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RESILIENT RETURNSSUSTAINABLE ASSET FINANCE IN ASIA
As Asian economies reach new heights, so does the stress being placed on the environment. This stress, combined with the increasing threat of climate change and its related consequences has the potential to limit Asia’s investment opportunities and long-term returns. Richard Warburton Executive Director, Arcadis John Batten Global Cities Director The trend of sustainable finance in real estate and infrastructure investment is continuing to gain momentum. Increasingly, financial institutions now recognize the importance of Environmental, Social and Governance (ESG) factors in determining, and driving the value of an asset. In 2017, McKinsey stated that over 25% of assets under management globally are being invested on the premise that ESG factors can affect a company’s performance and market value. Access to funding, whether it’s debt or equity, now comes with broader governance, social expectations and increased global regulations. Where private equity or project finance relies on international markets to achieve expected returns, it is now ESG indicators and the positive impact generation of that debt or equity, rather than the investment partners themselves, that are starting to set the rules. Financial institutions have also started to acknowledge the need to look beyond the initial mandated tenor, and consider the physical risks of climate change on an asset to identify related financial pitfalls. Investors need to update their processes on how they assess opportunities, by improved reporting and benchmarking of environmental and social resilience at the asset level. This begins with the time frame of when to start assessing the resiliency of an asset. To secure long-term, predictable returns the potential impacts from climate change on an asset need to be assessed as part of the standard decision making process. In Asia, the question remains to whether the investment and asset management communities are ready to respond to these climate related issues. Evidence to suggest that ESG factors are being considered during the real estate and infrastructure investment decision making process is limited, even though sustainability reporting has significantly increased over recent years. Resilient Returns looks at the next developments and trends in sustainable asset finance, and what market practitioners should take into consideration during their decision making process to create resiliency in their investments. INTRODUCTION
THE RISE OF SUSTAINABLE FINANCE The market’s focus on sustainable finance is a direct response to climate change concerns, increasing legislation and the impact of investment assets on the environment and surrounding communities. Although ESG reporting and benchmarking is not a new phenomenon there is no globally agreed definition, as such financial institutions are responding to market drivers in different ways and to different time frames. The closest statement comes from the Global Sustainable Investment Alliance (GSIA) identifying seven activities and strategies: 1. Negative/exclusionary screening 2. Positive/best-in-class screening 3. Norms-based screening 4. Integration of ESG factors 5. Sustainability themed investing 6. Impact/community investing 7. Corporate engagement and shareholder action An industry that is typically driven by commercial aspects, is now also being influenced by ESG regulation as well as reputation considerations. There are also numerous guidelines and principles that many companies have signed up to, or comply with, such as; SUSTAINABLE ASSET FINANCE IN ASIA 3 ESG refers to Environmental, Social and Governance factors central in the assessment of sustainable and ethical impact of investments, business strategy and operations. Organizations such as the UK’s Commonwealth Development Corporation insists on sound ESG management to ensure that development does not come at the expense of a damaged environment, poor conditions for local workers or negative impacts on communities. Environmental, Social and Governance (ESG) CARBON PRINCIPLES IFC PERFORMANCE STANDARDS OECD COMMON APPROACHES GREEN, SOCIAL AND SUSTAINABLE BOND PRINCIPLES UNITED NATIONS PRINCIPLES FOR RESPONSIBLE INVESTMENT (UNPRI) GREEN BOND & LOAN PRINCIPLES (GBP AND GLP) TASK FORCE ON CLIMATE RELATED FINANCIAL DISCLOSURES (TCFD) EQUATOR PRINCIPLES UNITED NATIONS GUIDING PRINCIPLES ON BUSINESS AND HUMAN RIGHTS WORLD BANK GROUP EHS GUIDELINES
ACCESS TO FINANCE The impacts of climate change are already being felt and natural disasters such as typhoons and floods are disrupting cities’ operations. These events not only unsettle businesses and residents, but also bring damage and financial loss to built assets. The need for financial institutions involvement in real estate and infrastructure investments to assess the environmental and social resiliency of their assets is increasingly important. Access to project finance now comes with an increasing set of governance considerations which aim at striking a balance between financial returns and the impact on people and the planet. The 2017 United Nations Climate Change Conference (COP23) discussed the implementation plans for combating climate change, including details of how The Paris Agreement will work once it comes online in 2020 and the role of sustainable finance in this process. Over the last decade there has been an increase in the uptake of reporting and benchmarking of ESG factors as well as the use of ‘negative screening’ during the investment decision making process. This change of behavior has been driven by the following stakeholder groups: Governments around the world have been strengthening their environmental, social, anti-corruption and corporate governance regulations following the 2008 financial crisis. Effective regulation can provide strong support for meeting challenges such as uncertainty in investments, the drop in consumer demands, sales and future orders. Ineffective regulation could, however, delay recovery, inhibit growth, undermine efforts to address complex issues such as climate change, and reinforce citizens’ scepticism of government. Investors are now clearer on the direct returns that can be generated from projects that invest in sound ESG performance and analysts are starting to incorporate ESG factors into their capital allocation recommendations. Corporations are embedding ESG factors in business governance, with their directors recognizing the need to take these matters seriously at board level and throughout the
5 wider organization, including jointly developing capacity with other parties to implement ESG governance. Citizens, including shareholders, are now more aware of sustainability issues and want to know that the products and the companies they invest in do not harm people or the environment. MEASUREMENT AND BENCHMARKING Independent groups such as Principles for Responsible Investment (PRI) have been advocating for ESG issues to be considered in investment and ownership decision making since 2006. Today, over USD $80 trillion of assets are under management by those supportive of the six Principles for Responsible Investment. There is a range of sustainability benchmarking tools that are becoming commonly used across the industry. These include the Dow Jones Sustainability Index (DJSI) and the Global Real Estate Sustainability Benchmark for real assets (GRESB), which now covers USD$3.5 trillion of assets across 64 countries. In 2018, GRESB launched a ‘Resilience Module’ which considers business resilience to meet investor demand for information regarding climate investment risk. ESG considerations typically center around the impact created by the asset on its surrounding environment, rather than the potential climate risk affect on the asset. Looking forward, understanding the resilience of a physical asset where a significant proportion of the risk could lie, and assessing the consequential impact of such risk on the asset’s future value will become increasingly important to access project finance. At the end of 2015, the Financial Stability Board (FSB) formed the Task Force on Climate-related Financial Disclosures (TCFD) to address physical, liability and transitional risks that climate change has across different industries. In 2017, the task force issued a series of recommendations designed to help companies disclose decision useful information with the aim to enable the financial sector to better understand climate related financial risks and opportunities. This disclosure of information will drive change and awareness across the industry as businesses look to report on their risk exposure to climate change events. SUSTAINABLE ASSET FINANCE IN ASIA 5 Sustainable finance is becoming increasingly relevant to Asia especially when looking at future-proofing investment opportunities against environmental, social and climate impacts to achieve more resilient returns.
“Asia may appear to be a slow starter regarding climate related or sustainable investing, but globally ESG investing has not been around for a long time. The increasing number of assets under management that takes ESG factors into account systematically is unlikely to abate.” Richard Warburton Executive Director, Arcadis
7 HOW ASIA IS RESPONDING Emerging markets often take a short-term view as economic impact and growth have been the primary focus. The rise of ESG reporting on major stock exchanges has acted as a catalyst in driving the region towards considered long-term environmental and social impacts. HONG KONG In 2015, the Hong Kong Stock Exchange moved ESG reporting requirements from recommended and voluntary, to comply or explain. Additionally, in 2018 the government announced a green bond issuance programme with a borrowing ceiling of HKD$100 billion to provide funding for green public works projects. Some of the city’s conglomerates, such Swire Properties and Mass Transit Railway (MTR) are launching, or planning their own green bonds this year – placing increased importance on sustainable finance. SINGAPORE Since 2016, the Singapore Stock Exchange (SGX) requires listed companies to publish a sustainability report. The SGX states clearly that “the addition of sustainability reporting to financial reporting provides a more comprehensive picture of the issuer. The inclusion of statements of financial position and comprehensive income provide an insight of the present and an account of the past year, while sustainability reports of ESG factors show the risks and opportunities within sight, managed for future returns. Taken together, the combined financial and sustainability reports enable a better assessment of the issuer’s financial prospects and quality of management.” MALAYSIA At the end of 2017, the Securities Commission Malaysia issued updated guidelines on sustainable and responsible investment with the aim of encouraging growth in this sector. The guidelines are not as comprehensive as other countries, but it suggests a trend towards sustainable investment in general. CHINA China’s desire to combine economic growth with their climate related goals appears to show no signs of slowing down. In 2017, China was the second largest issuer of green bonds, second only to the USA. Corporate sustainability reports are required for both the Shenzhen and Shanghai stock exchanges with the future focus likely to be on environmental impacts and issues. Sea-level rise, a direct consequence of climate change, is expected to impact up to 25% of China’s population. FINANCIAL INSTITUTIONS RESPONSE Financial institutions have responded to tighter regulations and change in governance in various ways that are beyond reporting and compliance. This response is being led at a corporate strategy level with headline statements in annual reports, however the cascade and adoption at an individual level is variable. Most financial institutions have publicly committed to making significant amounts of green, social, clean or sustainable finance available. Whilst the initial driver for these organizations may have been regulatory or reputational, the commercial business case for the focus on sustainable finance is increasingly robust. Financial institutions have also created new products such as green or climate related bonds and green loans. The green bond market has grown significantly from cUSD$37 billion in 2014, to cUSD$157 billion in 2017, according to the Climate Bonds Initiative (CBI), which was initially led by multilateral development banks such as European Investment Bank (EIB) and the World Bank. Others have followed and now many global corporations such as Apple, Starbucks and Toyota have issued green bonds. SUSTAINABLE ASSET FINANCE IN ASIA
THE EVOLVING BUSINESS LANDSCAPE The investment community needs to address the uncertainty around climate risk by understanding the overall relationship between an asset and its environment. The issues are particularly poignant for the real estate and infrastructure sectors in Asia where the impacts of climate change and rapid urbanization are likely to have the greatest affect. The main factors that the investment community needs to understand relate to resilience (environmental and social) and social license to operate. ENVIRONMENTAL AND SOCIAL RESILIENCE The 100 Resilient Cities initiative defines resilience as ‘the capacity of individuals, communities, institutions, businesses, and systems within a city to survive, adapt, and grow no matter what kinds of chronic stresses and acute shocks they experience.’ The questions investors and asset stakeholders need to ask themselves across the climate change challenge, include: • Are investors aware of how to assess the resilience of their portfolio? • What are the potential impacts on the asset as weather events become more frequent and intense? • How will increased congestion or worsening air quality impact the value of the asset? • If the city cannot supply fresh water for a week what are the scenarios that will play out? SOCIAL LICENSE TO OPERATE There is rising demand from investors and consumers that businesses must serve a greater purpose in society. Larry Fink, Chairman and CEO of BlackRock, in his annual letter to CEOs, titled ‘A sense of purpose’, comments that companies are now expected to do more than just driving financial performance, but they must also demonstrate their positive contribution to society. This way of thinking needs to be applied at the asset level. Building lasting relationships with the communities and neighbourhoods in which the asset is located is vital for maintaining long-term and purposeful value. Understanding the value created at a local and city level by an asset not only helps investors see the positive impacts, but also identifies its ability to respond to societal pressures and demands. CITY RESILIENCE CATEGORIES AND ISSUES CHRONIC STRESSES that weaken the fabric of a city on a day-to-day or cyclical basis • High unemployment • Inefficient public transport systems • Endemic violence • Chronic food and water shortages ACUTE SHOCKS that are sudden, sharp events that threaten a city • Earthquakes • Floods • Disease breakout • Terrorist attacks
9 CITY RESILIENCE FACTORS City resilience can be split into two categories: stresses and shocks. The measure of a city’s ability to react and recover from these events demonstrates its true resiliency. SUSTAINABLE ASSET FINANCE IN ASIA HIGH UNEMPLOYMENT Lack of employment can lead to slow economic growth, increased crime and social unrest. STRESS EARTHQUAKES Major earthquakes can cause critical financial damage to assets and investments. SHOCK URBAN FLOODING As climate change risk takes affect, a city can become vulnerable to severe weather events, which pose risks to inhabitants, businesses and infrastructure. SHOCK DISEASE BREAKOUT Major disasters can act as grounds to inflame the spreading of disease impacting asset value and limiting business operations. SHOCK INEFFICIENT CITY MOBILITY Successful mobility is determined by a city’s inhabitants’ ability to move freely throughout its built environment. If movement is limited, it directly inhibits business, employment and social growth. STRESS POOR AIR QUALITY Cities are hot spots for pollution due to increased fossil fuel emissions, creating a constant stress on a city’s fabric and inhabitants. STRESS WATER SCARCITY A lack of clean drinking water puts severe stress on a city’s ability to function. STRESS SOCIAL UNREST A lack of basic amenities can lead to city conflict. STRESS
LOOKING TO THE FUTURE Asian financial institutions need to understand the long-term risks associated with their investment and what they need to do to safeguard their asset. 1. DESIGNING FOR CLIMATE MITIGATION Whilst there might be a long-term investment focus, short-term impacts such as extreme weather events must be considered at the asset level on a regular basis. Assets that are designed and operated with sustainability and resilience in mind will produce higher returns, and are likely to maintain value longer than those without. 2. INCREASING THE TRADITIONAL INVESTMENT TIME HORIZONS The impact of climate change and rapid urbanization is already being felt in Asia. The focus of emerging countries is moving from solely economic development, to the rise of sustainable asset investment. However, long-term investment views are required, extending up to 10 years to support and generate more predictable, lower risk returns and enabling the true impact of sustainable development. 3. ENVIRONMENTAL AND SOCIAL RESILIENCE AT THE ASSET LEVEL Comparing a portfolio of buildings or funds on a resilience basis will allow investors and managers to make informed decisions around acquisitions, asset improvement and refurbishment. Knowing climate change resilience, or adaption, can help reduce insurance premiums and lower the cost of operations. A more resilient asset is less susceptible to unforeseen incidents or acute shocks. However, climate change resilience is only part of the equation, the social and community resilience of an asset or portfolio should also be understood. New accounting methods such as natural and social capital which outline the dependencies on the environment or communities can improve risk mitigation. 4. FURTHER INCREASE IN REPORTING AND BENCHMARKING Asian markets are expected to continue their adoption of reporting standards, either on a mandatory or voluntary basis. Initiatives such as the Task Force on Climate-Related Financial Disclosure (TFCD) will continue to raise prominence of increased data- driven approaches at the asset level. These approaches will become increasingly valuable as investors and asset managers become more operationally oriented. It is expected that portfolio comparisons regarding environmental and social resilience factors will allow investors to make informed decisions to protect their returns, and in some cases reputations too.
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“Our insights and knowledge of natural, social and economic capital have relevance for many industries and sectors at all stages of the value chain. In this instance the focus is on financial institutions who invest in and lend money for the construction of buildings and infrastructure in the Asian markets.” John Batten Global Cities Director
13 CONCLUSION Industrial growth, urbanization and an increase in population are all driving investment opportunities in real estate and infrastructure across Asia. The resiliency of these investment returns will be challenged by the increasing impact of climate change on assets. Increased focus and accountability from lenders and investors is required, on not only an asset’s environmental impact and contribution to mitigation, but also on its resiliency in the face of climate change. Without this clear ownership and action, access to project finance and the resiliency of returns are likely to diminish. Gone are the days when financial institutions could only embrace ESG loosely. The industry is starting to see a new reality whereby green finance and investment are no longer niche activities. There is an increasing number of funds reporting higher long-term returns meaning we have moved past the theoretical stage, and practice is now driving the agenda. However, those businesses who only consider ESG reporting, focussing on the positive or negative impacts, are missing a vital part of the equation. By reducing the exposure to environmental and social shocks and stresses, institutions could enhance the predictability of their returns in the face of a rapidly changing world. Without the analysis and understanding of these risks and opportunities, the likelihood of an increased number of financially stranded assets and reduced returns will be higher. In Asian markets, it is expected that we will start seeing the impacts more acutely as the environmental and social effects of climate change are felt at a local level. Real estate developments not supported by good quality local infrastructure, or not designed for more extreme weather events such as floods or droughts will see their value reduce. Assets that cannot be repositioned, or have their resiliency increased, will struggle to provide the typical or historical expected returns. The impact of the environment on an asset and its resiliency to climate change need to be fully considered, rather than just its short term impact on the environment. This changing focus on mitigation, adaptation and climate resilience of an asset needs to become a more integral factor in investment decision making. Ultimately, sustainable development and investment need to reduce an asset’s negative impact on the environment and the community in which it operates, mitigate against risks from future events, while generating attractive resilient returns for investors. SUSTAINABLE ASSET FINANCE IN ASIA
Our mission is to create exceptional and sustainable outcomes for our clients in natural and built asset environments. We understand that we will achieve this only by working differently and realizing our goals to create sustainable solutions and deliver exceptional outcomes for our clients, while helping our people realize their potential and enjoying the journey together. What makes us different... OUR PASSION FOR IMPROVING QUALITY OF LIFE WE FOCUS ON DELIVERING EXCEPTIONAL AND SUSTAINABLE OUTCOMES Focusing on achieving outcomes ensures the services, solutions and propositions we deliver on client projects and programs of work are designed to help them achieve, if not exceed, their overarching goals. We do this safely and consistently, for every client, whatever the challenge, wherever they are in the world. WE UNDERSTAND OUR CLIENTS’ BUSINESSES AND EVOLVING NEEDS We are known for the depth of our technical knowledge and expertise in the planning, creation, operation and renewal or regeneration of natural and built assets. Our capabilities span a wide range of professional disciplines, 18 core value propositions, 19 global market sectors and experience operating in over 70 countries. WE ARE LEADERS IN DESIGNING, CREATING, OPERATING AND MAINTAINING SUSTAINABLE SOCIETIES The world continues to develop and change, at a pace of increasing alacrity and with mounting pressure on our natural and built resources. At Arcadis, we understand that cities, urban and rural habitats need to respond to societal changes. Whether they’re challenged with rapid urbanization, increased mobility or environmental changes, we help clients meet each challenge safely, securely and in a way that improves quality of life. WE ARE NEVER FAR FROM WHERE WE’RE NEEDED Our global network of some 300+ offices worldwide ensures we are never far from where our clients need us. We believe in the power of diversity, combining our global capabilities with local knowledge. Operating to the highest standards of health, safety and integrity gives our clients a long term partner they can trust.
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Arcadis. Improving quality of life www.arcadis.com/asia ArcadisAsia @Arcadis_Asia ABOUT THIS REPORT: In this report Arcadis draws on its global experience on how incorporating environmental, social and governance (ESG) considerations into strategic and tactical decision making can yield both commercial and reputational benefits. It also considers the future and what lenders and investors need to consider to ensure their assets are resilient in the face of change. FURTHER READING: MAKING NATURAL CAPITAL COUNT SUSTAINABLE CITIES INDEX 2016 SUSTAINABLE CITIES MOBILITY INDEX 2017 CONTACT Richard Warburton Executive Director, Asia T +65 6239 8573 E richard.warburton@arcadis.com John Batten Global Cities Director T +852 2911 2000 E john.batten@arcadis.com