This article is sponsored by Edmond de Rothschild
While infrastructure and sustainability have always been inherently interlinked, what has changed are the technologies that enables its delivery, says Jean-Francis Dusch, global head of infrastructure and structured finance at Edmond de Rothschild Asset Management and chief executive of Edmond de Rothschild UK.
Between that technological advancement and a supportive regulatory environment – particularly SFDR and the EU Taxonomy – the sustainable infrastructure investment universe has been significantly enhanced, particularly for sophisticated asset managers.
What lending opportunities are you currently seeing in sustainable infrastructure?
As technology has developed and the pressure to reach net zero has grown, the nature of the investment opportunities that exist has diversified. The energy transition is no longer just about the renewable energy sector as it now encompasses everything from green mobility to social infrastructure with energy efficiency and the decarbonisation of utilities, so asset managers need to anticipate, have a conviction, be honest in implementing it and keep up.
Meanwhile, even within the energy sector, the types of investment opportunities that are emerging continue to evolve. The EU’s Fit for 55 initiative is designed to reduce greenhouse gas emissions by 55 percent by 2030. That is just a few short years away.
That will enhance the need to produce renewable energy, of course, but it also requires investment in the way that intermittent renewable energy is stored and transmitted to the grid. For example, we have been analysing the battery storage market for the last three to four years and made our first investment at the end of 2022, probably with a first to market transaction.
In short, our pipeline of sustainable infrastructure opportunities continues to grow and become ever more diverse.
How has the macroeconomic environment impacted this space?
As lenders, we capture base rate increases while keeping the margin levels we promised to investors, so there has been no negative impact there and, of course, inflation is a net positive for infrastructure equity players. As with previous periods of flux or crisis, existing infrastructure assets are once again proving their resilience, while there has been no slowdown in new investment opportunities either.
But what about some of the announcements we have seen recently, scaling back energy transition targets?
There has been a recent announcement pushing back the deadline for ending the sale of new petrol and diesel cars and phasing out gas boilers in the UK, but, globally, you have to understand that the energy transition is exactly that – a transition. And it is that transition process that is creating many of the investment opportunities that we see.
The energy transition is also not something that is new or transitory. There is huge momentum behind it. I have no concerns about deployment as a result of economic or budgetary constraints. On the contrary, the scale of financing need continues to grow dramatically.
You mentioned battery storage. What other new technologies are on the brink of becoming credit investment opportunities?
Battery storage is certainly a big one and, of course, there are different ways in which that market could develop. Hydropower mixed with more conventional renewable energy is an interesting area we invested in too, and hydrogen lies just around the corner. Meanwhile, EV charging is already up and running as a credit investment opportunity, although we need to be careful to avoid a bubble. We were a first mover in this space in 2019.
Then there is the acceleration of the decarbonisation of utilities, including natural resources storage or district heating, among others. Even digital infrastructure is presenting sustainable financing opportunities, with growing demand for net-zero data centres, for example, while new technologies are facilitating energy efficiency within social infrastructure. We have invested significantly in these sectors too.
We operate within distinct risk profiles as a lender, which could be anything from investment grade to BB or, recently, even more aggressive strategies where we take some quasi-equity risk to support growth of the energy transition and digital transition developers and operators. We provide the full range of infrastructure debt instruments to fully support the energy transition and invest with impact. We have to ensure the risk profile we have for a specific mandate is met.
We always analyse the underlying risk in any new form of infrastructure, therefore, before we present it to our investors. But yes, when we consider some of these technologies are starting to become credit friendly, in many instances we will be among the first movers, which means we will be able to command more security in the debt structure and spread.
To what extent do you consider social impact within the broad theme of sustainability?
Infrastructure has always been about social impact. At the end of the day, infrastructure provides an essential service to society and in doing so also creates jobs.
We track job creation and we are also aligned with several UN Sustainable Development Goals, which are focused on social impact. We then report progress against these metrics to our investors in both quantitative and qualitative form. We measure for each asset’s CO2 emissions avoided and the alignment against the global warming reduction goals.
What role are you able to play as a lender, as opposed to an equity investor, when it comes to driving sustainability agendas in the businesses you back?
We exert our influence, in the first instance, in our selection of assets. As a lender of conviction, with a focus on impact, we of course select assets we believe to be truly sustainable. We then contribute to the acceleration of sustainability goals set by governments and regulators by the say that we have as an arranger of debt.
We do not make decisions in terms of how strategy is implemented. But we can ensure that the owners of the company follow the strategy that we bought into, by ensuring that they meet their contractual obligations to us.
It is also worth noting that infrastructure debt is increasingly backed by institutional investors – often the same institutional investors that back the equity funds that are supporting these assets as well. Particularly within the confines of SFDR, there is a natural alignment in terms of what those equity holders and lenders want to achieve when it comes to sustainability.
What are investors looking for today in terms of sustainability reporting and how has that changed as the regulatory environment has evolved?
First, I would say that we have to be very humble when it comes to making statements about what investors want, because the whole regulatory regime with SFDR and the EU Taxonomy is still very much a work in progress and there are still different interpretations from one regulator to another across Europe’s member states.
Equally, investors are all on their own journey in terms of defining and achieving their sustainability goals. What was a nice-to-have for one investor six months ago, can suddenly become a priority in terms of reporting.
Then the reporting itself can take many different forms. We try to ascertain the best common denominator for our commingled funds, but close to half of our assets under management exist in managed accounts, where we are able to have a much closer relationship with the investor and therefore produce something that is tailor-made.
Some investors prefer something more quantitative, while others favour something more qualitative. What is important is that you are equipped to collect and analyse information and then report it in whatever specific format that investor wishes. It is time- and resource-consuming but we are committed and equipped to provide investors with what they wish for.
You also have to be aware that whatever you put in place today will probably need to evolve. It is a question of listening to your investors and taking your lead from them.
As focus on sustainability continues to intensify around the globe, how do you ensure you stay ahead of regulatory change?
Sustainability is about more than regulatory compliance. This is something that has always been extremely important to us as an asset manager. ESG was already a principal part of our debt financing term sheet when I started work in this field in the early 1990s.
Because we have such strong conviction about sustainability as a group, we have always been first movers. In 2018, we launched the first infrastructure debt fund with an energy transition label. All our funds are Article 8 and that is something we commit to contractually in our PPMs, so investors know what they are getting from the outset.
That mindset means we find ourselves, in many ways, ahead of the regulatory curve. We began work on the impact of SFDR and the EU Taxonomy over five years ago, factoring it into the way we report. We have therefore been able to anticipate change, while remaining structured in the way that we meet our ESG targets.
Would you say that the use of ESG or sustainability-linked finance is gaining traction?
We have structured and seen some deals that include ESG covenants or margin incentives – structural mechanisms that come into play depending on certain thresholds being breached or targets being reached. But I do not think this is a must have from a debt structuring standpoint. We need to have a conviction from the technical definition and purpose of the infrastructure itself, as well as the sponsor commitment to implement their ESG strategy.
I think it is more important that a lender is convinced that the asset itself is fundamentally sustainable and then fully integrates ESG into the pricing from inception. Does this asset have all the right ingredients to create a positive impact on the planet and are you able to monitor and measure that impact, for example CO2 emissions avoided and alignment with 2050 global warming reductions or other sustainable development goals? That, for us, is more important than tweaking the margins.