• Real Assets

ESG and real assets: A matter of balance

Assessing ESG risks within real asset investments is far from straightforward. Mark Versey and Stanley Kwong use five case studies to illustrate the balance of ESG risk factors that affects investment decision-making, beyond simply trying to be ‘green’.

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Investing in real assets requires patience, especially as capital will be tied up for a considerable time. As discussed in our recent white paper on The Role of Real Assets in Creating a Sustainable Future,1 the impact of projects on society and the environment can be wide and far reaching. If we are to meet the United Nations’ Sustainable Development Goals (SDGs) collectively, real assets will play a critical role. And while they may present some of the highest environmental, social and governance (ESG) risks, investments in emerging and frontier markets will also be crucial.

However, incorporating ESG considerations into real asset investment decisions is not straightforward. It requires a different approach to that used in public markets such as equities and bonds, where information is more readily available. Similarly, engagement does not work in the same way as with a listed company, with real assets investments typically involving multiple stakeholders on any given project.

The range of investment opportunities also varies greatly: a real estate development, for example, will not have the same ESG issues as an infrastructure project. But even within a specific asset class, the balance of positive and negative ESG impacts can differ wildly between investments. It is therefore important to have a tailored and bespoke ESG assessment on each transaction to reflect the unique potential of each investment to contribute to – or detract from – the SDGs.

Due to this complexity, investors need to take a balanced case-by-case approach, weighing the key positive and negative sides to determine which is strongest. The case studies that follow illustrate how crucial it is to determine a project’s net ESG balance when making an investment decision, and to ensure this balance remains positive throughout the life of the investment.

The expected financial return of such investments remains our core focus. While we do not cover financial analysis in the examples below, we have only used cases where the financials were positive and where the ESG characteristics had a major bearing on the investment decisions.

1. Real estate development in St John’s, Manchester, UK

Balancing regeneration potential versus the risk of social exclusion through gentrification. Net ESG balance: positive

This project will redevelop existing buildings into a complex including flats, offices and a film studio. On the face of it, this project is unambiguously positive from an ESG standpoint. It has the capacity to regenerate the local community, create jobs, embrace new technology businesses and improve the quality of life in the area. Yet with ESG factors, you should always dig deeper.

From an environmental aspect, this project received an excellent BREEAM evaluation, which gave us the confidence we needed.

From a governance perspective, we performed due diligence on the stakeholders involved in the project; from contractors to future tenants.

For instance, we reviewed the future corporate tenant in terms of:

  • Organisational culture, to ensure it treats employees with fairness and respect, and has not been linked to any controversies that have been evident in some technology companies;
  • Diversity and inclusion credentials (over 50 per cent of its global staff and 38 per cent of its board are women);
  • Our internal ESG ‘heatmap’ rating – which did not raise concerns.

Yet the most relevant dimension for such a project is its social impact. Sometimes, even if the parties involved have the best of intentions, a regeneration scheme can upset local community dynamics. A prime example, and one relevant to this project, is gentrification, which can increase inequality. If the local and wider perception of the project is that it creates an economic divide and splits communities, it can ultimately have a negative impact on longer-term growth and investment in the area.

This was particularly important for Manchester. Indeed, while its economy is growing at an impressive rate,2 it is also one of the ten most deprived cities in England.3 In addition, while it has a thriving local economy with a high retention of local graduates (69 per cent according to Manchester City Council’s State of the City Report 2018), it remains a traditional industrial hub, with 31 per cent of respondents identifying as working class in the latest census. It was therefore essential to gauge not only whether jobs would be created by the redevelopment, but who would benefit.

Jobs and inclusion, as well as an acceptance by the community and the broader public, were therefore identified as the two most important ESG factors to consider. In terms of jobs and inclusion, the redevelopment work was a positive, as were the tenant’s credentials as an inclusive employer. We now need to ensure it remains a truly diverse enterprise hub, as many developments of this nature tend to evolve towards solid corporate occupancy over time. This highlights the importance of continued monitoring of ESG factors.

In terms of community and wider public acceptance, we asked for assurances that the local heritage and mix of tenants would be maintained. Finally, as the former location of the Coronation Street recording studios, this was also a historic site, so it was crucial to retain and refurbish the original façade.

Following this analysis of the project’s ESG credentials, we concluded in favour of the redevelopment. Because this investment would help reduce inequality, create diverse opportunities, and offer inclusive regeneration of the area, we found its overall ESG balance to be net positive.

2. Energy-from-waste plant, Hooton, UK

Balancing national emissions reductions targets versus local community “licence to operate”. Net ESG balance: positive

This infrastructure equity investment will finance the construction of a plant to convert refuse into energy by burning it. This project seemed cut and dried from an ESG perspective, reducing both landfill and CO2 and creating local jobs. But once again, the situation was not straightforward.

Having reviewed the credentials of the various stakeholders, governance was not likely to have a material impact: strong due diligence processes had been set up to ensure the project would comply with the EU’s Industrial Emissions Directive, and all key counterparties had strong Health and Safety procedures in place. On the other hand, although the environmental case was strong on the surface, debate remains rife on the overall benefits of this technology. These are some of the key risks we needed to evaluate:

  • Renewable technology is developing at pace; will energy-from-waste one day be seen as negative compared to even cleaner energy like wind and solar?

A study showed that, despite emissions from burning waste to generate electricity, the plant would provide 82,000 tonnes of net annual CO2 savings compared to landfill, by preventing the aerobic breakdown of the waste while producing energy. In addition, England’s landfill sites are forecast to overflow by 2022 so there is a clear need for this type of alternative. The plant should be viewed as a waste-treatment facility providing an alternative to landfill, rather than as a pure energy provider.

  • Where would the waste come from, initially and in the future? If it were shipped over hundreds of miles, this would greatly reduce the plant’s positive CO2 impact.

Hooton Bio Power will be fuelled by “locally-sourced” waste, using 240,000 tonnes of refuse-derived fuel (RDF) each year, thanks to a 15-year feedstock supply agreement with the local waste aggregator, so the added emissions of transporting the refuse to the plant will be minimal.

  • What was the plant’s true environmental impact? Would it not remove materials from the circular economy and unnecessarily incinerate recyclables?

It will be the first project in Europe to use gasification technology provided by Japanese firm Kobelco Eco Solutions, which will enable it to process untreated refuse from black bin bags. We conducted feedstock due diligence, to ensure it will entirely be rerouted from landfill.

In this project, the social dimension was also important. When analysing the ESG impact of renewables it is easy to focus on their positive effects at a national and global level, while ignoring the disruption they may cause local communities – which can lead to their ultimate rejection and failure. Such a project needs to have a social “licence to operate”. Finally, burning waste to generate electricity can release carbon into the atmosphere with negative effects on the health of local inhabitants.

The plant was due to be located on an existing industrial site far away from the nearest households, but also away from any area of special scientific interest, limiting potentially harmful effects of emissions on health and the local environment. Moreover, the plant would create local jobs, and local businesses would be given a discount on the electricity produced.

Although we identified ESG risks, our analysis showed that on balance it was a net positive. This renewable energy project would promote sustainable growth at minimal cost to both the national and local environment, all with due consideration given to local communities and the social impact.

3. Refinancing an oil refinery in Ivory Coast

Balancing economic and social development potential versus corruption and CO2 emissions risks. Net ESG balance: positive

The transaction aimed to provide a loan to a major state-owned company to refinance high-interest debt, using the gains to fund improvements to an existing oil refinery.

Structured finance transactions often involve investing into existing or new infrastructure to support economic and social development, which is particularly important for emerging and frontier markets. However, few investors have the appetite to invest in such markets directly due to poor ESG data and concerns over transparency or corruption. Ivory Coast being a frontier market with known corruption issues, a careful ESG assessment was crucial.

In fact, as the transaction aimed to refinance an oil refinery in addition to the country’s poor record, it would seem an obvious candidate for rejection on ESG grounds. And yet, our analysis supported this investment (contrary to the following case study, where the credit risk and transaction structure were similar, but the ESG credentials did not stand up to scrutiny).

From a governance standpoint, Ivory Coast presents high country risks due to widespread corruption and a lack of transparency. It scores low on the Corruption Perceptions Index 2018 (105 out of 180 listed countries),4 is classified as ‘red’ in our jurisdiction index and scores low on our internal ESG sovereign rating model. However, Transparency International also found Ivory Coast has been making encouraging progress, with a total score of 35/100 points in 2018, up from 27/100 in 2013.

Improvements in governance and anti-corruption measures are priorities for the country’s president. The government is also making efforts to comply with international standards, including the Extractive Industries Transparency Initiative (EITI). Overall, the position of Ivory Coast in the Corruption Perceptions Index has improved significantly over recent years.

The other key governance risk related to the use of proceeds, which remained discretionary despite the stated aim to use them for the oil refinery. However, the transaction involved robust oversight mechanisms, with a large auditor and several multinational banks guaranteeing the monies would be used for their intended purpose.

The environmental impacts of the transaction were also more positive than it seemed. Not only was Ivory Coast complying with EITI rules, the gains obtained from the refinancing would be used to improve the operational efficiency of an existing refinery, not to build a new one. Overall, the investment would help reduce the country’s carbon emissions, but also its energy dependency on other countries.

It was the social impact of this project that tilted the ESG balance in its favour. Not only would it create jobs locally, it was also part of the country’s National Development Plan, which aims to improve the domestic economy and reduce its reliance on energy imports. Furthermore, it fits in well with the SDGs.

This is a case where the measure of the net positive/negative ESG balance reveals its full value. Thorough ESG analysis to take complex factors into account can make all the difference. For example, a dynamic assessment of improvements and forward-looking commitments is essential to encouraging positive reforms in developing countries, and projects such as this one can have a profound impact on a country’s social development. Without in-depth ESG analysis revealing these strong positive factors, the investment team would not have pursued the transaction.

4. Structured finance loan in Eastern Europe

Balancing the potential improvement of institutional governance versus political volatility and corruption risk. Net ESG balance: negative

The goal of this transaction was to finance policy-based institutional reforms, designed to improve governance in a high-risk emerging market in Eastern Europe.

As discussed earlier, its credit risk profile, underlying guarantees and transaction structure were very similar to those of the Ivory Coast project and, on the face of it, it also shared similar goals of improving ESG standards. Following the Ivory Coast example, this loan might also seem like a worthy investment, well-aligned with the SDGs. Yet our ESG analysis came to a very different conclusion.

Given the loan’s stated objectives, environmental impacts were not material, nor could we expect significant social improvements, aside from the indirect impacts of improved governance standards.

The material risks in this case related to governance. The country is a high-risk emerging market with a volatile political situation and suffers from widespread corruption. Because the building of robust governance institutions is essential to sustainable development and growth, we were supportive of the policy objectives of the development bank in brokering the funding arrangements. However, the due diligence process flagged concerns over the transparency and traceability of the financing. The extent to which funds are ring-fenced from the general government budgets and spending was also unclear, and there was no formal oversight mechanism. Given the lack of adequate financial controls, we held serious concerns the money could inadvertently be used to support further political and social repression.

In this instance, the ESG balance was a net negative and we declined the opportunity.

5. Two oil and gas storage infrastructure projects in the UK

Balancing infrastructure needs versus environmental risks in two similar projects. Net ESG balance: positive for one, negative for the other

These were two similar transactions aiming to finance oil and gas storage and distribution facilities in the UK, both with similarly strong financials.

Neither the governance nor the social factors were material, but both cases presented a high ESG risk from an environmental perspective. Interestingly, compared to the Ivory Coast example, the UK is much further along the low-carbon transition pathway, so the relevant environmental criteria are not the same. Given the UK’s current decarbonisation efforts and the increasing popularity of renewable alternatives, oil and gas is a high-impact sector in terms of ESG implications.

As the UK progresses towards its well-publicised target of net zero carbon emissions by 2050, it will mean picking the low-hanging fruit; in other words, those offering the easiest decarbonisation options. This brings into question the long-term viability of fossil-fuel-linked projects.

Looking at the details of both transactions, we identified key differences in that respect. One storage facility was purely meant to stock traditional fossil fuel, with no potential for other uses. In contrast, the other primarily held jet fuel. While this is of course not green, there is currently no commercially-viable alternative to jet fuel (though work is ongoing on electric aircraft), meaning it presents a much lower transition risk than ‘regular’ fuel. The risk of these assets becoming stranded within our investment timeframe was low. In addition, this second facility had potential capacity to store biofuels, further mitigating the transition risk.

After analysis, the net ESG balance was negative for the first project and positive for the second, and we made our investment decisions accordingly.

Rules of engagement

Investor engagement on real asset ESG issues is markedly different from corporate engagement for liquid assets. This is due to several factors:

  • The nature of the investment means investors are either funding a project or extending a loan within a specific timeframe, during which they will need to receive the right ESG assurances and see improvements;
  • The recipients of the proceeds are typically not public companies, but can range from governments to private entrepreneurs, and will not engage in the same way as highly-visible listed firms;
  • The number of investors is far fewer than the number of shareholders in a listed company, giving each investor greater responsibility in achieving positive outcomes.

For example, we invested in private debt issued by a family-owned logistics company that at the time had no framework to assess ESG risks. We challenged the company’s managers, who have since begun taking ESG into consideration and hired a sustainable development director. We continue to maintain active dialogue with them, providing guidance on further ESG improvements.

Identifying the material issues that tip the ESG scales

It is crucial to investigate and identify how ESG factors can affect real asset investments throughout their lifecycle; from origination to due diligence, investment approval, asset management and reporting. Making a truly informed investment decision requires investors to go one step further than just looking at the negatives. The positives, such as a project’s contribution to the SDGs, should also be considered.

To understand where to look for the most material ESG issues, and how best to determine the ESG balance, investors can benefit from defining a specific framework for each type of real asset investment. A common ESG policy can also allow them to follow a consistent approach and shared principles, and to ensure ESG considerations are embedded throughout the investment process. Finally, investors can leverage sector-specific risk data from ESG research on liquid assets, which can be relevant.

Simply applying a top-down perspective on ESG issues and a ‘risk-only’ lens can miss crucial elements while placing too great a weighting on non-material issues, leading to a gradual erosion of confidence in ESG analysis. Ultimately, investors should analyse each opportunity in depth to determine whether its ESG balance is a net positive or negative.

Our experience has shown that two projects to support the SDGs in developing countries can seem very similar, from the nature of their objectives to their credit risk profiles, yet the details of each project and accompanying guarantees can lead to different outcomes. Meanwhile, financing an oil and gas transaction can have a net positive ESG balance in a developing country like Ivory Coast but a net negative one in the UK, given the two countries’ different levels of advancement on the low-carbon transition pathway. Understanding what tips the scales is essential in making the right decisions.


  1. ESG gets physical: The role of real assets in creating a sustainable future, Laurence Monnier, Aviva Investors, June 2019
  2. Manchester’s Gross Value Added (GVA) per head of population grew by 6.4 per cent between 2015 and 2016, compared to 3.7 per cent for the UK (Source: ONS Regional Gross Value Added by local authority in the UK December 2017, Manchester City Council, State of the City Report 2018)
  3. According to the Indices of Deprivation 2015, Manchester ranks 5 out of 326 local authorities in England, where 1 is the most deprived. Source: Manchester City Council
  4. Source: Transparency International, Corruption Perceptions Index 2018

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