Out-Law News | 29 Aug 2022 | 1:55 pm | 5 min. read
Organisations behind major infrastructure projects should use the procurement process to ensure their projects conform to increasingly stringent environmental, social and governance (ESG) standards, experts have said.
Speaking at a recent event hosted by Pinsent Masons, experts from Deloitte, Norddeutsche Landesbank and Pinsent Masons warned there are likely to be funding implications for infrastructure projects that are unable to demonstrate ESG credentials.
The Pinsent Masons event focused on infrastructure investment. There was agreement across the panel that infrastructure investment is necessary to promote economic growth and that projects in the pipeline need to be deliverable, bankable and fair.
Much of the discussion at the event focused on the fact that many of the major infrastructure projects in the years ahead are anticipated to be linked to the energy transition – a concept that imagines a shift away from economies powered by fossil fuels to those powered by low carbon energy technologies instead – as policymakers and businesses alike across the globe pursue ‘net zero’ emissions and other decarbonisation targets.
Gillian Frew, infrastructure finance expert at Pinsent Masons, said: “The infrastructure sector is one of the largest emitters of carbon dioxide, but the challenge to respond to the energy transition is competing with the low profit margins already putting the sector under pressure. As long as price is the primary factor in public sector procurement, low carbon innovation which drives up costs will not be a priority.”
“That said, the push towards lower carbon technology is coming from different stakeholders and, increasingly, finance will not be available to fund projects which cannot demonstrate ESG credentials,” she said.
Kim Curtain, partner at Deloitte Australia, said that organisations involved in infrastructure projects are having to be nimbler and more adaptable to changing requirements from ESG initiatives and the impact on models of project finance. She said that there is an onus on governments to properly reflect the time, supply and cost challenges for industry involved in engaging with the ESG agenda in their procurement processes.
“Government needs to think differently about how it assesses value for money, as well as be really transparent about how things will be assessed so there is no incentive for bidders to unnecessarily low-ball and cut scope,” Curtain said. “The challenge is how you bring that in, but government needs to play its part. If ESG is a priority for government, as it should be, procuring agencies need to value it as part of their bid assessment – those qualitative outputs need to be given sufficient weight in the evaluation for quality ESG outcomes to be prioritised by bidders.”
Project finance specialist Catherine Workman of Pinsent Masons agreed. She said: “If you are bidding for a project and are expressly asked to include some particular requirements then everyone has to bid those. You need to create a level playing field. ESG costs. One of the ways to drive it is for the public sector to set the requirements and private sector lenders to get in behind it.”
John Hanley, senior director at Norddeutsche Landesbank, said that the ESG agenda is already influencing how new infrastructure projects are financed.
“We have looked at a number of projects over the last year where we embedded incentives in the structure with the intention of encouraging the shift towards leaner, greener, more efficient means of delivery of the project,” Hanley said. “For example, in some of the data centre transactions, as they improve their energy consumption metrics for operating the facilities there are reductions in the cost of the debt. We are trying to encourage developers and contractors to make their projects much more efficient and effective from a green, ESG perspective. Making these changes comes at a cost to them but there is the compensating benefit in terms of the reduced cost of debt."
As long as price is the primary factor in public sector procurement, low carbon innovation which drives up costs will not be a priority
Institutional investors are particularly focused on the ESG credentials of lenders’ distribution transactions, according to Hanley.
“If we turn up with a project and are exploring distributing, say, £50 million, one of the first questions they will ask is ‘what are the ESG credentials of the project?’. If it is, say, a waste plant creating noxious plumes of smoke in the English countryside then that will be a very short conversation, whereas if it is a project that is well thought through, has good sustainability and environmental credentials, then you are into a different conversation, so the institution market, from what I can see, is driving a significant change in the pattern of behaviour,” he said.
Frew said that some prospective investors in infrastructure may want to consider a reorganisation of their corporate structures to ringfence part of their business as a venture capital arm that can pursue higher risk opportunities in relation to modern methods of construction or new technologies. She also said that, in the case of new low carbon technologies specifically, consolidation in the market could provide “balance sheet support” and encourage investment.
According to Frew, low carbon technologies are often developed by small companies with small balance sheets, and this can dissuade potential investors from investing in new technology due to how they perceive the balance of risk and reward. If those providers are acquired by larger businesses, this could give prospective lenders greater confidence over the viability of the technologies and enable related infrastructure projects to go ahead, she said.
Workman said financing solutions had previously been found for the problem of small balance sheets behind new technology in the waste management industry.
“Some of the technologies that were being used in the waste management industry, the balance sheet was just far too small,” Workman said. “Fortunately, a large proportion of those were then corporately financed rather than project financed. That allowed some of the bigger waste operators to take a view as to how they would wrap the technology within the construction. In some instances, it was proven technology for them, and they had used it for a long time, so it was easier to do that. The private sector then, in its capacity as a corporate financier, became a non-commercial lender, which was an interesting model at the time.”
Public finance is needed to catalyse investment from commercial lenders in the ‘cleantech’ infrastructure projects required to decarbonise the global economy, according to Hanley.
Hanley said commercial lenders are likely to limit their investment in new low carbon technologies until those technologies have been “well established and proven”. He said governments and development banks have a “hugely important” role to play to support those technologies through to the point that they are “investable” more widely.
“As a commercial lender we prefer to look at tech that is proven and has an established track record rather than taking technology development risk,” Hanley said. “We have seen a number of projects across the jurisdictions we operate in which have had innovative new technology, or new configurations of pre-existing technology, which simply have not worked. That comes at a significant cost to the sponsors and the lenders when it all goes horribly wrong.”
“For the emerging technologies to support the energy transition, we are looking to development banks, such as the EIB and the UK Infrastructure Bank, as these are the institutions that should be offering support. If the government is serious about transforming the economy away from a carbon-based economy to a ‘net zero’ economy then the technology will need to be supported for three-to-five-to-10 years until they are well proven and well established and then they will become investable from a commercial project finance perspective,” he said.