Factoring in the Environment dimension of ESG in long- term infrastructure investment

Infrastructure and ESG (Environmental, Social and Governance) dimensions should be natural bedfellows: after all, infra is about providing essential daily-uses services for the community, – such as transport, energy, utilities, telecommunication, social facilities, etc – underpinning the whole economic and social development.

ESG has grown considerably in its importance to the investor community – in the context of global calls for reducing carbon footprint, combatting poverty, promoting healthy and safe labour, reinforcing corporate governance, while promoting diversity and inclusion.

For long term investors in infrastructure, like the ones federated under LTIIA, there are even more reasons to be serious about ESG, and more broadly sustainable development issues. Probability of a downside ESG event that can trigger financial liabilities – from environmental pollution to a governance malpractice – grows with a longer hold, hence implementation of ESG prevention and mitigation measures becomes much more important for sustaining financial performance of the investment[1]. The recent California power utility PG&E bankruptcy, the first ever large infra corporate default directly linked to Climate change, makes a clear point that the risks are already very present.

Failure to adequately address environmental concerns, whether drought-related wildfires or carbon emissions, can not only trigger financial liabilities, but can result in serious environmental damage and human costs, including the loss of life. The long hold periods of infrastructure investments amplify these risks, as well as social or governance risks and make their mitigation critical to sustaining financial performance over the long  run.

Yet, notwithstanding the broad agreement on the importance of ESG, still relatively few investors understand what it takes in practice to invest in infrastructure responsibly. Climate-change adaptation is a good case in point. “What can be measured can be managed”. It’s not just  enough  to tick  boxes, and  have an overall  good synthetic assessment when it comes to  ESG (PG&E was rated rather favourably in that respect,  due to  is obligation under the California law to   promote renewable energy  in its mix): you  have to have a more granular approach  and not rely  exclusively on third-party  data providers to make up your mind.

The risks for investors aren’t just financial, as for instance with the likely effect on a portfolio’s performance of increased fuel prices and stricter regulation carbon pricing. A second concern is the significant reputational risk associated with carbon-heavy projects, which might deter responsible and ethical investors from otherwise valuable projects.

This is where infra investors, and external stakeholders, can usefully  refer to  existing guidance or on-going work by  GRESB  (the GRESB infrastructure asset assessment, offering quality ESG data and advanced analytical tools to benchmark ESG performance, identify areas for improvement and engage with investors ) or LTIIA ( The ESG Handbook  for Long term investors in Infrastructure) just  to mention a few: many more are active in this sustainability rating  market  like GIB SuRe, Envision-Zofnass, ISCA, or the IDB Safeguards and WBG-IFC performance standards…

Finally, regulation-wise, ESG criteria are also considered when assessing the regulation-requirements applicable for banks in the ‘Basel III framework’. In their transposition of these guidelines, the European institutions are currently   considering , similar to what is envisaged for insurance undertakings ,that  capital charges for exposures to infrastructure projects would be reduced, provided those projects comply with a set of criteria, including ESG, deemed to lower their risk profile and enhance the predictability of their cash flows.

SO, checking  the ESG dimension is no longer an  option for investors, bankers and regulators alike when it comes to  infrastructure  investment: it is now a key part of the due diligence  process required, but one that  still needs further benchmarking  and standardized approach going forward. 

[1] A market study conducted by  GRESB and EDHEC Infra, and to  be published by  spring  2019,  should start documenting  this rather intuitive take away that  financial  performance in the long  run is linked to  incorporating  ERSG criteria in the due diligence, project  section and rolling  out process