How to de-risk infrastructure finance

Output from a conference hosted by Mott MacDonald at the London Stock Exchange on 29 June 2016 Attracting investment through environmental and social governance Preparing projects to attract better finance options PPP frameworks as a catalyst for sustainable development How to de-risk infrastructure finance

2 I Mott MacDonald I How to de-risk infrastructure finance How to de-risk infrastructure finance I Mott MacDonald I 3 The money to meet development needs is there, but funders are looking for lowrisk investments Unlock US$6trn of annual investment in infrastructure with sustainability Global infrastructure needs are huge. Population growth, expanding consumption, urbanisation, social development and climate change all place giant demands on our asset base. Around 75% of the infrastructure required in 2050 is still to be built. According to the World Economic Forum, global investment in infrastructure needs to hit US$5trn- US$6trn a year for the next 20-30 years to meet global development needs. However, with constrained government budgets and long-term lending by banks curtailed by regulation, where will this money come from? Private capital and investment from nontraditional lenders such as insurers and pension funds have to be mobilised to plug the shortfall. With more than US$80trn in global bond markets, US$60trn in worldwide bank deposits, US$50trn in equity markets and US$47trn controlled by high net worth individuals, sufficient funds exist to drive the development we urgently need. But following the global economic downturn, private funds are riskaverse and fearful of the next financial shock. This is where sustainability comes into play. By designing assets for long-term resilience, whole-life cost efficiency, and with embedded environmental, social and governance (ESG) best practice, projects can be substantially de-risked. Private capital finds the investment opportunities it needs in infrastructure projects which are better designed to serve end users and wider society for the long term. It s a win-win situation, showing that bottom line returns and a positive impact can and should go hand in hand. Keith Howells Executive board chairman and CEO, Mott MacDonald

4 I Mott MacDonald I How to de-risk infrastructure finance How to de-risk infrastructure finance I Mott MacDonald I 5 Implementing sustainable principles will bridge the bankability gap Integrating sustainability adds value In our interconnected world there is growing evidence that integrating sustainability adds value to both day-to-day operation and long-term strategies. And sustainability criteria are increasingly becoming a requirement of project developers and investors. It s irrelevant whether it s the sustainability strategy that increases profits, or strong businesses that tend to act sustainably the outcomes are the same. Sustainability is a good proxy for strong and profitable business, now and in the long term. So it is not surprising that organisations such as the United Nations and the European Bank for Reconstruction and Development put great emphasis on applying sustainability principles to investments. Other organisations, such as Global Infrastructure Basel and the Sustainable Infrastructure Foundation, are developing standards and tools that help to assess the sustainability values of infrastructure investments. These standards and tools are welcomed by international investors and project developers as they help to bridge the bankability gap in funding for infrastructure projects. Much has been said about how to solve the funding gap in the delivery of infrastructure projects in both developed economies and the emerging markets. But the growing shortfall is not due to a lack of capital; what is missing is the confidence that new projects will be delivered on time and that promised returns on investment will be paid. This bankability gap is one of the key challenges preventing the delivery of the infrastructure projects needed to match projected world growth. Sustainability provides the confidence needed to bridge the bankability gap for a number of reasons: A more interconnected world requires increased transparency in project development. New standards and tools are highlighting business cases which show the link between sustainability and strong business. Institutional investors are increasingly looking at sustainability indicators in investment opportunities. Project developers increasingly understand the advantages of sustainable infrastructure. Davide Stronati Global sustainability leader, Mott MacDonald

6 I Mott MacDonald I How to de-risk infrastructure finance How to de-risk infrastructure finance I Mott MacDonald I 7 ESG is key to financing the UN s sustainable development goals A focus on environmental and social governance (ESG) will ensure infrastructure development is fit for the long term The 17 UN Sustainable Development Goals (SDGs) are ambitious and far-reaching, and represent the global development agenda through to 2030. They encapsulate economic, social and environmental sustainability the three interlocking, mutually reinforcing dimensions of sustainable development. Infrastructure is key to achieving the SDGs. Sustainable energy and water infrastructure will expand access to basic services and reduce carbon emissions and air pollution. Improved transport links will enable more people to benefit from employment opportunities in urban centres and improve resource efficiency. Educational facilities will empower future generations with better skills and training. And this infrastructure must be developed with a focus on human wellbeing, resilience and whole-life costs so that it serves communities for the long term. Governments cannot deliver sustainable and resilient infrastructure alone. The private sector and the financial sector have a vital role to play. But all too often, environmental, social and governance (ESG) issues crucial to sustainable development are not routinely integrated into investment analysis and decision-making. Examples of ESG issues include climate change and natural disaster risks, environmental degradation, human rights violations, forced resettlement, corruption and lack of transparency. This inhibits the flow of capital to sustainable and resilient infrastructure projects so urgently needed, particularly in developing countries. This is why UN Environment, UN Global Compact, and institutional investors developed the principles for responsible investment (PRI) a global framework and initiative launched in 2006 to integrate ESG issues into investment decisions. So far, more than 1500 institutional investors such as pension funds, insurers, government reserve funds and foundations representing over US$60trn in assets under management have signed up to the PRI. As risk managers, risk carriers and investors, the insurance industry is a key actor in the global financial system and the sustainable development agenda. The core business of insurers is to understand, manage and carry risk. This risk management expertise is key to protecting assets, lives and livelihoods, developing sustainable and resilient infrastructure, and promoting the transition to a low carbon and resource efficient economy. Globally, insurers also represent over US$30trn in assets under management. In 2012, UN Environment together with insurers launched the principles for sustainable insurance (PSI) a global framework and initiative to integrate ESG issues into insurance decisions. So far, insurers representing more than 20% of world premium volume have signed up to the PSI. Both the PRI and the PSI are examples of best practice global frameworks and collaborative initiatives that support the financing of the SDGs. Butch Bacani Programme leader, UN Environment s Principles for Sustainable Insurance Initiative

8 I Mott MacDonald I How to de-risk infrastructure finance How to de-risk infrastructure finance I Mott MacDonald I 9 PPP frameworks can be a key element in our drive to deliver the sustainable infrastructure so urgently needed Public private partnerships (PPPs) must be a catalyst for sustainable development PPPs differ from market to market, but basically consist of a contract between government and a private company which is tasked with providing an asset or service for a defined period. The private partner takes on management and risk responsibility in return for remuneration either as a direct payment from the public sector, or through payments or fares levied on end users. PPPs are used globally in all sectors to deliver the hard infrastructure needed to support development, and are seen as bringing together the best of both worlds private sector efficiency and public sector understanding of local needs. interests, while limited budgets may mean shortterm affordability is chosen over optimised solutions. As for the private sector, it will deliver on the brief, but needs to be incentivised to focus on resilience and sustainability when it has historically been rewarded for delivering solutions at the lowest cost. PPPs will become more common over the coming decade even in countries with limited experience of the procurement method so embedding sustainability in the process is crucial. John Seed Director of investment advisory services, Mott MacDonald However, PPPs are not perfect. Many governments are conscious of the electoral cycle, so often put short to medium-term gains over long-term

10 I Mott MacDonald I How to de-risk infrastructure finance How to de-risk infrastructure finance I Mott MacDonald I 11 Five changes in behaviour to attract private finance: And five changes in procurement: 1. Focus on leadership and political will Both public and private sectors need to make sustainability paramount, with an understanding of the long-term benefits of doing so. 3. Qualitative evaluation Measure PPP schemes against the best and most stringent standards and criteria to promote quality. 6. 8. Make the most of ESG assessment tools These will optimise the sustainability and resilience of the project. 2. Optimise value for money analyses Consider the outcomes you want to achieve and how well these fit into the PPP framework. 4. Improve stakeholder engagement The best PPP schemes are those in which all stakeholders have contributed to shaping the project from an early stage. Training may be needed to drive those solutions. 5. Consider whole-life costs Sustainability means looking at the full project lifecycle, not aiming for the lowest engineering, procurement and construction costs. Begin with due diligence Consider what makes the project bankable from the earliest stage. 7. Appoint professional advisors early They will help steer the PPP project forward. 10. Use best practice standards which have worked elsewhere Rather than reinvent standards, contracts and specifications for each new project, use and refine those which have been proven to do the job. 9. Develop a PPP checklist for the SDGs PPP projects have the potential to deliver the UN s SDGs. Mott MacDonald is working with the UN Economic Commission for Europe and the University of Manchester to develop a scoring system against which project performance and outcomes can be measured. The system could form the basis for bankability criteria, unlocking finance.

12 I Mott MacDonald I How to de-risk infrastructure finance How to de-risk infrastructure finance I Mott MacDonald I 13 Better preparation will increase the project pipeline A new 40M online platform will support development of green infrastructure schemes Only a small portion of the US$65bn available each year from international financial institutions (IFIs) goes towards sustainable infrastructure in emerging economies infrastructure that delivers long-term social benefit, is environmentally acceptable and provides strong return on investment. IFIs must bring these criteria into investment decisions, and the European Bank for Reconstruction & Development (EBRD) already commits a minimum of 40% of annual funds towards green infrastructure projects. The main reason for the growing shortfall in infrastructure funding is not a lack of finance, but the lack of wellprepared projects. EBRD responded by setting up the Infrastructure Project Preparation Facility (IPPF), a 40M platform to support the delivery of more sustainable assets. The IPPF is split into two streams, one for public private partnership (PPP) projects seeking private finance, the other for commercialised public sector investment projects in sustainable infrastructure. The efficiency and replicability of projects is improved through quick access to consultants who can deliver properly prepared projects. By linking policy advice to project preparation, the IPPF provides expertise on PPPs and enables knowledge sharing between public and private sectors, strengthening local capacity. The EBRD s IPPF was created in the context of increased infrastructure support called for by the G20, the World Economic Forum s Global Advisory Council and development banks such as the World Bank Group, Asian Development Bank (ADB), Inter-American Development Bank (IADB), African Development Bank (AfDB) and Islamic Development Bank (IsDB) all of which recognise that IFIs must provide more investment to fund urgent sustainable infrastructure. With better project preparation, we can develop a pipeline of green infrastructure schemes in emerging economies to tackle local development needs. Matthew Jordan-Tank Head of infrastructure policy and project preparation, EBRD

14 I Mott MacDonald I How to de-risk infrastructure finance How to de-risk infrastructure finance I Mott MacDonald I 15 Banks agree transparency attracts better financing options Well-prepared projects give lenders confidence to invest Talking to the representatives of multilateral development banks, one thing is abundantly clear: the money is there, but more consistency in planning and transparency in project preparation are needed to get public sector projects off the ground. This led us to create the International Infrastructure Support System (IISS) an online platform for project stakeholders to design well-prepared projects and ultimately to facilitate efficient project delivery. IISS allows government clients to prepare individual projects on the platform, which acts as a project management tool for stakeholders but does not substitute for structuring or transaction advisors. IISS also serves as a shop window for private sector and other stakeholders looking for investment opportunities. Those preparing projects on IISS need to complete a series of environmental, social, economic, technical, legal, governance and financial questions devised by hundreds of experts in each field before their projects go live. Altogether there are more than 3000 detailed questions spread across over 30 sub-sectors. The aim is to ensure projects are well prepared and reach set standards for transparency. IISS provides governments with a user-friendly system which is easily replicable. It aims to reduce the transaction costs and time required to prepare projects especially helpful in emerging economies where there is a need to quickly design a pipeline of investable projects. Meanwhile, investors, lenders and financiers gain confidence that their investments are secure. Today IISS has more than 200 users, working on over 30 projects around the world. The pipeline of projects is growing through development banks and governments. All those we speak to are clear that if projects are well prepared, they will maximise their financing options, including through public private partnerships, to take them through to delivery. Christophe Dossarps CEO, Sustainable Infrastructure Foundation

16 I Mott MacDonald I How to de-risk infrastructure finance How to de-risk infrastructure finance I Mott MacDonald I 17 Use standards which encourage resilience to attract private finance Sustainable infrastructure is the opportunity private investors have been waiting for If the vast amount of infrastructure development projected over the next two decades is done with sustainability at its core, then we could see sustainable infrastructure emerge as a financial asset class in its own right. There is great market liquidity at the moment. Lots of private capital needs suitable vehicles for investment. At the same time, decreased government budgets mean a rising investment gap in infrastructure. The opportunity is there to engage private investors. However, to make infrastructure more attractive to investors, it has to have sustainability and long-term resilience embedded throughout the project lifecycle. We already know the benefits of this to those who use the asset: better performance, lower whole-life costs to owners and end users, and a more positive effect on the environment. But there are clear benefits to investors too. Low risk assets are more attractive in a very riskaverse financial climate. Sustainable infrastructure offers investors a chance to diversify their portfolios, as it has a low correlation with other asset classes. They also benefit from more favourable insurance terms, as assets are built with long-term resilience in mind. To help unlock some of this private capital, we developed SuRe the standard for sustainable and resilient infrastructure which assures investors that key economic and social governance criteria have been met. The standard was developed with investment bank Natixis along with several other stakeholders to help define a common understanding between the public sector, financial institutions and construction companies, and support a wellstructured approach to the design of sustainable projects. SuRe and other standards encourage sustainability and resilience to be considered at the design stage, in order to attract private finance. If we are to build the assets so urgently needed to cope with population growth, urbanisation and social development and to meet the UN s Sustainable Development Goals then engaging private capital is crucial. Sustainability will unleash it. Hans-Peter Egler CEO, Global Infrastructure Basel Foundation

18 I Mott MacDonald I How to de-risk infrastructure finance How to de-risk infrastructure finance I Mott MacDonald I 19 SuRe Leveraging private sector investment in sustainable infrastructure The standard for sustainable and resilient infrastructure (SuRe) was launched by Global Infrastructure Basel Foundation at the COP 21 climate negotiations held in Paris in December 2015. SuRe is a voluntary standard which integrates key sustainability and resilience criteria into infrastructure development. The aim is to mobilise both private and public funding in global infrastructure by ensuring safe, low-risk investments which maximise social benefits while limiting the environmental footprint. The standard is split into 14 themes: 4. Governance Anti-corruption and transparency 6. Society Labour rights and working conditions 8. Society Community impacts 10. Environment Climate 13. Environment Natural resources Each theme is divided into more specific criteria, creating a common language and understanding between developers, financiers, asset owners and local authorities. 2. Governance Sustainability and resilience management 11. Environment Biodiversity and ecosystems 1. 5. 7. 14. Governance Management and oversight Society Human rights Society Customer focus and inclusiveness Environment Land use and landscape 3. Governance Stakeholder engagement 9. Society Socioeconomic development 12. Environment Environmental protection

20 I Mott MacDonald I How to de-risk infrastructure finance Engineering. Management. Development. For more information on investing in sustainable infrastructure, talk to: John Seed, director of investment advisory services: John.Seed@mottmac.com Davide Stronati, global sustainability leader: Davide.Stronati@mottmac.com