Themes of the Year 2019: ESG is not quite ready for its close-up

Mainstream recognition of these practices ended up highlighting the difficulties the industry faces in measuring and adhering to them.

Looking back, it’s fair to say 2019 has been the year when environmental, social and governance issues have been thrust into the mainstream of infrastructure investing. Like anything that falls under the limelight, though, it’s fair to say the journey has not been entirely smooth.

Case in point: in February, we ran a guest article by Anton Pil, managing partner at JPMorgan Global Alternatives, stating that “ESG has become the dominant trend” in infrastructure. Pil correctly identified the consequences that firms would suffer if they failed to adhere to ESG standards while underlining their importance.

And yet, in late June, as if to illustrate just how difficult it can be to adhere to those practices, JPMorgan – alongside fellow shareholders Hermes Infrastructure, UBS Infrastructure and Whitehelm Capital – found itself in the eye of the storm when portfolio company Southern Water, a UK utility, was fined a record £126 million ($166 million; €149 million) by regulator Ofwat. The reason for the fine: “Serious failures in the operation of its sewage treatment sites and for deliberately misreporting its performance,” according to the watchdog.

The Southern Water debacle exposed the vulnerabilities that nascent ESG scoring systems still have. GRESB Infrastructure, an ESG benchmarker fast becoming the industry standard, had awarded the utility a five-star rating in its 2018 results. The Archmore International Infrastructure Fund I, the UBS vehicle holding Southern Water, was given a four out of five score in the benchmarker’s 2019 results. In marketing materials dated 13 September – after the fine had been levied – UBS was still touting Southern Water’s five-star GRESB rating.

Verification – of ESG scores and measuring in general – quickly emerged as one of the challenges facing the industry in our Deep Dive on the issue, published in early December. Others challenges included, to name just a few: a lack of standardisation (and whether that is possible or desirable); little LP consensus over the importance of ESG; and differing opinions on whether ESG scores should be used as the basis to obtain favourable loan terms.

The good news, as we’ve also highlighted throughout the year, is that the momentum around ESG is not going away. Therefore, some of these growing pains will continue to be ironed out. Hopefully, the systems underpinning ESG measurement will have become much more robust in a year’s time.

As DIF Capital Partners’ head of ESG, Frank Siblesz, put it: “It took over 500 years to develop accountancy standards, and now on the sustainability side we’re expected to develop reporting standards in 10 or 20 years. There’s still a lot of room to improve.”

At Infrastructure Investor, we expect those improvements to come thick and fast.