Climate Impact through Infrastructure Debt

Why invest in Climate Impact through Infrastructure Debt

• Income: Defensive source of income and diversification for investors.
• Downside protection: Provide strong downside protection due to the characteristics of infrastructure projects, such as monopolistic or semi-monopolistic sectors, regulated demand, and inelasticity.
• Duration: Typically features long-term horizons, aligning with closed-end fund maturities ranging from 10 to 20+ years, which can appeal to investors seeking stable, long-duration assets.
• Risk/return: Various return and risk characteristics based on factors such as debt seniority, credit quality, and project risk profile, catering to different investor preferences and objectives.
• Sustainability: Potential to contribute to sustainable development by financing critical initiatives like renewable energy, transportation modernization, and other green projects, thus aligning investment objectives with broader sustainable goals.

What are the main risks of Climate Impact through Infrastructure Debt

• Geopolitical Risk
• Credit Risk
• Interest Rate Risk
• Long-term illiquidity Risk
• Construction and Operational Risk
• Market Risk
• Currency Risk
• Environmental and Social Risk

What characterizes Climate Impact through Infrastructure Debt?

• Industry/Sector: Infrastructure development projects encompass various sectors such as energy/utilities, transportation, telecommunications, and social infrastructure.
• Instruments: Debt Tranches (Senior and Mezzanine) are utilized for financing, providing investors with different levels of risk and potential returns within the capital structure.
• Maturity Profile: Typically Long-Term (10 to 20+ years), aligning with infrastructure projects' extended lifespan and revenue-generating potential.
• Credit Quality: Typically lower/moderate or moderate/higher risk, but significantly depended on the project and borrower, reflecting the diverse range of projects and entities involved, each with its risk profile.
• Interest Rate Risk: Typically floating rate, but depending on the structure and duration of instruments, influenced by market dynamics and the terms of the debt, with potential impacts on the valuation and cash flows of investments.
• Borrower Size: Varied, including Government Entities, Corporations, and Special Purpose Vehicles (SPVs), representing a diverse range of entities responsible for financing and executing infrastructure projects.
• ESG Impact: Significant, with opportunities to support sustainable development and renewable energy initiatives, but also facing risks related to environmental and social factors, highlighting the dual role of infrastructure debt in contributing to positive environmental and social outcomes while navigating associated risks.

Question 1. How can investing in infrastructure debt contribute towards the transition to net zero?

HSBC Asset Management

Infrastructure is responsible for the majority of greenhouse gas emissions worldwide, estimated at c.80% of total emissions (Source: Infrastructure for Climate Action report - UNOPS, UNEP and University of Oxford), with a large portion associated to energy, buildings and transport. 

Infrastructure debt has a critical role to play given the massive investment required for the transition to net zero, complementing sponsors and government funding. Through the asset class, institutional investors potentiate the transition to net zero while continuing to seek the long term and stable returns associated with the infrastructure sector. However, risk tolerance and/or regulatory constraints may impact investor demand early on for some of the new sectors and technologies that will be required for the transition. Credit risk underwriting capabilities and the ability to structure robust financing terms are determinant for portfolio performance as sector range and risk appetite expand to meet the investment needs associated with the transition to net zero.

Infranity

The infrastructure sector is the backbone of the green transition. Transforming our economies to achieve net zero emissions require a massive overhaul of infrastructure. The "Green Transition" theme will likely dominate the European infrastructure market for decades to come, addressing critical environmental issues like climate change and the shift to zero-carbon operations. Additionally, it will support the process to become energy independent. 

Major infrastructure debt megatrends, like the energy transition, and decarbonized industry and mobility, are fuelling this transformation. The energy transition encompasses investments in renewable energy, energy efficiency, district heating, biofuels, battery storage and more – all areas where debt financing plays a crucial role. Decarbonized mobility, meanwhile, includes both established sectors like rolling stock leasing and fleet electrification, and emerging areas like EV charging, gigafactories and smart mobility. These trends highlight the critical importance of infrastructure debt financing in achieving carbon neutrality.

MetLife

Infrastructure investment is vital for enhancing quality of life, driving economic development and promoting social equity. It fundamentally shapes how we live, how economies function and the inclusivity and resilience of our communities and environment. More specifically with respect to net zero, we believe the renewable energy sector quite clearly has a significant role to play. Average annual investment of around $4.8 trillion is needed between 2024 and 2030 to align with BNEF’s Paris Agreement-aligned Net Zero Scenario. Investment in new renewable energy projects alone accounted for $623 billion in 2023, with around $1.3 trillion per year needed between 2024 and 2030.

In terms of infrastructure debt, over the last few years both large commercial and local specialised banks have gradually increased their exposure to the renewables sector, replacing other sponsors and corporates with more affordable debt solutions. Green infrastructure assets have caught the eye of investors, and the renewables sector remains a tempting choice. It’s largely backed by governments and offers a straightforward path to contribute to the low carbon transition.

Question 2. To what extent does following a climate impact strategy impact returns for an infrastructure debt portfolio?

Infranity

We acknowledge concentration risk in sector-specific climate strategies, favouring diversification. However, we believe climate assets can deliver strong returns without dragging on performance. This requires robust origination capabilities to capture the full spectrum of opportunities, with the objective to invest in the most attractive deals selectively and proactively.

Distinguishing between markets and sectors is crucial, as is identifying where in the capital stack risk-adjusted returns are optimised. In some established, oversubscribed markets in Europe, established sectors such opco level financing of wind and solar projects does not deliver attractive credit margins to investors. In such cases, we explore alternative means of gaining the exposure to the asset class such as investing in a structured and protective manner at holdco or corporate level. Furthermore, we see an emergent new frontier of climate impact markets, including for example battery storage, EV charging, gigafactories, carbon capture and sequestration, and hydrogen where risk-adjusted returns remain compelling as investors are properly compensated for the underlying complexity.

HSBC Asset Management

There is the misconception that climate impact investing coincides with concessionary returns. Many of the sectors crucial for the mitigation and adaptation to climate change – such as climate technologies, electrification, energy storage, clean fuels, CCUS, etc. – are associated with higher financial returns. Institutional debt investors typically have limited appetite for technology risk and require robust business cases and revenue models, backed by strong offtake contracts, to ensure attractive risk-adjusted returns that are key for continued investor interest for the asset class. Higher returns may be possible through geographical and sector diversification, as well as by targeting the less crowded mid-market investment space.

MetLife

Infrastructure debt with a sustainability angle can offer an attractive opportunity for investors. But to deliver both economic returns and positive impact benefits, we advocate a targeted approach. This means selecting investments that align with sustainability goals – such as mitigating climate change – while incorporating robust risk management practices.

Going back to the renewables sector, one of the primary hurdles for lending to renewables today is pricing. The competitive nature of the market and the huge amount of liquidity available have led to thinner margins for lenders, who have been gradually taking on more risks. The experience of the sponsor or asset manager is vital. They will be responsible for optimizing production across subsidized, contracted, and merchant stages, and their expertise can significantly influence the overall success of the investment.

Question 3. How do you ensure you find the most attractive infrastructure debt opportunities in the market?

Metlife

Along with experience and expertise, one of the most significant factors in sourcing attractive opportunities is strong industry relationships. We have been financing infrastructure debt in Europe for over 15 years, and across that period we have established a comprehensive network of industry relationships, allowing access to a diverse range of deals. We have a dedicated investment team sourcing opportunities and although selecting the right credit is the key starting point, protections are further enhanced through negotiating appropriate covenants, lien position and collateral. For us, structure is critical to limiting downside risk and driving long-term results.

HSBC Asset Management

Having access to a broad origination platform and established relationships in the market are key to being able to source attractive infrastructure debt opportunities. Opportunities can include:

• Bilaterals: directly originated by the fund, these loans will typically be higher yielding loans, with tighter covenants, with the possibility for repeat business as the team build on existing relationships.
• Mid-Market: typically with a single arranging bank or a small club of lenders.
• Syndicated Loans: arranged by a group of banks, these loans are typically of significant size. 

Our approach at HSBC Asset Management is to leverage the footprint, network, and brand of the HSBC group to source opportunities whilst also originating opportunities globally from a variety of different sources (such as banks, advisors, sponsors) and across several markets. 

Infranity

We source deals through a constant dialogue with the market and involve all members of our very diverse investment team which includes more than 10 nationalities and provides us with a vast local network of sponsors with unique access to the European infrastructure financing pipeline, while breadth of sector and asset class experience supports rapid identification of priority transactions and sustained deployment.

Our ability to offer large tickets and experienced deal teams affords Infranity a privileged negotiation position, enabling us to offer single lender solutions to middle market players or be part of a small club of lead lenders on larger transactions. This typically means more access to fees and more influence in structuring the transaction.

Overall, we originate over 400 investment opportunities per year and typically invest in c.20 transactions, as we focus on selecting only the most suitable and attractive transactions for each of our vehicles.