Author(s) – Karthik Bharath Kumar, Akshay Pai

ESG Considerations and their impact on Infrastructure in India.

Environmental, Social, Governance (ESG) based investing is a term synonymous with sustainable investments in infrastructure for socially responsible projects. This philosophy has taken off after the 2000s, particularly in the last decade with the UN Principles for Responsible Investing (PRI) attracting support of more than 1800 signatories representing around $70 trillion in assets under management. These signatories have committed to the incorporation of ESG as a metric while making project evaluation and investment decisions – highlighting the importance of ESG considerations while conceptualizing or planning a project.

A common inhibition for Project Managers is that incorporating too much of ESG consideration into the project would harm the performance parameters, especially profitability reflected in NPV. However, multiple examples and studies show that projects with ESG parameters considered consistently have a lower cost of capital, lower risk volatility, lower adverse actions and impacts. Historically projects with high ESG considerations have outperformed similar projects without such considerations incorporated over the medium to long term.

Why ESG makes sense for Infrastructure Firms:

• Projects with ESG considerations factored in the feasibility and conception stage consistently outperform non ESG compliant projects in the financing, funding and risk-adjusted returns in the long term.
• 97% of infrastructure project companies are exposed to ESG risks which can impact their bottom-line over the long run. Infrastructure projects have long gestation periods and there is limited scope to adapt to changes that occur once a project has been conceptualized and implemented based on certain assumptions and conditions.
• A majority of the Infrastructure funds based in developed countries with mature markets now use ESG in their investment strategies when looking for projects to invest in. Funds in developed markets tend to offer unsecured funding to infrastructure projects deemed ‘risk-appropriate’, ESG considerations can aid extending this to the undeveloped secured loan-based markets as well.
• ESG is being adopted by credit rating agencies when rating infrastructure firms, a poor ESG rating impacts the cost of debt financing. Most infrastructure projects are heavily levered to take advantage of the low cost of debt in WACC structure and a minor change in the cost of debt can have a disproportional change in WACC.
• Focus on ESG in financing projects is projected to increase in direct proportion to global climate change.

For all these reasons and more incorporating ESG considerations into their projects is a necessity for infrastructure firms looking to regain some semblance of normalization in the post Covid-19 era. However, ESG considerations transcend the project level and can be applied to the entire organization to structure your enterprise to be ESG compliant. The modern consensus about ESG is that it is not just a project risk management strategy but an organizational risk management strategy that codifies good business practices into a logically structured matrix that must be adhered to in order to maintain a decent organizational risk profile.

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