This article is sponsored by EY Luxembourg.
In recent years, we have seen the rise of sophisticated asset-owners and long-term investors (eg, pension funds) seeking to align their investment strategies with sustainability concerns, impacting their approach to infrastructure investments.
At the same time, the gap between infrastructure projects and the ability of countries to pick up the bill is becoming less and less maintainable, allowing private investors to reassess their investment allocations.
The sustainable infrastructure sector should therefore undergo exponential growth in the coming years.
What are the main challenges of sustainable infrastructure investment today?
Fast-growing populations and aging infrastructure networks are, together with public-debt limit constraints, the main challenges facing the sector. Furthermore, infrastructure investments, mostly public assets, have a greater appetite for sustainability if they want to meet taxpayers’ expectations. When an infrastructure investment is co-invested privately, investors’ mindsets will have to change to capture its real return. Infrastructure investments will indeed require ongoing assessment and monitoring of variables for several years prior to achieve the “big picture” of real value creation from a sustainable point of view.
Modern investment strategies are therefore not only about rebuilding existing infrastructure but should also focus on applying new sustainability standards in the pursuit of a positive impact on the whole community. This revisited approach to infrastructure investment should therefore consider technological disruption, carbon footprint, climate resilience, changing consumer behavior and awareness of environmental and social governance as key drivers.
Investing in infrastructure today therefore requires reconsideration in investment strategies, such as viability, sustainability and timeline. Infrastructure – typically considered as a conservative asset class – is now facing new risks, and stakeholders within this market will have to rapidly adapt and consider the feasibility of the projects they would like to invest in.
How to deploy effective key performance indicators (KPIs) for sustainability?
The performance of a sustainable infrastructure investment should not only be measured by and reported according to financial performance but also to social and environmental impacts.
In this context, KPIs are now shifting toward measurable sustainability and positive footprint on environmental (nuclear energy, carbon emissions), governance (absence of corruption) and social concerns (human rights, aging population) in the long run.
How to integrate environmental, social and governance criteria in the infrastructure investment market?
Over the past few years, deplorable business practices – including child labor, human rights abuses, negative environmental impact, poor governance and lack of gender equality – led to the birth of a new type of consumer, focusing on the fight for social and environmentally-conscious practices.
Measuring KPIs: Best practices
Establish social and environmental objectives for relevant stakeholders
Set performance targets related to the pre-defined objectives using standardized metrics (ie, measuring the carbon footprint of the assets).
Manage and monitor the performance of final beneficiaries against those targets
Report social and environmental performance to relevant stakeholders
This shift in consumer behavior has triggered a growing concern for investors, since they must now weigh ESG criteria as an additional factor when it comes to investing in a specific project. This changing behavior will impact our approach to infrastructure. As a result, stakeholders are increasingly seeking to align market-competitive financial returns with environmental, governance and social indicators.
In this context, there is a growing appetite for responsible investment vehicles or instruments such as Green Bonds (bonds whose proceeds are invested in eco-friendly projects), or Impact Bonds (bonds whose returns are linked to the achievement of desired social objectives) with a label delivered by a recognized agency. These kinds of instruments are typically used to invest in renewable energy projects as well as for transportation (eg, charging infrastructure for hybrid/ electric vehicles), utilities (eg, wastewater treatment), and social infrastructure (eg, healthcare, education and recreation facilities).
What about Luxembourg?
In Luxembourg, the Luxembourg Finance Labelling Agency (also known as “LuxFLAG”), is an independent, non-profit-making labeling agency created in 2006 by the European Investment Fund, the Luxembourg Fund Industry association, the Luxembourg Bankers’ Association, the Luxembourg Stock Exchange, the Appui au Développement Autonome (ADA), the Luxembourg Ministry of Finance and the Ministry of Foreign Affairs in Luxembourg. LuxFLAG promote the raising of capital for responsible investing sectors through the issuance of several labels (climate finance, ESG and microfinance labels) and Green Bonds certifications.
Furthermore, Luxembourg is not only offering a large variety of financial solutions for sustainability, impact and responsible investment structures, but also hosts the stock exchange with the largest market share of listed green bonds worldwide.
Can we hope for a better future?
The Report on US Sustainable, Responsible and Impact Investing Trends 2018 published last year reports that one out of four dollars of professionally managed assets ($13 trillion in total) now include sustainability criteria into their investment strategy, which is a considerable increase, as that amount was close to $3 trillion overall in 2010. Also, BlackRock has recently predicted that the investment in ESG funds will rise to more than $400 billion over the next 10 years.
Today, fund managers, development finance institutions, diversified financial institutions/banks, private foundations, pension funds, insurance companies, family offices, individual investors, NGOs, and religious institutions have turned into a more sustainable infrastructure investment.
According to a Global Impact Investment Network report published in April, “Over 1,340 organizations currently manage $502 billion in impact investing assets worldwide.”
Given the gap between infrastructure needs and countries’ abilities to fund them, the global demand for investment in infrastructure should continue to be very high in the coming years. The growing consideration of social, governance and environmental factors in investing is also a sign of a larger shift in the global financial markets – an increasing number of people are recognizing that their money should do more than just make more money but that their investments should also seek to fuel meaningful and sustainable social and environmental impacts. Consequently, the future of sustainable infrastructure investment is undoubtfully bright!
EY Luxembourg is taking a proactive approach in the development of infrastructure asset classes by living up to our commitment to help our clients leverage on changes and seizing new opportunities. Recently, EY held a seminar on infrastructure investment, where top specialists in the areas of Private Equity and Sustainable Infrastructure talked about the current trends taking place in the market.
Discussions also took place around the challenges being face by stakeholders who are aiming to create value and make an impact through their investments. Overall, the gathering proved to be successful in identifying where the needs for ad-hoc solutions lie. However, it also served as a reminder that key questions and challenges remain throughout the industry.
Renaud Labye is an associate partner, Private Equity, Tax Advisory at EY Luxembourg.
Zeeshan Ahmed is an associate partner, Private Equity & Infrastructure at EY Luxembourg.
Pamela Alvarado is a tax advisory consultant at EY Luxembourg.