Of all the risks to keep LPs awake at night, how to adapt to a changing climate is quickly moving up the list.

“Climate resilience is one of the hottest topics of conversation for our LPs – I’ve noticed a rapid increase in focus from them around how prepared our assets are for climate change,” says QIC partner Leisel Moorhead, who is responsible for managing ESG concerns for the Brisbane-headquartered fund manager’s infrastructure assets. In fact, she says, it represents one of the most pressing risks investors and asset owners are currently grappling with.

That should come as no surprise. After all, climate change continues to dominate the headlines, whether it’s Swedish teenager Greta Thunberg’s campaigning at the United Nations or Extinction Rebellion protests bringing central London to a halt – little wonder, then, that LPs should have the issue at front of mind.

But quantifying the risk and putting a number on it has proved to be much harder, with little in the way of benchmarking to assess how resilient assets are in comparison to others.

How big is the challenge? And might it even present an opportunity for investors?

Resilient strategy

One firm that certainly thinks climate change could present opportunities is French infrastructure fund manager Meridiam, which announced in September it was partnering with the Rockefeller Foundation to launch a new fund dedicated to urban resilience infrastructure.

The vehicle will target €500 million, investing in both developed and emerging markets and across sectors – a broad remit as long as investments meet the criteria of improving urban resilience.

“Climate resilience is one of the hottest topics of conversation for our LPs”

Leisel Moorhead

In a blog post, the Rockefeller Foundation said the goal was “to create an industry standard for resilience infrastructure,” specifically those assets that are “built to improve daily life, ensure survival and support continued growth in the face of increasingly hazardous climate events”.

It is an undoubtedly bold move. While the fund will be a niche product for now, it is one of the first instances where a fund’s strategy has revolved solely around the theme of resilience, rather than taking a more generalist approach.

Emma Herd, chief executive of the Investor Group on Climate Change, an organisation bringing together like-minded investors in Australia and New Zealand, has seen more focus on the latter approach to date from her members.

“When we looked at the issue of how to get more capital into climate adaptation, we found that to make it stack up from a financial perspective you needed to have an integrated approach to funding,” she says.

“It’s very hard to generate a return off a seawall, for example, but you can protect return through measures you undertake around a port or an airport. It’s quite hard to separate out what is a straight adaptation measure, so we’re tending to see integrated climate funds that do both, reducing emissions and increasing resilience on the way through, for example.

“That’s not to say there isn’t a lot of thinking going on about how to create a resilience fund. There are lots of conversations around how to make this work, but the question is: how do you do it and still generate private sector-level returns?”

Chris Leslie, a senior managing director for Macquarie Infrastructure and Real Assets based in New York, says that flood barriers or levees, which he characterises as ‘resilience as a service’, could be a category for investment in future.

“There are fewer of these investment opportunities in existence and they require innovative financing solutions, but they are likely to be increasingly required.  We are evaluating these opportunities as part of our broader investment mandate,” he says.

Making trade-offs

At QIC, Moorhead says the need to balance the investment decisions of today with the potential impact that a future climate may have on an asset is the major challenge.

“If you’re designing and building something new, it’s much easier to take account of adaptation costs in that design process, so it’s probably the easiest and most cost-effective way to achieve low vulnerability,” she says.

“But on existing assets, you’re weighing up the cost of prevention now versus what you expect to be higher reactive adaptation costs in the future. There’s always that trade-off: what’s the most effective, efficient and equitable way of investing for resilience? Is it the customers today who pay the cost or is it shared among the customers of the future? These are real-life conversations that happen at the moment.”

By way of example, Moorhead points to the development of the new parallel runway at Brisbane Airport, in which QIC holds a 25 percent stake on behalf of its clients.

The airport’s owners were building a new runway on the site, which is in a low-lying coastal area, one that is already subject to potential storm surges and is exposed to a rise in sea levels in the future. In the end, the decision was made to build the runway approximately 1.8 metres higher than was required by regulation to mitigate against the risk.

“You can do all the climate modelling in the world, but the team still had to take a decision to incur that extra cost to raise the level of the runway,” Moorhead says. “That decision, while there’s a higher upfront cost, improves longer-term resilience and is more cost effective. When you’re building a runway, you don’t really get the option to raise its height in 20 years’ time. That would be cost prohibitive, so you have to make that trade-off.”

“Rather than trying to have an average across a fund manager portfolio, you need to get into the detail of each asset, and in each geography”

Michael Cummings
AMP Capital

An Australian government case study on the project found that the cost during preliminary design of considering climate change impacts was “negligible”, while the additional outlay of funds during construction was “outweighed by the confidence that all future climate change impacts have been considered and there will be no need to upgrade the runway for some time”.

MIRA’s Leslie says that resilience enhancements do not necessarily need to be capital intensive, though.

“For example, [we can implement] operational changes that use data, forecasting capacity and technology to predict and respond to climate change impacts with improved management protocols.  The UN Global Commission on Adaptation report demonstrated that these investments have the highest pay-back ratio,” he says.

But firmly quantifying the precise numbers is still not easy, despite awareness of the issue growing greatly in recent years. Efforts are underway to produce industry benchmarking systems, with Natixis and EDHECinfra recently announcing a research programme into an ESG index that would include climate resilience, but it is highly complex.

As IGCC put it in a 2017 report about Australian assets: “To date, no comprehensive estimates seem to exist on the cost of climate change impacts in Australia and the likely level of investment required for adaptation measures. This makes cost-benefit analysis of climate change adaptation at an aggregated level impossible to quantify.”

Transitional risks

Adding to the complexity is the fact that no two assets are ever the same.

Moorhead says that a major challenge when assessing climate resilience in a portfolio is the fact that infrastructure assets are heterogeneous by their nature.

“Some are new, some are old, they’re built with different materials, and some have interdependencies with other networks. There’s definitely no one size fits all.”

Michael Cummings, head of AMP Capital’s Australia and New Zealand infrastructure funds, echoes this, saying that when it comes to the risk of physical damage to assets, it depends enormously on the type of asset and where in the world it is located, as risks are quite specific to the climate in each region. An electricity distribution network in Australia is susceptible to an increase in bushfires caused by extreme temperatures and drought, for example, while a comparable asset in New Zealand must contend with the threat of extreme storms instead.

But there’s another way to consider climate change risk, Cummings points out, stemming from potential reductions in demand for assets if consumer appetite changes, or increased costs if regulation tightens. He calls these transitional risks.

This could be whether there is an ongoing impact on flights, for example, from consumer choices that deem flying to not be a good climate option, through to electricity, with people sourcing their own through use of solar,” he says.

“My point of view on airports, for example, is that I think the airlines and the makers of the airplanes are well onto that, and what you’ll see is continuing efficiency driven through new engines,” he says, with benefits for consumers and the environment coming as a result of that focus.

“We recently sold a business that had undergone several resilience upgrades which had improved its sustainability as a business – this proved to be highly valuable to potential buyers during that sales process”

Chris Leslie

But the point is that fund managers should be aware of these secondary risks, too, and that they will differ hugely from asset to asset.

“While we look at it from a portfolio point of view, we are a much more active investor on the assets themselves. Rather than trying to have an average across a fund manager portfolio, you need to get into the detail of each asset, and in each geography,” he says. “That’s why we take active board positions and ideally majority control [in assets].”

It’s also increasingly clear that resilience is an important part of protecting an asset’s value when it comes time to sell.

“We recently sold a business that had undergone several resilience upgrades which had improved its sustainability as a business – this proved to be highly valuable to potential buyers during that sales process,” Leslie says.

‘Work in progress’

AMP Capital, MIRA and QIC do not have plans to follow Meridiam in producing a specific climate resilience-focused fund, but it’s clear that all of them, along with most other responsible investors, are already considering this issue with respect to their existing fund portfolios and how it could affect returns.

“Overall, I think investors are looking for resilient infrastructure, and resilience around climate change and risk management being integrated into an overall investment, rather than on niche products [like Meridiam and Rockefeller’s fund],” Cummings says. “That fund has its place in the market, don’t get me wrong – but mainstream infrastructure investors will still be making sure that they’re choosing managers that have got robust processes in place from origination through to asset management and exit.”

Herd describes efforts to produce specific resilience strategies, and to better quantify the benefits of mitigation and adaptation as a “work in progress”. But progress is being made.

“We’ve done the work on avoiding emissions as a fairly standard benchmark in terms of the environmental benefits, but on the adaptation side we don’t have an equivalent resilience rating or metric that you can use in a standardised way to show that there is benefit to be had in increasing investment in adaptation projects.”

In the recent past, she says, there was “nothing” there. But now, with the launch of funds like Meridiam’s and Rockefeller’s, and the development of benchmarks like Natixis’ and EDHECinfra’s, the issue is rising up the agenda.

The tricky task of benchmarking

“We’re seeing benchmarks come through really quickly. When we first looked at this a few years ago, there was nothing, and there was a very strong focus on transition risk,” says Emma Herd, chief executive of the Investor Group on Climate Change.

“Now we’re beginning to see portfolio-level approaches emerging, with new service providers looking to take the science and integrate it into financial assessment and build it up into some sort of benchmark that can be used on an ongoing basis.”

Natixis and EDHECinfra recently announced new research into developing an ESG index for infrastructure that would include climate resilience, while GRESB already publishes an ESG benchmark.

The 2019 edition of GRESB’s benchmark saw infrastructure funds participate in resilience reporting for the first time, alongside individual assets, with a 62 percent uptick in the number of assets taking part.

GRESB said this showed an “increasing awareness of the need to respond to investor attention on climate risks and resilience”.

The research found that funds and assets scored well on senior employee responsibility, communication with governance bodies and implementing business strategies, with more than 75 percent of respondents in each case responding positively to those metrics. However, the results showed there was still room for improvement in other areas, with less than 10 percent of funds setting specific climate resilience or risk targets and under 50 percent measuring their resilience-related performance and outcomes.