By John C.S. Anderson, Global Head of Corporate Finance and Infrastructure at Manulife
ESG incorporation best practice
In our experience, approaches to ESG incorporation vary across infrastructure investing. What does not vary is a laser focus on the “G” of good governance, which has long been a table-stakes, bare minimum requirement for successful private operation of public-interest assets in infrastructure investing programmes.
How infrastructure investors respond to “E” and “S” issues are better indicators of leading practice. The environment is particularly relevant as infrastructure projects have such a direct impact on biodiversity, resource use and the local environment, as well as potential significant impacts on the energy transition.
The presence of new or existing infrastructure within communities makes handling of social issues another key differentiator in the development of and investment in infrastructure projects. Safe operation, the implementation of diversity, equity and inclusion initiatives, and good community relations play a key role in maintaining projects’ social license to operate and their ability to generate attractive returns to investors.
These factors cannot be applied ad hoc. They need to be integrated systematically across various types of infrastructure assets in portfolio construction. Checklists and frameworks provide a useful starting point to ensure a thorough approach. As infrastructure assets are so diverse, it’s also important that ESG factors are evaluated in the context of their materiality on an asset-by-asset basis. Will mishandling or ignoring these factors have a potential negative impact on an owner’s license to operate, on an asset’s long-term returns, or on the regulatory environment?
Leading practice is also about the sharing of sustainability expertise with others in the industry. This might be through taking the opportunity to lead participation in external initiatives or collaborative engagements. It may also be about actively engaging with infrastructure management teams to help them effectively interact with the natural environment and local communities, engagement that effectively helps them fund their future growth.
What can others learn from infrastructure?
Traditionally, infrastructure investors have been primarily concerned with physical risks. The sector has deep expertise in dealing with these asset-specific exposures. But physical risk is an important consideration across all asset classes and sectors, impacting, as they do, on supply chains, physical storefronts or manufacturing locations, and access to resources such as power and water. Learning from infrastructure investors’ focus on physical risk is certainly something that might provide valuable for other asset classes.
Traditionally, infrastructure investors have been primarily concerned with physical risks. The sector has deep expertise in dealing with these asset-specific exposures
Leaders within the sector have also invested heavily in sustainability professionals to help design sustainable investing processes and provide a range of ESG-related decision-useful metrics. They have demonstrated that the integration of ESG factors into investment analysis and due diligence, aided by credible certification, creates value through stewardship, investment and ESG integration.
As with other asset classes, collaboration is important. At Manulife Investment Management, we have found that participating in collaborative engagements and working groups, promoting sustainability standards and disclosure, and influencing corporate sustainability have all proved effective in strengthening ESG integration within the infrastructure asset class.
What barriers do investors face to further ESG incorporation?
Differences in size, geography and ownership structure can determine the types of barriers faced by infrastructure investors who are concerned about ESG factors. When it comes to addressing ESG issues, resources play a key role, as many smaller firms lack dedicated ESG specialists, limiting their ability to effectively analyse the ESG demands raised by individual assets.
Ownership structures in infrastructure are also unlike other asset classes. Majority ownership positions are unusual and most investors do not directly operate infrastructure assets. We can influence but we cannot control to the same degree as majority owners and operators, making it difficult to guide decisions on the ground. For example, we can look to encourage operators to improve reporting and disclosure by adhering to specific reporting standards, but we cannot always dictate. This is changing, as we are seeing greater levels of collaboration with investors, enabling us to work together to drive effective change.
Measuring this change remains challenging. Key performance indicators around sustainable investment are still evolving and quantitative measures are often lacking, making it difficult to compare and benchmark assets. Increasingly credible reporting standards are emerging and, with heightened interest around sustainable investing, investors are more readily sharing information and metrics to enable proper benchmarking.
The coherency and efficiency of reporting within the infrastructure asset class is improving, and will continue to do so. We are still in the early stages, but we will have more agreed standards in place that will allow us to develop far more thoughtful approaches to monitoring and reporting ESG performance.
We will also see more innovation. Infrastructure investing is already driving some of the most important contributions towards a lower carbon economy. For example, we have invested in new agri-voltaic technology, in a solar project we have developed to bring seven megawatts of solar energy to a community while also maintaining the ground for local cranberry farmers. The project combines potentially attractive risk-adjusted returns generated from long-term contracts and the opportunity to support the local community’s transition to cleaner energy.
We will also see more innovation. Infrastructure investing is already driving some of the most important contributions towards a lower carbon economy
We believe that these innovations can influence valuations, portfolio construction decisions and transaction underwriting. But projects like these require time and planning and arise when ESG issues are placed at the core of fundamental analysis. In doing so, we can demonstrate that strong ESG practices are essential to building strong companies with reputations for excellence.
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