Financing the infrastructure deficit
21 October 2021
New Zealand has an infrastructure deficit that stems from decades of underinvestment. Finding ways to fund the numerous transport projects, social housing builds, schools, hospitals and other infrastructure assets required to bridge the deficit has been a perennial challenge for New Zealand.
In the past, we have sought to fill the funding gap by the use of PPPs (public private partnerships) - where private enterprises took on the task of building and funding public infrastructure. More recently, under the current government, the central Government balance sheet has been put to work by funding the 'shovel ready' programme and numerous other infrastructure projects approved by central government.
However, an economy the size of New Zealand cannot afford to fund all of the work that needs to be done through the Government balance sheet and the PPP model has been put on ice. Now, the challenge of funding infrastructure has become even more difficult with an overlay of decarbonisation, sustainability and climate change mitigation.
The good news is that there is no shortage of private capital available to fund infrastructure projects in New Zealand or internationally.
Infrastructure is seen as an ideal investment for superannuation and pension funds, insurance companies and other investors looking for long-term stable returns. There is also a growing trend internationally for investors to move their investments out of traditional industries and into investments which can meet standards of ethical, green and sustainable development - including sustainable infrastructure.
“'Sustainable infrastructure projects' are those projects that are planned, designed, constructed, operated and decommissioned in a manner to ensure economic and financial, social, environmental (including climate resilience) and institutional sustainability over the entire life cycle of the project.”
New Zealand is in an ideal position at present to capitalise on the move to ethical and sustainable investment. A number of New Zealand's infrastructure requirements could be structured as sustainable infrastructure - from solar farms and wind farms in the energy sector to upgrades of three water systems designed to provide better water quality outcomes to upgrades of transport systems to reduce carbon emissions.
And with the implementation of the Climate Change Commission's recommendations we have an ideal opportunity to make choices to promote sustainable projects that will not only achieve the country's overall sustainability and greenhouse gas reduction efforts, but will also attract private investment capital that will mean the projects can be constructed sooner with less pressure on the government's balance sheet.
In order to bridge the infrastructure deficit and to ensure that new and existing infrastructure assets are developed, retrofitted and maintained in a way that prioritises environmental and social sustainability as well as climate resilience - private capital (both equity and finance) has an instrumental role to play.
From 2000 to 2020:
- Debt capital made available to companies carrying out renewable energy projects went from 1.71% of total infrastructure financing to 12.17%
- Debt capital made available to companies carrying out non-renewable power generation went from 61.49% to 6.06%
- Debt capital made available to companies carrying out social infrastructure projects went from 2% to 16.78%.
Private capital and sustainable Infrastructure - a dynamic relationship
Globally, there is a dynamic relationship emerging between sustainable infrastructure and green finance:
- On one hand, the balance sheets of financial institutions are increasingly exposed to climate change effects. The nature of lending means that the exposure of a customer to more frequent severe weather events (fire, flood, droughts) and rising sea levels can become an aggregated exposure for financial institutions. These climate change effects heighten credit, market and liquidity risks - which can destabilise a financial institution and even the broader financial system
- On the other hand, the infrastructure deficit in New Zealand has a funding gap. The Government balance sheet has capacity constraints as to how much infrastructure it can fund.
Green finance is a tool available to financial institutions to combat climate risks in their loan and investment portfolios. Green finance can also be the source of capital to fund sustainable infrastructure - helping bridge the infrastructure funding gap.
Sustainable infrastructure development in New Zealand has the opportunity to tap into two different regimes for funding - the green loan market and the sustainably linked loans market.
Green loans and sustainability linked loans are regimes governed by a framework of market standards and guidelines developed by industry bodies and market participants with a view to promoting the development and integrity of green finance:
- Green loans are any type of loan instrument made available exclusively to finance or re-finance, in whole or in part, new and/or existing eligible green projects. Green projects include:
- renewable energy
- energy efficiency (new and refurbishing buildings, smart grids, etc)
- pollution prevention and control
- clean transportation
- sustainable water and wastewater management
- green buildings
- Sustainability linked loans are any types of loan instruments/facilities which incentivise the borrower's achievement of ambitious, predetermined sustainability performance objectives.
A sustainability linked loan can be differentiated from a green loan as the sustainability linked loan focuses on the on going sustainability profile of a borrower over time rather than the delivery (and maintenance) of a specific green project. It is for the borrower to set sustainability performance targets (which are agreed with the lender) by reference to key performance indicators, external ratings and/or equivalent metrics by which the borrower’s sustainability profile can be tracked for the purpose of the loan.
"Sustainable debt - bonds and loans raised with environmental and social purposes in mind - rose 29% to NZ$732.1b in 2020, the greatest issuance amount ever in a single year, according to energy research group."
Banks going green
Ever since the European Investment Bank issued the first green bond in 2007, there has been an accelerating trend of banks using their position in the economy to drive efforts to mitigate climate change - both at a local level and at an industry level. Many banks have signalled their intent by choosing to sign up and be held accountable to international industry conventions.
The most notable local and international conventions include:
United Nations Finance Initiative: Principles for Responsible Banking
As of today, 240 financial institutions (including New Zealand's four largest trading banks) have signed up to the United Nations Principles for Responsible Banking which requires each bank's business strategies to be consistent with the goals of the Paris Agreement.
The Principles for Responsible Banking provides the framework for a sustainable banking system, enabling the banking industry to demonstrate how it makes a positive contribution to society. The principles embed sustainability at the strategic, portfolio and transactional levels across all business areas on financial institutions.
Signatory banks commit to taking three key steps which enable them to continuously improve their impact and contribution to society:
- Impact analysis: identifying the most significant impacts of products and services on the societies, economies and environments that the bank operates in
- Target setting: setting and achieving measurable targets in the bank's areas of most significant impact
- Reporting: publicly report on progress on implementing the principles, being transparent about impacts and contributions.
United Nations Finance Initiative: Net-Zero Banking Alliance
The Net-Zero Banking Alliance brings together 53 banks from 27 countries representing almost a quarter of global banking assets (over US$37t), which are committed to aligning their lending and investment portfolios with net-zero emissions by 2050.
Members of this alliance have agreed to accelerate and support the implementation of decarbonisation strategies and the setting of intermediate targets at 2030 or sooner.
New Mandatory New Zealand Climate-Related Disclosure Regime
In April 2021, the New Zealand Government has introduced legislation to make climate-related disclosures mandatory for some organisations. If approved by Parliament, the legislation will require around 200 large Financial Markets Conduct Act reporting entities to start making climate related disclosures for financial years commencing in 2022, with disclosures being made in 2023 at the earliest. These requirements would extend to all registered banks, credit unions, and building societies with total assets of more than NZ$1b.
The challenges for infrastructure in transition
While the green finance trend presents multiple opportunities for funding of sustainable infrastructure, it is also the harbinger of change for environmentally damaging infrastructure projects and practices.
It is becoming increasingly more difficult for developers of 'dirty' infrastructure assets to access funding for development - the industries in the cross hairs at the moment include oil and gas facilities, mining and fossil fuel fired power stations.
However, there is risk in transitioning away from traditional infrastructure before you have your sustainable replacement infrastructure in place. Infrastructure projects are complex and integrating sustainable and climate related factors into their design, planning, and operation adds further complexity. And the process of transition doesn't happen quickly - generally, infrastructure assets can have a consenting phase of over three years with a building phase of three to seven years. Closing down traditional infrastructure too fast can result in unintended consequences. We have seen this recently in the electricity sector where sustainable generation is growing quickly but we still need coal and gas fired plants to 'keep the lights on'.
If the policy settings discourage investment in traditional generation and asset owners cannot obtain finance or find that financing for new projects is more expensive because they don't meet the criteria for sustainability, then the risks for the economy are exacerbated.
As a result, a modern economy will continue to require investment into carbon heavy infrastructure assets as part of a broader strategic movement to decarbonisation.
As private capital shifts towards sustainable infrastructure, this may leave central governments as the funders of last resort for integral carbon heavy infrastructure assets.
There is a delicate balancing act between policy settings that encourage and enable the transition to a low carbon economy and the need to manage the transition in a way that does not result in significant damage to the economy.