Roberto Ballinez
Executive Finance & Infrastructure Director
HR Ratings
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Expert Contributor

Responsible Investment in Infrastructure Projects

By Roberto Ballinez | Mon, 04/25/2022 - 09:00

Currently, the idea of aligning environmental, social and governance (ESG) objectives with the expectations of a financial return from projects related to infrastructure construction, operation, rehabilitation, or maintenance must consider, as a premise, the fact that any investor may require from the project sponsor or the issuer of the debt associated with it, reliable, relevant, and exhaustive information on ESG risks.

If the issuer does not comply either with the generation of information or with the ESG commitments offered, the market could isolate it from sources of financing. This would decrease the project’s financial returns. Under this scenario, the consequences of failing to meet commitments could potentially be negative. Therefore, the issuer must create and protect its reputation with investors, since reputational risks can become financial risks.

Although the incentives (between the buy side and the sell side) seem to be aligned to carry out responsible investments and although we think that the issuers, committed to this reality, will obtain a win-win relationship, becoming an infrastructure company that is concerned about ESG issues is not easy, even more so because the process to achieve it is often rife with obstacles.

Investment in infrastructure is fundamental to the functioning of any human community. Society needs energy, water, housing, transportation, hospitals, schools, drainage, public lighting, and roads. Also, there is always a need not only to build new infrastructure but also to preserve, expand, and upgrade existing assets. However, due to the characteristics of these assets, the resources to build, operate and maintain them are generally high and are conceived under a long-term horizon.

Now let's talk about the challenges and obstacles. Due to the wide variety of assets in the infrastructure sector, it is natural that each project faces different ESG risks. Beyond technical or financial issues, sometimes projects are prevented from starting or must stop due to environmental or social issues. Some examples are the release of rights of way, biodiversity issues, the regulation regarding environmental impact studies, and the human rights of the communities around a project. In most cases, the company also requires help from the government to solve these issues.

Regarding the supply chain, a technically inevitable obstacle is the fact that the infrastructure sector intensively uses materials and supplies that, typically, affect the environment. The cement, steel, paint, and asphalt industries, among others, generate greenhouse gases that are difficult to eliminate or offset. The emissions come from the burning of fuel to generate thermal energy and from the chemical processes related to manufacturing the inputs.

If, in addition, these inputs are manufactured in places far from where the work is being carried out, their transportation will require additional burning of fossil fuels. The situation worsens if these inputs come from countries where the energy to manufacture them is generated in coal-fired power plants.

Another challenge is that although many companies that have committed to building resilient infrastructure are generating projects that can meet certain ESG performance indicators, over time they may discover that current technology is not enough to reach them. In addition, determining and comparing indicators related to energy consumption, water management, waste generation and biodiversity degradation, among others, can be difficult when there is no regulation that requires companies to uniformly disclose such information.

Paradoxically, even though the infrastructure sector faces challenges in mitigating its ESG risks compared to other sectors of the economy, much of the ESG investment in the world is associated with projects from this sector (particularly energy, housing, and transport). According to the Climate Bonds Initiative, the proportion of green bonds issued during 2021 for these purposes represented 52.1 percent in terms of amount placed.

This leads me to think that the sector is aware of what ESG risks represent and that it is incorporating them into its growth processes. However, although this performance shows the good intentions of infrastructure companies, in my opinion, we must pay attention to the materialization of the commitments offered by the issuers. Commitments that, obviously, investors must review when deciding on which project to put their money into.

In conclusion, the infrastructure sector can present a project with good ESG indicators to the market but the important factor for the investor is to know exhaustively what the goals are and how and when they will be achieved. Likewise, it must require the existence of mechanisms to enforce commitments and ensure that these mechanisms are realistic from a financial and operational point of view.

To maintain a position of trust, companies must adopt transparency and responsibility in their daily operations, demonstrating that ESG is a real commitment that is linked to measurable, auditable, comparable objectives that can be shared publicly. For those who do not meet their commitments or obligations, the investor could establish various penalties, including accelerated prepayments, higher surcharges, and retainage.

The transition toward activities and ways of life that lead us to a sustainable world is still a work in process. The challenges are many and they need to be faced with commitment and responsibility. We must encourage those companies that genuinely want to take their first steps in that direction and not punish them for being small or inexperienced. However, along with this trust, compliance and monitoring structures must be created that provide the investor with protection and reliability.

On the other side of the equation, investors must train specialists and create investment and ESG risk committees for the assets in which they invest. A responsible investment means knowing in detail what project will be financed and what ESG and financial risks it entails. Investment funds dedicated to the infrastructure sector can find a roadmap in the information generated by organizations such as GRI, IIRC, SASB, UNPRI and CDSB. This information promotes responsible investment through methodologies, taxonomies, standards, and useful procedures for monitoring these issues. We hope that investors become interested in both the credit quality of the project and the ESG risks behind it.

Photo by:   Roberto Ballinez