This article is sponsored by Edmond de Rothschild
Why is sustainability so important, in the context of infrastructure, in particular?
Infrastructure is all about providing essential services to society, so sustainability is embedded at its core. Indeed, sustainability has been a fundamental component of infrastructure investing since the dawn of the industry, even when that investing involved toll roads and airports, for example, which would never be described as green and which our platform does not invest in hugely.
Edmond de Rothschild has a history of advising governments tendering such projects under PPP schemes. Beyond the finance considerations, such projects’ development involves the analysis of their social impact, such as job creation, and how they could be designed to mitigate any potential environmental harm, such as protecting species and avoiding pollution. In that sense, this is not something new. It has always been there.
However, sustainability has, of course, become a great deal more prominent in recent years with the Paris Agreement at COP21 in 2015 and COP26 in Glasgow last year. As an industry, we are already working towards COP27 and trying to anticipate what will be discussed.
Government infrastructure initiatives have also had a profound effect. Just look at the recent infrastructure bill in the US and the EU’s Fit for 55 programme, which is designed to accelerate the reduction of carbon emissions by 2030.
Meanwhile, as asset managers working on behalf of institutions, we had anticipated the 2021 SFDR directive/EU Taxonomy for years, which is imposing, in a positive sense, enhanced reporting requirements on ESG. In this sense, in 2018, we were the first infrastructure debt asset manager to be granted a Greenfin label.
The need to protect the planet is a given. We know we need to reduce CO2 emissions and reduce global warming, and we know we need to build greener infrastructure. The above regulation combined with technological breakthroughs shall support the flow of private capital to meet these objectives, thus setting a virtuous circle.
What role does private infrastructure debt have to play in driving sustainability?
Our role, long before the energy transition was labelled the energy transition and before SFDR came into play, was to finance the creation of sustainable infrastructure and to ensure its long-term place in the economy. That is the starting point. We can do that in myriad ways. We can invest in renewable energy, battery storage, green mobility and hydrogen. We can help decarbonise utilities and support their transition away from fossil fuels. We can drive energy efficiency within social infrastructure such as hospitals and schools. Digital infrastructure has a role to play in decreasing carbon emissions and having a positive impact on society.
The financing needed to fulfil all of this is immense, with hundreds of billions of investments in Europe alone over the next seven or eight years, underpinning EU Fit for 55. A lot of that capital will necessarily be private capital. And it is an attractive investment opportunity for asset managers such as ourselves and the institutions we represent. What is sustainable can be profitable, and what is profitable can be sustainable. Our view is our finance supports sustainability.
What are your views on ESG- or sustainability-linked finance?
The idea of offering margin ratchets based on sustainability is reasonable and we have executed it on some of those deals. But I think the link between financing and sustainability goes way beyond pricing. I think the contractual commitments that borrowers are willing to make – the covenants that we put in place – are more significant in allowing us, as lenders, to monitor progress and act if the borrower fails to do what it is supposed to do.
Sustainability is embedded in infrastructure, and as a conviction-driven asset manager we believe we can have a real impact in the way we structure our debt.
How is the current geopolitical backdrop, and war in Ukraine, impacting your deployment activity?
War in Ukraine has not affected our ability to assign capital to sustainable infrastructure projects. On the contrary, we have already deployed €1 billion in 2022, while during the same period last year, we had deployed closer to €800 million. A lot of that capital has been deployed in infrastructure assets with a very strong ESG impact.
War in Ukraine has made us more aware of potential supply issues which can have an impact on construction costs or operating costs. We have always been able to find solutions, however, and to mitigate risks at a portfolio level. The energy security challenge was also emphasised by the conflict, which necessitated some thinking but also accelerated the implementation of renewable energy.
And what impact could a prolonged macroeconomic downturn have on the industry?
I am not qualified to say whether we are facing a prolonged economic downturn or not. But what I can say is that, historically, whenever there has been a downturn, governments have used infrastructure plans to bolster the economy. Of course, we are looking at the impact of inflation and rising interest rates closely. These trends have already been in play since the end of last year and have not slowed demand for infrastructure. In fact, in some cases they have even created opportunities. That said, I always emphasise the need to remain humble and cautious. It is important to monitor political and economic developments.
“What is sustainable can be profitable, and what is profitable can be sustainable”
For the most part, infrastructure is a resilient asset class. Having worked in the industry for three decades, through several financial crises, a global pandemic and now war in Ukraine, we have always been able to support the development of sustainable infrastructure, no matter the macroeconomic or geopolitical backdrop. This is what attracts investors as well and helps us contribute to managing the effects of such events.
How do you factor sustainability and climate resilience into your underwriting and diligence?
These topics have always been a part of our investment process. When we set up our infrastructure debt offering in 2014, we were one of the first asset managers to talk proactively about the energy transition. We have had an ESG questionnaire embedded in our due diligence process since day one, which determines whether a borrower satisfies our ESG criteria. Furthermore, we had been anticipating the SFDR directive for a number of years ahead of its implementation and so have carried out a lot of work around measuring the impact of our investments.
Alongside our internal ESG team, we employ independent consultants that calculate CO2 emissions avoided, for example, or classify investments against the global warming reduction targets. These are concrete measures that we can report on, which is key to our investors, being subject to the SFDR directive.
As a conviction-driven asset manager supporting the energy transition, we are also willing to support the transition of existing assets to reduce their reliance on fossil fuels, in most cases to zero. Such a transformation story can be embedded in the structure of the debt instrument that we extend. We add covenants so that progress against ESG targets can be monitored and give us some rights to act should we not be satisfied with progress made by the borrower.
In short, we factor sustainability into our process from the moment we source a deal, through to structuring and then monitoring the asset throughout the life of the investment, including the comprehensive reporting to our investors.
The scope of sustainable infrastructure investment is broad, as you have mentioned. But are there any themes that are particularly attractive to you right now?
As asset managers, we need to bring diversification to our portfolios and, for us, sustainability exists within all infrastructure sectors. In transport, for example, green mobility is clearly a major theme. Five years ago, we were the first asset manager to provide debt finance to an EV charging point operator.
Sustainability is central to digital infrastructure as well, with its material impact on society. It allows, for example, people to work, learn and monitor their health remotely within their homes, thereby removing the need to travel by car or by plane, and so reducing their carbon footprint.
Renewable energy, obviously, is a highly impactful sector from a sustainability point of view, and we could easily invest 70 or 80 percent of our funds in that space if we wanted to. But, in reality, renewables represent closer to 35 percent of our portfolio because it would be a misconception to reduce ESG to renewable energy when building a portfolio. There are so many other sustainable investment opportunities, such as energy efficiency for social infrastructure or the decarbonisation of utilities, which enable us to further diversify our portfolios whilst contributing to a global ESG impact.
What about some of the newer sustainability technologies that are starting to come to the fore?
The continued development of new technologies will be critical to meeting sustainability objectives. Huge strides have already been taken in the areas of floating offshore wind, hydro-generation, battery storage and hydrogen vehicles, to name a few.
It is important, as asset managers, that we really understand the assets from their technical, technological definition and the regulation underpinning their implementation and operation. Some of my team members have engineering backgrounds and worked for industrial sponsors; some have advised governments. We have spent years analysing these technologies, which is why we are excited to bring these newer projects into our portfolios, in such a way that there is a strong level of security, but also attractive yields. And, in doing so, we diversify our asset base and continue to provide a strong contribution to global sustainability.