Since Russia invaded Ukraine on 24 February, an estimated 38,000 people have lost their lives and 14 million been forced to flee their homes, triggering a humanitarian crisis, the like of which has not been seen in Europe since the Second World War. Global energy markets were sent into a tailspin as Russia cut off supplies to a number of EU states, pushing up prices and stopping post-covid economic recoveries in their tracks.
With energy supplies now wielded as a weapon of war by some, the rush to net zero has acquired emergency status. Here are five ways in which the infrastructure industry is prioritising sustainability.
1. Expediting renewables investment
In March this year, the leaders of 27 EU member states agreed in the Versailles Declaration to phase out the bloc’s dependence on Russian fossil fuels as quickly as possible. This included a near-total ban on Russian-exported crude oil by the end of 2022. Under the REPowerEU plan, EU countries must generate 45 percent of power from renewable sources by 2030, up from around 22 percent today. Wind power will play a particularly key role in this, with a target set to almost triple the bloc’s wind power capacity by the end of the decade.
It was not long before the private infrastructure industry responded to the crisis by pledging to direct more capital towards renewable energy production, and to work harder to get developing projects off the ground faster. As we have seen in recent fundraising – $17.4 billion was raised by renewables-specific funds in H1 2022 alone – there is plenty of capital about. However, finding the cash is not the problem.
“Quick fixes, particularly in the energy space, are hard to come by,” says Chris Archer, co-head of EMEA for Macquarie Asset Management’s Green Investment Group. “New generation and storage capacity takes time to come online, and there are typically lots of moving pieces which need to fall into place.”
Indeed, even with more institutional interest in early-stage renewables investing, there is much to contend with before solutions can start to impact on Europe’s energy crisis.
This includes acquiring the requisite energy experience, sourcing (now more expensive) materials in a fractured supply chain, scaling up construction in a time of labour shortages, and enduring what can be a frustratingly long permitting process. According to research by energy think tank Ember, wind and solar permitting times are significantly in excess of the EU limit in many countries – particularly for onshore wind.
Some infrastructure investors are backing small-scale energy products, such as rooftop solar, to help ease the burden on national grids in a time of soaring household energy bills and under threat of winter blackouts. Energy efficiency measures – which the EU says can account for one-third of the energy savings required to meet the targeted reduction in gas consumption agreed in Versailles – are also an emerging investment proposition.
2. Safeguarding ecosystems
While wind power may have been slated as a way out of the energy security crisis, one of the biggest obstacles in getting wind projects off the ground is their potential to negatively impact biodiversity. An oft-neglected aspect of the ‘E’ in ESG, biodiversity loss was classed by the World Economic Forum as the third biggest global risk by impact and the fourth biggest risk in terms of likelihood, out of any category of risk.
The extent to which human intervention is destroying the planet is well known, but perhaps the urgency of the situation – and the impact of neglecting biodiversity in financial considerations – is less well understood. Around one million species face extinction over the next few decades. Waste systems – or the lack thereof – are responsible for an estimated 150 million metric tons of virtually indestructible plastic that resides in our seas and oceans, killing marine animals and infiltrating animal and human food and water systems with microplastics and nanoplastics.
Improving recycling technology and availability is therefore a critical element of the biodiversity impact agenda. “The number-one priority should be increased and effective sorting infrastructure… especially for films and flexibles,” says Adam Herriott, a sector specialist in resource management at WRAP, an environmental NGO. “We also need to develop the ability and technology to remove plastics from the residual waste stream, as well as more reprocessing capacity across all formats, including films and tray-to-tray recycling.”
In other infrastructure sectors, however, there is generally little attention paid to the impact of new or existing developments on biodiversity and nature due to a lack of agreement on how to measure impact and factor it into decision-making.
This is set to change with the imminent arrival of the Taskforce on Nature-related Financial Disclosures (TNFD) framework, which aims to direct capital away from “nature-negative outcomes and toward nature-positive outcomes”, through providing better information on the risks and opportunities present in investment activities. Furthermore, according to Joss Blamire, director of infrastructure at benchmarking organisation GRESB, “biodiversity and habitats… saw a 17 percent increase in reporting” in this year’s assessment.
For infrastructure investors, the insurance risk of the impact of climate change is already high, with the increasing frequency and magnitude of floods, fires and other natural disasters weighing heavily on development decisions. But when it comes to biodiversity, there is a risk that omitting it in the environmental pillar of an ESG strategy could have serious consequences for investors. The TNFD estimates that around $44 trillion of economic value is at least moderately dependent on nature.
“We believe that infrastructure companies that do not pivot to a nature-positive economy are likely to face a series of transition risks, including regulatory, litigation and loss of their social licence to operate,” says Rhianydd Griffith, senior vice-president, infrastructure at Federated Hermes. “Getting ahead of this curve by understanding the company’s current relationship with nature will empower organisations to develop more sustainable operations, products and supply chains that contribute to the protection and restoration of biodiversity.”
3. Protecting people
This “social licence to operate” is a delicate consideration for asset owners to manage. In a nutshell, a social licence is about displaying fairness and integrity in the provision of essential services to society, in order that local communities are not economically exploited or negatively impacted.
“If you are really looking to be an investor in an asset over the long term, you need to be a member of the community long term,” says Jordi Francesch, head of asset management at Glennmont Partners. “You need to contribute to, and support, local communities.”
A social licence has always been important to infrastructure, but now carries more weight as efforts to bring about a ‘just transition’ to renewable energy ramp up. “It’s incumbent on asset operators to understand that expectations have increased, to leverage creativity and to engage with communities to prevent problems before they occur,” says Scott Lawrence, head of infrastructure at CPP Investments.
One way to achieve this would be to maximise the social pillar of an ESG strategy. Generally considered the most difficult of the E, S and G to integrate into assessment and monitoring practices, the incoming (although delayed) EU Social Taxonomy should go some way to smoothing the path towards greater measurement of and accountability for the social-related impact of infrastructure investments.
In the meantime, LPs are increasingly demanding more of their GPs on the social side. “With the upcoming EU regulation on mandatory human rights due diligence, we see an increased focus on social factors,” says Axel Brändström, head of real assets at Swedish pension fund Alecta. “Pre-investment we have integrated questions around this in our ESG due diligence process, and other social factors that we keep an eye on are health and safety, as well as diversity.”
With infrastructure providing an essential service to society, managers are increasingly cognisant of the value-creation potential of maximising social benefits, more than just limiting the downside risk of misusing an operating licence. Consciousness over compliance is a trend we expect to see more of.
4. Advancing ESG excellence
There is clear evidence that commitment to ESG continues to grow in the asset class. GRESB recently published the results of its 2022 Infrastructure Assessment, which reveal a 17 percent uptick in the number of assets participating in the benchmark this year. These assets represent a combined valuation of $1.1 trillion. On the fund side, participation is up 11 percent on last year, with funds representing 70 different countries.
When looking at average scores, Europe is the best performing region for both assets and funds: scores improved by 14 percent and 9 percent respectively. In terms of sector, network utilities assets scored the highest, but social infrastructure assets recorded the biggest improvement on 2021 scores, up 20 percent. At the fund level, energy and water resources funds scored highest, and improved 53 percent on last year.
When it comes to demonstrating ESG excellence to LPs, beating a benchmark is, of course, important. But there is more to transparency than only quantifiable performance. In a 2021 survey of institutional investors by asset manager Schroders, 53 percent of respondents said that “clear and transparent details of the fund objectives including sectors or firms excluded or included” would better help them understand or invest in a particular fund. Beating environmental or social benchmarks were both further down respondents’ priority list.
“A ‘set and forget’ strategy can’t deliver meaningful ESG outcomes – active management is key,” says Kristina Kloberdanz, chief sustainability officer at Macquarie Asset Management. “Managers need to be constantly engaged with portfolio company management teams to track progress against ESG priorities, share knowledge and understand what additional support may be needed to meet their objectives.”
While the infrastructure industry is almost entirely on board with the importance of implementing and maintaining an ESG policy, for many, the challenge now is to do it better. Satisfying and retaining LPs is far from the only driver to improve ESG excellence. “There is mounting empirical data that shows ESG value creation – whether it be from operating cost savings realised through asset optimisation initiatives, or preservation of asset value by futureproofing operations to prevent value erosion as the world progresses to net zero,” says Himanshu Saxena, CEO at Starwood Energy Group.
5. Tapping into technology
Advances in reporting technology are helping to boost the collection and analysis of ESG data from portfolio companies, and improve the transparency of this information as it is reported down to fund investors. Although progress is being made, there is still a long way to go.
Among fund leaders surveyed by affiliate title Private Funds CFO in 2022, for example, only 8 percent said it was not challenging to collect ESG data from portfolio companies – for the remainder, this activity was deemed either slightly or very challenging.
“Without specialised technological solutions, the industry would never be able to generate and evaluate the enormous amounts of data points connected to ESG,” says Christian Schütz, director ESG at Golding Capital Partners. Such solutions may include artificial intelligence to collate and analyse data points, data extraction software at fund administrators, or cloud-based ESG management processes.
Technological developments can also help accrue data at the asset level, for example by monitoring carbon emissions, energy efficiency or onsite renewable energy generation in real time – information that could lead to significant widespread advances in transparency in the struggle against greenwashing. Not to mention technology’s wider potential to expedite decarbonisation pathways, such as through battery storage, electric vehicles and hydrogen.
As more third-party software and solutions providers are established that can demonstrate value-add potential – “compared to those [ESG start-ups] merely acting as data consolidation conduits”, says Schütz – developments in data and reporting technology should take ESG to the next level in private markets.