Integrating impact in infrastructure investment strategies and operations
Over the last 4 years Meridiam and ENEA Consulting have collaborated, both on identifying and de-risking new investment opportunities – in the low carbon transition field – and on designing a unique “impact” framework for Meridiam that supports its investment thesis in sustainable infrastructure. Infrastructure is a sustainability and resilience enabler and together they represent interconnected longterm value for the entire stakeholder spectrum.
Last month, Meridiam presented investors with an annual impact report of activities across all of the firm’s investment funds against a combined framework of ESG-SDG* target and performance indicators, using a proprietary, purpose-built impact evaluation system that we believe is unique in our field. Here is what we have learned about the complementarity of impact and financial performance of investment in infrastructure. More important now than ever, we would like to share our approach and conclusions.
Developing and investing in high impact infrastructure globally is one of the main challenges of the coming decades and a condition to a long-term sustainable future. It is necessary and possible to act now, and the market is ready for it, specifically to provide an immediate but sustainable response to the current sanitary and economic crisis.
Infrastructure is a priority to design a low carbon and inclusive economy as it allows most of the physical flows that support the “real” economy (information being transmitted through datacentres and fibre networks; mobility relying on public transportation, roads, airports and highways; international trade relying on harbours and global logistics).
Infrastructure should be considered and designed as an enabler to sustainable activities. To state the obvious, developing gas supply infrastructure in ports will be a pre-requisite to have ships switching from oil to (bio)gas, strengthening electricity transmission networks is essential to exploit the full potential of renewables and developing high performance public transport infrastructure is key to alleviate congestion.
Infrastructure also encompasses social infrastructure which form part of any country’s ability to provide sustainable public service to its population in relation to health, education, access to a fair justice system etc. Such elements are fundamental to address public expectations.
Dealing with infrastructure is also a long-term play. Infrastructure projects are long-term assets and tend to lock our choices for 50+ years in many cases. We need to fully integrate long term sustainability targets into infrastructure planning and development, and it has to be done systematically in all new projects. (baked in like the digital transition with more economic inclusion from day 1)
To encourage a more sustainable economy, we will need huge amounts of capital being deployed in new infrastructure and revamping of existing ones, to support the emergence and deployment of sustainable solutions. According to the OECD, a $6.9 tn annual invested per year until 2030 will be required to meet Paris Agreement target. As these new investment needs are – by design – aligned with a long-term sustainability agenda, they represent promising opportunities assuming they can deliver attractive risk-adjusted returns.
We believe this is the case as sustainable considerations and risk management have a lot in common when it comes to infrastructure investment. Properly designing and assessing projects to meet sustainability goals means thinking far beyond current environmental, social and governance (ESG) practices and obligations and to anticipate the full spectrum of long-term risks and opportunities. Considering both the impact that environmental and social changes can have on assets, and the impact generated by these assets on their environment and social context, throughout their life cycle, is critical.
Sustainability matters become extremely strategic for investors as they determine the long-term value of these assets. From a risk perspective, facing water shortage on power plants, as it already happens to Indian utilities for instance, designing mobility infrastructure that are not adapted to future mobility uses, or not anticipating the carbon value when structuring an investment in airports will very likely affect long-term and total returns. This goes beyond the well-known concept of carbon-intensive stranded assets as even green assets can become stranded if for instance, they do not address adaptation considerations.
Societal, market and technological shifts now offer a plethora of unprecedented opportunities for asset managers to achieve attractive returns, deploy investments and deliver higher impacts: citizens are demanding more action, new technologies and innovative business models are stepping up, and we are seeing a strong evolution of financial regulatory frameworks and initiatives from the finance industry.
This push has led to the evolution of new frameworks to incorporate the social, economic and environmental dimensions of our changing society. The United Nations, through the Sustainable Development Goals (SDGs), provides an international tool that embraces the full spectrum of such impacts. The European taxonomy is designed to include a more stringent integration of environmental and social aspects of business activities and investments called “sustainable”, although technical criteria are yet mainly focus on greenhouse gases.
Large asset owners’ recent commitments to re-allocate capital to sustainable activities (e.g. GPIF, NZ Superfund, the UN-convened Net-Zero Asset Owner Alliance representing nearly USD 4 trillion are creating a large demand for sustainable assets. This has led to an oversubscription of green papers as investors anticipate an impact on the long-term value, the cost of capital as well as on the “licence to operate” of the underlying assets they invest in.
We need collectively to make sure that these developments are moving in the right direction from an environmental and social standpoint. This means having the adequate tool to measure and monitor impact.
On this front, the measurement of “impact” also showed recent progress thanks to new frameworks, tools and data allowing corporate and financial players to better understand risks and opportunities. Although imperfect, there is a growing amount of higher quality data available. This is either generated by companies (meters, geolocation technologies, artificial intelligence, apps providing real-time and/or visualisation tools), regulation (mandatory and homogenised reporting) and better scientific approaches to anticipate and fully evaluate impacts (global and sectoral climate scenarios, lifecycle analysis, carbon and water footprints).
We believe this is just the beginning of a major evolution. After having designed a very sophisticated accounting and financial system, we now need to develop a robust accounting system for environmental and social aspects for unlisted assets, starting with infrastructure. It is complex but innovation will keep accelerating as stakeholders are now truly looking for it.
Here are some lessons we can share after two years of intense research, collaboration and implementation efforts to integrate “impact” in a concrete and ambitious way into the real life of Meridiam’s activities:
- Consider a holistic framework to cover all type of impacts and avoid shortcuts. Be more granular on what is the most important (concept of materiality). Adapting efforts to actual materiality is mandatory.
- Do not remain at the surface as the devil is often in the detail and outcomes may be counterintuitive. Being granular and project specific on what truly matters (e.g. looking at behaviours, supply chain, externalities) is essential.
- Contextualize impacts depending on the type of geographies you invest in
- Develop relevant and detailed KPIs at the asset level.
- Set objectives and benchmark yourself.
- Design an “impact roadmap” to achieve these objectives and implement it. Adapt methodologies, tools and procedures to manage impact throughout the life of the fund.
- Make performance assessment and reporting tools user-friendly and visual – which does not mean “simple” nor “fully standardized” – for all your stakeholders
- Onboard stakeholders and make it part of your value proposition to align interests
- Be transparent and ready to be challenged.
- Once you have integrated impact at the right level, you can explore further synergies with your financial and investment strategy.
Of course, it takes time and requires top management support, energy, efforts and money to design such a strategy and to implement it properly. However, we believe players involved in infrastructure investing should consider it as a core business methodology, not a “nice to have.” This is because infrastructure investing and sustainability are now inextricably linked.
With much momentum and progress to date there is inevitably more work ahead. Below are some considerations to keep moving things forward:
- Push for the development of ambitious and robust methodologies and impact strategies, even if this represents an immediate investment.
Development of innovative financial mechanisms would help to align the interests of stakeholders and share the delta of value created or add value to strategies aiming at optimizing long-term environmental and social impacts.
- Accelerate research on the correlations between impact and “risk/return”
- Train all stakeholders on impact
While much effort will be needed over time, we are convinced, based on our practitioners’ experience, that new approaches and standards can be implemented to assess and monitor positive impacts of infrastructures and go beyond current practices. This is a demanding path but we believe this journey will help our industrial community to frame more resilient investments to the benefit of all. Our belief in this approach runs deep, and our capacity to translate this from vision to implementation bears witness to our level of commitment. Our hope is that this path will lead to a sector-wide transformation, with ESG-SDG impact assessment becoming a mainstream requirement for all infrastructure investment.