Infrastructure investing has looked like a very good business in recent years. Initially, interest in infrastructure was due to its role as a long-term, inflation-resistant vehicle for institutional investors. But the crying need for building, repairing and upgrading the built world while most governments are short on funds has given it an almost socially-conscious image.
Most such funds have realised they can easily more towards doing ESG-related investments. Often, it’s just about looking for the right investment option.
For example, Edmond de Rothschild Asset Management (UK) Ltd recently handled a transaction for a leading provider of offshore support vessels, explained Audrey Colin-West, managing director and head of transport and social infrastructure, real assets and structured finance. The provider wanted to transition from traditional rescue vessels for the oil and gas industry to the service operation vessel (SOV), the ships that are used for offshore wind farm maintenance.
“When we looked at this transaction, we decided not to take part in the refinancing of the term loan which was dedicated to the existing fleet of rescue vessels, with a lot of exposure to oil and gas,” said Colin-West, and instead supported the construction of a facility to build SOV vessels.
Rapidly-growing funds
Edmond de Rothschild launched its infrastructure finance offering in August 2014 with 500 million euros of assets under management (AuM). The fund is now at 5 billion, mostly raised from institutional investors.
Alexandre Baudin, vice-president of I Squared Capital, a 10-year-old global infrastructure manager with 36 billion euros in AuM explained that ESG has risen in the priorities of investors over the past decade to be one of the top three.
“By investing in processes, in humans, in all sorts of resources at portfolio company levels, we will reap the benefits of these investments when we sell these businesses eventually,” he said.
Infrastructure ESG challenges
However, like everywhere else in sustainable finance, there are challenges for ESG and infrastructure. While emphasising that her firm sees ESG as being integral to the green transition, Gwen Colin, the ESG director at Vauban Infrastructure Partners (which manages 7.1 billion euro AuM), agreed with other green finance professionals about the limitations of current EU legislation.
Colin also agreed that there is a ESG data collection issue. But she said that in working with real assets, data collection in itself is not a problem. She said the problem is the growing diversity “a real cacophony” of demands for reporting and incompatible processes.
“All the time they are spending in reporting data, they should be on the ground finding action plans and initiatives in order to have better (ESG) results,” she said.
Dealing with economic changes
While infrastructure funds did very well during the worst of the Covid-19 pandemic, the developments of 2022, with interest rate hikes in reaction to inflation caused by the easing of pandemic restrictions and the energy consequences of the war launched by Russia against Ukraine have forced them to adapt but have also created opportunities.
Dorin Alexandru Badea, senior investor director of Amber Infrastructure, discussed a hydrogen-ready gas transmission asset it is financing in Romania that could link Black Sea gas fields to the main backbone European-financed 500 million euro BRUA pipeline through Romania.
“That would provide a significant addition to energy security and to diversify diversification of supply sources, to a number of Central European countries, some of them essentially energy starved,” he said. “Finding the right balance (between energy security and the energy transition) is extremely important.”
Infrastructure inflation mechanisms
Infrastructure assets have a certain amount of immunity to inflation hikes because very often they have an inflation protection mechanism passing increased costs on to end users, explained Edmond de Rothschild’s Colin-West. However, as her fund is a debt fund, she said “the main issue with inflation is actually the impact on the portfolio valuation.”
Most transactions carried out prior to this year were done, like so many household mortgages, on a fixed rate basis. This means high inflation has a “very negative impact” on valuation, as well as the investors’ asset allocation for infrastructure debt funds.
However, Colin-West said, there is a way around this: “leave the financing floating – so not fix the base rate.” Since inflation and interest rates are interlinked, “by leaving the base rate floating, at least the lender will capture the inflation to a certain extent.”
Another alternative is to structure inflation-linked products – inflationary financing, where the principle is readjusted against an inflation index. “It’s quite common in the UK,” said Colin-West. “It’s a little less common in Europe, but it clearly can be the way forward.”
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