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BlackRock’s four steps to integrate ESG into infrastructure investing

ESG must be included in the four main pillars of investment decision-making, say the firm's Teresa O'Flynn and Katherine Sherwin.

Teresa O’Flynn
Katherine Sherwin

It is no longer possible to ignore the fact that environmental, social and governance factors have become a defining factor in companies’ long-term prospects. This could not be more true for infrastructure, given the physical and long-term nature of our investments.

Infrastructure is also at the forefront of many current and emerging ESG factors, from the impact of climate change to increasing energy demands, urbanisation trends and population growth, that are changing our needs in transport, digital and social infrastructure.

Simply put, it has become a fiduciary duty of infrastructure investors to place ESG considerations at the core of their investment philosophies, and to ensure that they are being integrated in a determined way at each stage of the investment process: from product strategy, to investment decision-making, and asset operation and management.

It is now widely appreciated that ESG risk is as important as other risk factors, such as liquidity and credit risk. Yet although the ‘why’ is recognised, the ‘how’ remains less clear cut, and the journey to ESG integration can still be one that is challenging to navigate. Here is a four-step approach.

1 Sourcing and screening

ESG considerations should commence right at the early sourcing and screening stage of any potential investment opportunity. Being aware of what ‘red flags’ or ‘deal-breakers’ may exist, and how these align with wider investment positions on ESG exposure, is critical from the very start.

Given the physical nature of infrastructure, there are always going to be site-specific factors to consider, such as contaminated land, flood risk and biodiversity sensitivities and, increasingly, physical climatic impacts, such as rising sea levels, storm frequency and intensity, and other changing weather patterns.

Desktop reviews of key documents – including planning permission conditions, environmental impact assessments, and geotechnical and ecological reports – help investors to understand what the potential ESG concerns might be at this early stage. These in turn inform the decisions on whether to progress with the opportunity or not. Such analysis will also help direct future detailed due diligence. At BlackRock we have found that of the investment opportunities we have declined due to ESG concerns, the majority have been dismissed at the sourcing and screening stage before we even progressed with more detailed due diligence.

2 Due diligence

It is important during this multifaceted process to ‘deep dive’ into material ESG risks and opportunities that were flagged in the initial investment review or that may emerge during due diligence. There can be a huge amount of information to review. Site visits are often critical. Partnering with engineering, environmental and energy consultants will often help identify the most material ESG factors, as well as the environmental, social and financial implications. A system of proprietary investment ESG questionnaires can help focus the reviews by asking a series of questions on the potential ESG risks associated with any new investment. This approach ensures that material ESG risks are being identified on a deal-by-deal basis and that they can be fully assessed.

3 Investment committee

Any approach to ESG integration must be underpinned by transparency, with an emphasis on ensuring that ESG risks are not only identified and analysed but are fully recorded in investment committee papers and other transaction documents. This enables full visibility of the potential risks, but also enables greater discussion on how such risks can be managed and mitigated in the delivery of the wider investment business plan.

There should be a process for ensuring ESG considerations can be openly discussed at investment committees, or other decision-making forums, and that recommendations are made using considered judgment based on the information and data provided. As ESG factors become increasingly important to investment success, we have found they are increasingly discussed at investment committee. This is not always just through the lens of risk management, and discussions on maximising ESG opportunities to drive increased value are becoming more prevalent. That said, if we cannot get comfortable with any ESG risks, we will not invest.

4 Reporting, measurement and disclosure

ESG responsibilities do not end at the point of transaction. It is important to emphasise active asset management that drives continuous improvements in sustainability performance, with a consideration to the ongoing measurement of environmental and social impacts.

Although a major hurdle for many years, the availability of data and insights that can be used to inform sustainable asset management is improving. This is enabling asset owners to better track key metrics, such as project-level energy consumption, water consumption and greenhouse emissions, and areas such as physical and transition climatic risk exposures. Disclosure frameworks, such as GRESB and the UN Principles for Responsible Investment, provide valuable ways of measuring and benchmarking performance against peers.The tracking, management and reporting of performance indicators needs to be cemented into each investment’s action plan –  for example, agreeing upfront how to track and report displaced greenhouse emissions for renewables investments, or how to develop and monitor community support programmes and societal impacts.

The infrastructure sector’s approach to impact reporting is also rising up the agenda and helping to meet growing investor demands on quantifying and reporting environmental and societal impact performance.

The reporting of accurate, tangible ESG performance data is going to become mainstream in the near future. This places an even greater responsibility on partnering with asset managers and operators, as well as third-party data specialists, that can together support the measurement and collation of such information.

ESG factors present some clear risks to the infrastructure sector, but there are major opportunities too. Ensuring ESG issues are central to investment philosophies is as much about de-risking investments as it is about driving real and measurable benefits to the communities the assets are serving.

Teresa O’Flynn is BlackRock Alternatives Investors’ global head of sustainable investing and Katherine Sherwin is BlackRock’s head of real assets ESG integration