Andrea Lockerby analyses the financing challenges and opportunities for developing sustainable infrastructure.
The UK is aiming to become a net zero economy by 2050, but to decarbonise in this time will require a huge shift in levels of investment, government ministers say.
Globally, this transition will require trillions of pounds reallocated and invested into new technologies, services and infrastructure, and that’s on top of becoming more resilient to the effects of climate change.
It is widely recognised that sustainable infrastructure is critical to achieving global climate targets. As such, whether it’s developing roads, buildings, energy or water infrastructure, consciously considering the economic, social and environmental implications of an infrastructure project is becoming increasingly important.
These considerations can include ensuring a lower carbon and environmental footprint, protecting natural ecosystems, and proving resilience to changing climates.
But how do these costly, crucial projects get off the ground, and is funding them getting easier or more difficult?
How are sustainable infrastructure projects funded?
Green financing aims to boost financial flows from the public, private and not-for-profit sectors towards sustainable development priorities. For some projects, environmental impact is the primary consideration, but more commonly, it’s considered alongside the ability to make money, according to the UN’s Environmental Programme.
The UK, which was the first major country to publish a green finance strategy in 2019, has a National Wealth Fund, which has almost £28bn to invest in UK energy and infrastructure through funding, lending or guaranteeing debt to get projects started.
In addition, there are initiatives such as the UK government’s Green Financing Programme, which raises financing from investors to fund green expenditures, including clean transport and renewable energy.
There are several stakeholders involved in green finance, including international financial institutions (IFIs), who can play an important role in building capacity, assisting with project pipelines and designs, and ensuring compliance with international standards in order to attract private capital, experts say. They can also help to reduce costs and risks.
There are various models and mechanisms of green financing, including public-private partnerships, government funding, climate funds and ESG-linked (environmental, social, and governance) loans.
Green bonds are among those that are gaining traction. This type of financing funnels investments into initiatives including renewable energy, clean transportation and conservation.
Another emerging trend is impact investing – where investors are accountable to the social outcomes they include in their theses and for the outcomes of the project they’ve invested in. It is sometimes linked to the concept of an impact economy, a system in which social and environmental outcomes are given as much prominence as economic output metrics like GDP.
Impact investors were one of the first investors in climate technologies and ventures that support the transition to a low-carbon economy, according to a recent report by the British Private Equity and Venture Capital Association (BVCA).
However, impact investing currently accounts for less than 1% of the whole UK investment management market, the report states. But, BVCA argues in the report that there is significant room for growth of impact investment, given the right incentives and enabling environment.
Blue bonds are another emerging financing instrument. The UK’s first corporate blue bond was recently issued by Tideway London, the newly completed ‘super sewer’ that is designed to intercept the tens of millions of tonnes of sewage pollution that has historically been spilt into the Thames every year.
After issuing 18 green bonds since 2017, Tideway decided that the tunnel becoming operational was the right time to issue a blue bond, which is a subset of green bonds, selected to represent the specific investor benefits to sea and marine environments. There was also more clarity around blue bonds with the International Capital Market Association’s (ICMA) publication of guidelines in 2023.
The eight-year bond, issued in June this year, will provide Tideway with money for the project system acceptance period, which is due to be completed in 2027. This involves monitoring, testing and maintaining the tunnel before it is handed over to Thames Water.
Elina Beale, Tideway’s head of treasury, says the initial decision to issue green bonds prior to this was relatively straightforward.
“Everything we do is green, so aligning our strategy with the purpose of the project was a very logical approach,” she says.
This was also the case with the recent blue bond, she adds.
“The new [ICMA] guidelines made it easier to tell the story to investors,” she says.
The bonds have also enabled them to widen the investor pool, says Mathew Duncan, chief financial officer at Tideway.
“Perhaps it’s easier to say in hindsight, but we’d have probably found it harder to get a strong level of interest if we didn’t go down the green route so evidently and clearly in those early years,” he says.
“I’m convinced our approach to align down the green bond route helped because it added to the momentum in the marketplace at the same time,” he says. “Investors are looking to align themselves with the ESG principles.”
The process of issuing green bonds involved setting delivery goals to be completed by the end of the Tideway project.
“We said we have around 54 legacy commitments,” Duncan says. “We actively monitor those – a lot are all about improving the areas we’re working in to make sure we restore something that might’ve been interrupted as a result of our works.”
“We use them when we’ve gone for one of our layers of financing,” he says.
Tideway required a form of funding called a revolving credit facility, which allows it to borrow, repay, and re-borrow funds flexibly up to a set limit.
“Because we’ve been able to deliver on those legacy commitments, they’ve given us a discount on fees and interest rates paid against that particular facility,” Duncan says.
Duncan says the process of issuing green bonds ‘demonstrates our thinking and getting stakeholders to buy into that as a concept’. He says the approach is an example of using financing to drive behaviour in the short term.
“It’s an example of encouraging investors to buy into the approach we’re taking,” he says. “If we’d chased traditional funding routes instead, to some extent, the financing would’ve felt disconnected to what was going on within all other parts of the project.”
Barriers to sustainable infrastructure finance
In the UK, there are many large-scale infrastructure projects underway, including transport projects such as High Speed 2 (HS2) and energy projects, such as the Hinkley Point C nuclear power station.
Many of these projects are designed to deliver environmental benefits, either by building something new – such as the Thames Tideway Tunnel and the Elizabeth Line – or improving existing infrastructure.
One commonality with all of these projects is their huge cost and, alongside this, financial risk. However, when it comes to financing sustainable infrastructure, there is an investment gap.
It’s estimated that around $2.6 trillion is needed every year up to 2030 to meet the UN’s sustainable development goals (SDGs), and that closing this investment gap could require more than three times the current level of investment in clean energy.
For Tideway, one barrier was that issuing the blue bond meant having to explain things to the investor community.
“Blue bonds are a subset of green bonds,” says Beale. “What’s slightly harder to explain to investors is that we’re using it towards the same assets; nothing has changed.”
Duncan says green and blue bonds come with an additional element of reporting and compliance, but argues that it was worth the extra effort because investors appreciate having the extra information.
For a project with so many risks attached, Duncan says, the bigger risk was whether it would be able to raise the finance required.
What does the future look like for sustainable infrastructure funding?
There is a growing appetite from investors around sustainable infrastructure, says Stuart McMillan, head of infrastructure at the law firm Burgess Salmon.
“A lot of banks are now keen to lend green loans,” he says. “And a lot more housing developments are funded by green loans now.”
“A lot of funders at the moment are keen to be seen giving green loans,” he says. “This is the direction of travel for a lot of big investment funds – they have to report on their ESG credentials, so a lot of them will be looking at funding and investing in things that are moving towards net-zero.”
For example, McMillan says, the Bank of Scotland is investing £15 millon into the Social and Sustainable Housing Fund, to raise homes’ standards to high energy efficiency standards.
However, globally, the situation looks more stagnant; there will be an estimated investment gap of more than $3 trillion a year over the next decade.
This is despite an increase in the bankable projects involving renewable power, green transport, sustainable water and waste and green buildings, as stated HCBC in a 2020 report on driving sustainable infrastructure.
Financing of infrastructure projects is limited, the report states, and lacks sufficient investment from the private sector. This is partly because, while institutional investors are keen to invest, there is currently no way for them to verify which assets are genuinely sustainable.
However, experts say that public investment banks (like the National Wealth Fund) are often more able to provide funding for projects that have higher upfront costs, without the promise of short-term returns, and some uncertainty about their future effectiveness.
HCBC argues that stakeholders, including major financial institutions, asset managers and governments, must work together to help combat climate change, even if there’s no blueprint for this in a competitive market.
The post Building tomorrow: Financing for sustainable infrastructure appeared first on Circular Online.