Plans to Unleash Sustainable Infrastructure Flows Accelerate

An initiative is working to standardise the asset class with a labelling framework, blended finance options and public-private partnerships.

Even if previously untapped by some institutional investors, the opportunities to invest in sustainable infrastructure could soon grow and reveal manifold advantages.

According to Christian Déséglise, Head of Sustainable Finance and Investments, Global Banking & Markets at HSBC, sustainable infrastructure “is linked to both immediate economic growth and longer-term growth”.

Many agree. Sustainable infrastructure investments are a central driver of the growth story of the 21st century and the delivery of the Paris Agreement, the Global Commission on the Economy and Climate initiative wrote in a 2018 New Climate Economy (NCE) project.

The new growth agenda, as described by the NCE, is based on an understanding that growth, climate action and development are inextricably linked and the “only economic growth path that is sustainable”.

“Transitioning to this low-carbon, sustainable growth path could deliver a direct economic gain of US$26 trillion through to 2030 compared to business-as-usual,” according to an analysis for the report.

The NCE warned however that getting it wrong will lock us into “an unsustainable growth path, with global warming of potentially more than 3°C, severely disrupting the lives and livelihoods of billions, from residents of coastal Asian megacities to farming communities in America”.

Despite the importance of sustainable infrastructure, unlocking investments by the private sector has faced barriers in the past.

Private-public partnerships

A major initiative seeks to tackle these difficulties, accelerate private investment flows and close the sustainable infrastructure investment gap, which the OECD estimated to be US$6.9 trillion per year to 2030.

The private-public partnership platform ‘Finance to Accelerate the Sustainable Transition-Infrastructure’ (FAST-Infra) was founded last year as a collaboration between HSBC, the OECD, the International Finance Corporation (IFC), Global Infrastructure Facility (GIF) and the Climate Policy Initiative, under the auspices of French President Emmanuel Macron’s One Planet Lab.

It has evolved into a broad-based collaboration involving banks, asset managers, governments, multilateral development banks (MDBs) and NGOs among others.

FAST-Infra works on five solutions to create greater standardisation and transform sustainable infrastructure into a mainstream, liquid asset class.

Déséglise comments: “The first two of these ideas are potentially transformative for the market as a whole: the ‘sustainable infrastructure label’ and the ‘technology enabled [project life cycle] platform’ to facilitate origination and distribution of infra loans.”

The label will give governments and investors a clear vision about the requirements that need to be fulfilled to classify infrastructure, such as buildings and transport, as sustainable. It seeks to create a definition and common standard for the asset class, which has been lacking so far.

“We think that a consistent and broadly accepted label defining sustainable infrastructure assets around ESG, as well as climate resiliency dimensions, will have a catalytic impact in two areas; it will serve to draw in private capital; and it will encourage host governments and developers to introduce higher sustainability standards into the infrastructure they are developing at the pre-construction phase,” Déséglise explains.

The proposed label draws on existing frameworks, standards, and taxonomies to provide coherency and comparability across the global infrastructure finance market, such as the Green Bond Principles, the UN Sustainable Development Goals (SDGs) or the EU Taxonomy. A formal public consultation period for the label will be launched in mid/end May and the final version is planned to be published in time for COP26 in November.

Jason Zhengrong Lu, Head of the GIF, which co-chairs the label work with Australian financial services group Macquarie, explains that the definition focuses on the dimensions of “environmental, social, governance, and adaptation and resilience, and then shifts these into a series of 15 different criteria”.

For institutional investors, the label will create transparency and help to manage ESG and reputational risks by setting up disclosure and reporting standards, he says.

The remaining working groups of the initiative support the financing of projects, as they aim to build deal-flow and de-risk sustainable infrastructure projects with elements of blended finance, adds Déséglise.

It includes a public-private partnership for a global off-take liquidity risk guarantee, i.e., for example, a specialty insurance company that provides liquidity guarantees for a fee; an open-sourced managed co-lending portfolio programme; and a sustainable financing facility for national development banks to provide on-lending to projects.

But FAST-Infra alone cannot solve all the bottlenecks to mobilise private finance at scale.

It needs to collaborate with other initiatives, which provide support at the upstream and midstream stages of project lifecycles.

Government collaboration

One of these initiatives is the GIF, a partnership among governments, MDBs, private sector investors and financiers. It supports the preparation, structuring and de-risking of sustainable infrastructure projects in emerging markets.

GIF works to create a pipeline of bankable projects for private investors, which has historically presented a key barrier to sustainable infrastructure investments.

As Lu explains, “economic infrastructure is typically very capital intensive”, with relatively large project preparation costs and requiring several years of preparation time.

Private investors don’t normally have the high-risk appetite required for such large-scale infrastructure projects, for which governments are often responsible, he says.

Since its inception in 2015 as a G20 initiative, the GIF has supported 102 infrastructure programmes and projects in 50 emerging markets and generated US$50 billion in private finance for a total of US$76 billion investments.

It does this by tapping into its private sector network and providing both funding and hands on technical expertise to MDB partners and governments to ensure that projects are bankable.

In partnership with the UN-convened Global Investors for Sustainable Development (GISD) Alliance initiative, a group of CEOs seeking to deliver solutions to scale up long-term investment in sustainable development, the GIF is also in the process of creating two downstream blended finance solutions.

One is a project-level credit enhancement facility, which addresses foreign exchange risk and refinancing risks for example, as well as a portfolio-level blended finance facility.

Enabling policy and regulation

From a macro perspective, supportive government policies are crucial in shaping the investment opportunity.

By introducing strong, innovative and enabling policies, many emerging market governments have been able to attract investors to sustainable infrastructure, a 2021 report by the Climate Finance Leadership Initiative (CFLI) says.

Most sustainable infrastructure investments have a lifetime exceeding 15 years, which means that investors looking to mobilise investment in new sustainable infrastructure need to account for the economic and currency profile of each country, CFLI writes.

Brazil, as a result of its comparatively stable and enabling environment, “attracted around US$70 billion in clean energy projects between 2010 and 2020, including significant volumes of cross-border investment”, the CFLI report adds.

To further increase sustainable infrastructure finance, it can require changes in regulation for institutional investors.

Michael Sieg, Founder and Group Chief Executive of ThomasLloyd, a Zurich-based infrastructure impact investor for emerging markets, explains that in particular institutional investors face barriers because of the illiquidity profile of infrastructure assets and their categorisation as private equity.

He says that “the big facilitator would be if regulators would allow institutions to invest in infrastructure directly – direct investment, direct lending”.

Changes to the Swiss pension fund regulation adopted in 2020 provide examples of more favourable regulatory treatment of infrastructure evolving. The BVV2 separates infrastructure from other alternative assets and allows an allocation of up to 10% of total assets only to infrastructure.

Law firm Linklaters said that the review of the European long-term investment fund (ELTIF) regulatory framework has the potential to be a key vehicle in the EU’s drive to increase capital flows into long-term real economy investments such as infrastructure projects.

A legislative proposal for the amendments to ELTIF is planned to be adopted by Q3 2021. In the same quarter, the Commission will adopt its review of prudential rules (Solvency II Directive) to create better incentives for insurers to invest in infrastructure projects.

Evolving opportunities

Common reasons why institutional investors incorporate infrastructure in their portfolios are a desire for reliable income streams, low correlation to other asset classes, and inflation hedging.

Despite liquidity concerns, in a time of low interest rates, the attractivity of unlisted infrastructure investments is rising.

HSBC’s Déséglise explains: “Returns in the private market can be better than in the public market because the former offers an illiquidity premium, and prices in the private market are not compressed by quantitative easing as in the public market.

“At the same time, credit downgrades are uncommon in the private infrastructure space, and recovery levels on bankruptcy generally higher than for corporate credits.”

“While some large pension funds make relatively high allocations [to unlisted infrastructure equity], the average amongst large institutions is 2% and the average amongst a wider group of pension plans is 1.3%,” according to EDHECinfra, an international index and research provider, citing an OECD survey in a 2021 paper.

Frederic Blanc-Brude, Director at EDHECinfra, believes that “investors fail to invest enough because they could not until recently access the right benchmarks, including data that measures risk and how correlated with other asset classes infrastructure is”.

But now they can, by using newly developed EDHEC indices, which reflect the true value and risk of these investments, he says.

The EDHEC emerging markets unlisted infrastructure equity index returned 11.44% over the past three years for the regions Latin America and South East Asia, as of Q1 2021.

Smaller sustainable infrastructure projects may also be less risky for investors.

GIF’s Lu explains that smaller projects take a relatively shorter time to put together, require less capital, and are more manageable from a private sector perspective.

While private investments in sustainable infrastructure have been slow so far, activities point to rapid changes lying ahead for the asset class.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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