, I don’t mean the ability to adapt to changes once they have taken place, but rather to anticipate those changes before they happen. Of course, we also need to be able to structure the debt instruments, but that’s table stakes. What really sets an asset manager apart is the industrial and technological knowledge of its team, as well as in-depth knowledge of both individual markets and regulatory frameworks and strong relationships with the public sector.
Different regions have different sets of rules and behaviours. So, you need to have relationships with the decision-makers behind tendering projects and the implementation of regulatory frameworks. The greater the breadth of that experience, the more able you are to take advantage of the energy transition opportunity set, because it is vast and it is global.
If the ability to look ahead is important, what do you see as the next wave of investment propositions?
Take something like floating offshore wind. We have been looking carefully at that sector for the past three years, and it is now starting to become ‘investable’. The same is true of battery storage. There have been a handful of transactions so far, but more are coming.
Hydrogen is clearly another very hot topic, and we are starting to see transactions that can make sense for our investors as well. Meanwhile, we ourselves carried out one of the very first project financings of an EV charging asset linked to the Trans European Transport Network – Green Mobility – around 18 months ago.
Inevitably, the approach has to be different when compared with lending to highly evolved sectors where you have done many similar deals in the past. It is almost like going back 25 years to when the first mobile networks were being rolled out and project financing needed to be raised.
Nobody could really predict mobile penetration and so assumptions had to be conservative when defining quantum of debt and the appropriate security package. These are new and partly unproven business plans and, again, that is where depth of experience comes in to mitigate the risk and bring the risk profile to what our investors wish us to invest in.
How competitive is the lending landscape for these types of asset?
It varies significantly from country to country and from regulatory regime to regulatory regime. You have to approach value assessment and risk mitigation differently, depending on where you are looking. It is tailor-made and experienced asset managers will appreciate and embrace this challenge.
Indeed, sometimes the situation differs from region to region, even within a single market. So you need to have local experience, but you also need to have an understanding of global trends, in order not to misjudge an investment.
“What really sets an asset manager apart is the industrial and technological knowledge of its team, as well as in-depth knowledge of individual markets and regulatory frameworks”
For example, the first merchant deals we participated in took place 20 or 25 years ago. They were not necessarily a success, but they taught us a great deal. We are able to look back at those transactions in relation to current pricing projections, which proved key in our risk assessment and acceptance as well as in sizing of the debt and the level of cushion we want to embed in the structure.
However, pricing isn’t everything and analysing an asset is about making sense of a complex, comprehensive set of components; pricing is just one.
What are the biggest challenges you would associate with deploying capital in these sectors?
The biggest challenge but also opportunity is probably the speed of technological evolution that is now taking place and the need to assess the associated risk.
Equally, the regulatory environment has evolved, sometimes rapidly. You have to consider the policy backdrop and the history of how a given jurisdiction has behaved. Then you need to look at the revenue drivers.
“You have to have the skills and experience to be able to take a view on what the operational challenges of an asset will be, beginning with its remaining life”
Are you dealing with a feed-in tariff. Is it corporate PPA? Is there an element of merchant risk? Is that merchant risk full or partial? We also have to consider if that framework is likely to remain in place or if a country may decide to transition to a more merchant environment, perhaps for budgetary reasons.
Operational considerations are crucial too. You have to have the skills and experience to be able take a view on what the operational challenges of an asset will be, beginning with its remaining life. There are many moving parts to be taken into account which differ from country to country and sub-sector to sub-sector. And these considerations can pull in opposite directions, so it is all about weighing up individual opportunities on a case-by-case basis and structuring the underlying debt instrument on a tailor-made basis.
Has covid impacted interest in the energy transition agenda?
I think the pandemic has created more awareness. It has highlighted the importance of protecting the planet and of caring about society. It was interesting that in the early days of lockdown, pollution levels declined rapidly and air quality improved, which just served to remind everyone that it is possible and necessary to live in a cleaner world.
At the same time, however, I think that train had already left the station and was travelling at high speed. Certainly, the transactions that we are working on would have taken place anyway.
Do you think government reactions to the pandemic will have a meaningful impact on dealflow?
I do think that governments will deliver. We advised quite a number of them and have good insight into their plans. There is a firm commitment to 2050 targets around global warming and CO2 emissions and we know that infrastructure investment is an important way to boost economic growth when the economy has suffered.
That should help accelerate the implementation of some of these programmes that have been announced. But, at the same time, we are not waiting for governments to turn stimulus plans into action. Our job is to invest on behalf of our LPs and we cannot afford to wait for government initiatives to translate into investable propositions.
How else will energy transition evolve?
I believe one reason that people like myself and my team, and our peers in the market, are involved in this sector is that we have a conviction that we need to protect our planet and contribute to sustainable development. We care about the planet and about society. ESG means something to us and is a clear commitment of the Edmond de Rothschild Group. It is exciting and a blessing to be a part of the energy transition.
It is clear that government commitment to the transition is now also strong. It has become a global phenomenon. And the speed of tech evolution is remarkable.
To be honest, for me, it’s really about whether LP liquidity can keep pace with the sheer scale of investment opportunities. And, of course, for us as asset managers, to convince those LPs that we are the right people to make that happen. This is a critically important challenge that the world is grappling with and I am truly excited to have a role to play.
From an LP perspective, what is the advantage of accessing the energy transition through debt, rather than equity?
The appetite for infrastructure debt is certainly growing, which is a positive. Although the majority of the financing comes from debt, historical LP appetite and fundraising has been focused initially on equity. There are two distinct strategies within infrastructure debt. There is the senior play, at perhaps a 250bps spread, involving investment-grade assets and Solvency II eligibility, which is certainly very attractive for insurance companies. It is a liability-matching exercise, which is also generating attractive yield when compared with listed corporate or even sovereign bonds, right now.
There are also the higher-yield, or yield-plus, strategies, involving junior debt or perhaps riskier senior debt, generating a 5-6 percent spread. Here the appeal for LPs is a high-yielding investment with the added benefit of that element of security: fixed income and predictable cashflow.
As the world of equity becomes increasingly competitive, with more and more capital being raised, returns in many areas are sometimes being squeezed into the mid-single digits, and so a yield-plus debt exposure is becoming increasingly attractive. We were one of the first to introduce a separate yield-plus strategy to also avoid conflict of interest and offer investors the benefits of both strategies across separate portfolios. We seem to have identified a strong demand here.