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Infrastructure’s ESG revolution

LP pressure and proliferating regulation mean GPs are stepping up their game.

Investors are scrutinising the ESG credentials of their infrastructure managers like never before. And just under three-quarters of LPs believe the adoption of a strong ESG policy will lead to better long-term returns in their private markets portfolios, according to Infrastructure Investor’s LP Perspectives 2022 Study.

“Given infrastructure’s mission of delivering on environmental and societal goals, there is a natural fit with ESG,” says Gordon Bajnai, head of global infrastructure at Campbell Lutyens. “Sectors such as energy and transportation have a measurable impact on our efforts to decarbonise the world, whilst sectors such as digital have a huge role to play in bridging divides in society. ESG measurement, reporting and benchmarking have become standard in infrastructure. If you want to raise money, these things are a must-have and not a nice-to-have.”

Of course, there are regulatory imperatives as well. Bajnai says the EU Sustainable Finance Disclosure Regulation marks a revolutionary step that will affect not only those managers investing in Europe, but anyone who wants to raise money from European investors: “We can already see the US moving in the same direction and other parts of the world are also catching up. I think it is becoming clear that ESG will be the framework within which you have to compete, and not an optional extra.”

“LP due diligence around ESG used to be about ensuring the GP was assessing ESG risks on the way into a deal,” says Brent Burnett, co-head of real assets at Hamilton Lane. “Now they also want to be sure that the GP has the systems and processes in place to monitor, measure and report on those ESG risks across the portfolio.

“It is a topic that is front and centre for capital allocators today. Those GPs that are successful in raising capital will not only have comprehensive ESG policies, but also the procedures required to implement those policies, so that LPs can be comfortable that this is something that they take seriously.”

On the right track

Broadly speaking, LPs are pleased with the progress GPs are making. Roughly 90 percent of investors are somewhat satisfied with their GPs’ performance in the areas of implementation of planned strategies and the frequency and quality of reporting. This is also reflected in this year’s GRESB scores, which indicate that infrastructure, as an asset class, has taken another big leap forward.

The average GRESB scores for all assets and funds increased by 10 and 12 points respectively, while the average by sector increased by 18 percent. “It’s pleasing to see another big increase in GRESB scores this year and growth in the benchmarking participation rates,” says chief of standards and innovation at GRESB, Rick Walters. “The sector is clearly on board with ESG and taking it ever more seriously. Investors and funds know how to report on it and report well.”

Walters adds that although Europe and the Americas remain ahead of other regions, the gap is narrowing. “Sector scores are also converging,” he says. “Those that were previously lagging have stepped up their game in the last year, driving up the overall average score for assets from 62 in 2020 to 72 in 2021.”

And while COP26 contributed to momentum around combatting climate change, the pandemic has increased focus on non-environmental aspects of ESG, and social responsibility in particular. “The pandemic’s devastating impact, particularly on disadvantaged groups, has raised the profile of social issues, emphasising to investors the importance of addressing the ‘S’ factors in their allocation decisions and in the assets they currently hold,” says Walters.

Tavneet Bakshi, partner and head of EMEA at FIRSTavenue, says: “There has been a sea change in attitudes towards ESG. Not only are LPs demanding more ESG focus in everything they invest in but, in Europe at least, there has also been new regulation clamping down on greenwashing. That is forcing GPs to make concrete statements about their approach to ESG. It can no longer just be a page in a pitchbook, with some woolly language about an ESG philosophy. Increasingly, LP due diligence has a dedicated ESG section, with at least a couple of hours spent on ESG reporting, metrics and how integrated this is in the investment process and at a portfolio company level.”

Bakshi adds that investors are starting to express a preference for funds to be compliant with either Article 8 or Article 9 of the SFDR. “It isn’t every investor, but I don’t think it will be long before that becomes a prerequisite,” she says.

However, while 49 percent of respondents believe their GPs are taking climate risk seriously enough when it comes to their own investment policies, 29 percent actively disagreed with the statement, suggesting an inconsistent approach.

A little under half of investors have requested to avoid an individual investment for ESG reasons, while 20 percent have declined a fund based on their ESG due diligence.