No longer a ‘soft’ option

ESG has erupted into the mainstream of infrastructure investing, with the ‘S’ sharply elbowing its way to centre stage.

You had only to attend the Day 1 ESG stream at our Global Summit to realise that environmental, social and governance practices are front and centre for industry professionals. As Anton Pil of JPMorgan Global Alternatives wrote in a recent commentary: “ESG has become the dominant trend shaping the private infrastructure investment landscape.”

Much as we agree with Pil, it hasn’t escaped us how the more mainstream ‘E’ has hijacked attention from the much-harder-to-measure ‘S’ and, to a lesser extent, the ‘G’. No more, though. Asset owners’ licence to operate – and by extension, their governance and corporate culture – are very much under the spotlight. For infrastructure investors – managers of essential assets serving diverse communities – that licence to operate is a key part of their business.

The stakes are high. Future Fund’s James Fraser-Smith told Global Summit attendees that a bad reputation leads to the destruction of value. Lincoln Webb of the British Columbia Investment Management Corporation argued that a weak reputation leaves investors vulnerable to irrational policies and actions. And Foresight Group’s Beth Watkins highlighted how a manager’s reputation will determine which LPs will invest with it.

And yet it stuns us how many people in the industry still give so little thought to these social-governance issues, casually dismissing them as ‘soft topics’ – especially given that the consequences can be so severe.

In our March issue roundtable, Ardian’s Marion Calcine warned of the “negative advertisement [generated] in cases where companies have gone bust, notably due to high levels of debt”. That “negative advertisement” can put pressure on entire sectors, even when the highly indebted companies in question have not gone bust.

In the UK, for example, high levels of debt within utilities operators – and the impact this has had on consumers – have contributed to a hardening of tone from the regulators. In an article published in late February in the Financial Times, Ofwat chairman Jonson Cox told water companies to prepare for “peak intrusion” as his organisation pushed them to be “more mindful of their social obligations”, and to keep a lid on rising bills, excessive debt and leaks.

The ‘S’, of course, has for a long time been the hardest nut to crack. JPMorgan’s Pil and Partners Group’s Esther Peiner, who also took part in our roundtable, both acknowledged how difficult it is to measure the social component of ESG. To make matters worse, “social factors are deeply influenced by local context”, as Pil highlighted.

But the ‘S’ is crucial to engendering public trust, a volatile commodity whose importance the industry is arguably underestimating. Former CIA media analyst Martin Gurri, feted in some corners for predicting Brexit and the rise of Donald Trump in his 2014 book The Revolt of the Public and the Crisis of Authority in the New Millennium, explained the challenge in a March interview with The Intercept:

“To function properly, industrial institutions need to have some proprietary control over the stories that get told about them. Once this control is lost, and a host of competing narratives about them arise, public trust inevitably starts to evaporate. This is what we see happening all around us. The effect has been a massive crisis of authority.”

Ultimately, LPs will be key to ensuring the industry is delivering on the entire ESG package. The signs are they are taking it seriously. First Super chief executive Bill Watson cautioned asset owners recently on the perils of offering a substandard service. And the Chicago Teachers’ Pension Fund is showing its willingness to put its money where its mouth is with its $25 million mandate for a minority/women-owned infrastructure firm.

As Peiner warned in our roundtable: “In five to 10 years, we will see that certain assets will be easier to divest because they are ESG-compliant, while others will sit on the shelf because no one will want them.” That will apply to firms too.