IRA tax credits will usher in a new wave of ESG in America

The anti-ESG movement has grabbed headlines lately – but ESG-conscious projects will be grabbing investors’ dollars, creating measurable impact along the way.

Infrastructure investors and policy wonks alike have been celebrating the Inflation Reduction Act for its nudging of private money towards clean energy projects. Less discussed, however, but just as important, is the IRA’s nudging of investors towards creating impact.

Colloquially, infrastructure players are calling these nudges “tax credit adders” – or rather, the boosts to both the investment tax credits and production tax credits present in the IRA for meeting certain labour and building standards.

There are a few ways investors can dodge ITC penalties if they don’t meet those labour standards. First, investors can be grandfathered in for full credit if construction of their project commenced before 29 January, 2023. This rule would explain why there was a “mad dash” at the end of last year, as Sam Guthrie, a senior counsel specialising in renewable energy tax matters at law firm Allen & Overy, called it, to safe-harbour projects in localities with especially high prevailing wage levels, such as New York.

But that ship has sailed. Now, the only other ways to circumvent labour standards are to have a project that is small enough – meaning it has a maximum net output of less than 1MW alternating current – or to procure a “good faith exemption” to apprenticeship requirements if there aren’t apprentices available in the area where the project is being built, or if the building team is four people or less.

“Everyone is going to comply with these rules. In the case of an ITC, a 6 percent ITC without the 5x multiplier is just not economical and that deal wouldn’t get financed,” explained Guthrie.

If investors do receive a penalty for failing to comply, damages can be paid to either the labourer who was underpaid and to the IRS to regain the full value of the credit. However, investors would be unwise to attempt to skirt the rules on the off chance that no audit is performed afterwards, as their financing prospects could take a hit.

One executive at a major international bank put it quite simply: “Whether or not other GPs can handle those social governance points within the IRA will impact our lending practices, certainly. And the more it goes on, it won’t just impact ours. We saw it with fossil fuels just a few years ago. When we look at where we finance, that plays a big role. It’s not an easy thing to transform an industry, to transform a sector, and to get it to embrace diversity, inclusion, etc.”

The banking source continued: “We pick the partners that we work with very carefully. They are actively focused on doing [ESG-related] things and demonstrably doing things. And over the next 12, 24, 36 months, I think you’ll see that certain firms which haven’t done these things will be excluded from certain financing options.”

In terms of the E and the S in ESG, the IRA’s tax credit system will prove to be a huge boost, incentivising investment in clean energy projects that are located in disadvantaged and underserved areas, with workforces that are paid and trained well.

That will have a measurable impact. And in that sense, it brings to mind what Equilibrium Capital chairman Dave Chen told us back in 2017: that the most interesting conversation in impact investment was, ‘How is the market used… to create intentional impact?’. The first generation of ITCs and PTCs were remarkably successful in mobilising non-impact investors to committing capital towards the E. This latest generation stands to repeat that trick, but with the S also firmly in its sights.

The impact on the G, however, remains to be seen. Infrastructure asset managers are notoriously monolithic, with perspectives from women, non-white investors and investors from socioeconomically disadvantaged areas being underrepresented. Will executive teams with more sensitivities to those areas and those groups prioritised by the IRA’s “adders”, then, have an easier time landing deals? Sourcing labour? Securing financing?

With the opportunity of the IRA, investors face a test not seen before.