How to measure the value of climate resilient infrastructure

Back in 2015, the then gov­er­nor of the Bank of Eng­land, Mark Car­ney, made a blis­ter­ing speech at Lloyd’s of Lon­don, the heart of the insur­ance indus­try, about the eco­nom­ic threat pre­sent­ed by cli­mate change.  

List­ing the ram­i­fi­ca­tions of sea-lev­el ris­es, droughts, storms and oth­er increas­ing­ly severe weath­er events, he warned that insur­ers need­ed to be at the “cut­ting edge” when it came to man­ag­ing the risks posed to crit­i­cal infra­struc­ture. 

Carney’s stark mes­sage wasn’t lost on Car­los Sánchez, an expert in cli­mate finance who was work­ing at the time for a mul­ti­lat­er­al lender on cli­mate resilience projects in Latin Amer­i­ca. The Spaniard recalls that it helped to instil “a change of men­tal­i­ty in the finan­cial indus­try about how cli­mate risks are processed and assim­i­lat­ed. This was not just eth­i­cal­ly dri­ven. It was also moti­vat­ed by strate­gic and finan­cial mate­ri­al­i­ty.” 

Today, Sánchez is exec­u­tive direc­tor of the Coali­tion for Cli­mate Resilient Invest­ment (CCRI), which was formed in 2019 to bring togeth­er par­ties rang­ing from insur­ers and investors to gov­ern­ments and cred­it rat­ing agen­cies. 

The CCRI is chaired by his cur­rent employ­er, risk advi­so­ry firm Willis Tow­ers Wat­son, with close sup­port from the UK gov­ern­ment and HSBC. The coali­tion takes its cue from Carney’s call to be at the cut­ting edge of cli­mate risk man­age­ment for infra­struc­ture projects. At the core of its mis­sion is an accep­tance that finan­cial mar­kets world­wide have made slow progress in incor­po­rat­ing cli­mate resilience into their deci­sion-mak­ing process­es. 

This shouldn’t be read as lack of inter­est, stress­es Sánchez, who points out that the CCRI’s abil­i­ty to con­vene infra­struc­ture play­ers with a com­bined asset base exceed­ing £19tn indi­cates a gen­er­al readi­ness to act. 

The CCRI is not the only play­er in this field, either. The Coali­tion for Dis­as­ter Resilient Infra­struc­ture, the Glob­al Com­mis­sion on Adap­ta­tion and the Finance to Accel­er­ate the Sus­tain­able Tran­si­tion – Infra­struc­ture ini­tia­tive are just some of the oth­er col­lec­tives to have formed.    

The prob­lem instead, he says, is the absence of a stan­dard set of tools to iden­ti­fy, assess and, most cru­cial­ly, val­ue improve­ments to the cli­mate resilience of infra­struc­ture assets. Because of this, financiers are fly­ing blind. They are unable to accu­rate­ly price future cli­mate risks into poten­tial infra­struc­ture invest­ments. The infra­struc­ture sec­tor is there­fore fac­ing a mas­sive “resilience gap” in financ­ing, which rep­re­sents a seri­ous chal­lenge to over­come.  

Research pub­lished by Anglia Ruskin Uni­ver­si­ty and the Mott Mac­Don­ald con­sul­tan­cy in the year of Carney’s speech esti­mat­ed that $200bn would be need­ed annu­al­ly by 2035 to address $1tn of loss­es from cli­mate impacts. The cur­rent lev­el of invest­ment in this area is a mere $30bn a year, accord­ing to the World Bank Group and its Glob­al Facil­i­ty for Dis­as­ter Reduc­tion and Recov­ery.    

To make mat­ters worse, infra­struc­ture man­agers and devel­op­ers that take cli­mate resilience seri­ous­ly gain pre­cious lit­tle reward from the equi­ty, cred­it and insur­ance mar­kets. The high­er insur­ance pre­mi­ums or costs of cap­i­tal that infra­struc­ture spon­sors often face if they dis­close resilience risks asso­ci­at­ed with assets are the “real tragedy”, accord­ing to Sánchez. 

“Mem­bers of the coali­tion tell us: ‘We’ve been in com­pet­i­tive process­es for infra­struc­ture invest­ment where, as a result of recog­nis­ing that an asset is sub­ject to a high lev­el of expo­sure, we’re auto­mat­i­cal­ly placed last in the queue because our propo­si­tion is not attrac­tive,’” he says.

The CCRI has mount­ed a two-pronged response to these evi­dent mar­ket fail­ures. Its first key move has been a top-down effort to help nation­al gov­ern­ments assess the sys­temic risks and resilience needs of their crit­i­cal infra­struc­ture assets. Over the past 18 months, a group of 50 mem­bers have been devel­op­ing a met­ric for gaug­ing the over­all risk expo­sure of a giv­en country’s built infra­struc­ture, cou­pled with a tool for pri­ori­tis­ing resilience-relat­ed invest­ments. 

Such equip­ment is not only an aid to deci­sion-mak­ers in putting a price on cli­mate risks, Sánchez says. It also helps them to build the polit­i­cal case for redi­rect­ing pub­lic resources to resilience projects. 

He has in mind a recent stress test by rein­sur­ance giant Swiss Re, which found that 18% of the world’s eco­nom­ic out­put could be lost before 2050 if cli­mate threats are ignored. Even so, Sánchez acknowl­edges that it would still be con­tentious to redi­rect pub­lic funds towards flood defences rather than hos­pi­tals, say. 

“Pol­i­cy-mak­ers are say­ing: ‘If you’re ask­ing us to real­lo­cate mon­ey from non-cli­mate issues to cli­mate issues, and if we might not see the val­ue of doing that for 20 years, that’s not very appeal­ing.’” 

In an ide­al world, the CCRI’s resilience met­ric would act as a proxy for a cred­it rat­ing agency, there­by pre­sent­ing an imme­di­ate incen­tive in terms of low­er costs of cap­i­tal for resilient infra­struc­ture projects. 

For reg­u­la­to­ry rea­sons, cred­it rat­ing agen­cies are not involved in the CCRI’s evolv­ing dis­cus­sions, but Sánchez is con­fi­dent that its met­ric will gain trac­tion quick­ly once it’s finalised.

The CCRI’s sec­ond key move in response to the mar­ket fail­ures is more bot­tom-up in nature. It is focused on help­ing investors to inte­grate cli­mate risks into their cash flow mod­els. The goal here is to counter the com­mon mis­con­cep­tion that cli­mate resilience entails high ini­tial costs that take a long time to recoup. 

The coalition’s analy­sis of returns data from real case stud­ies indi­cates that the oppo­site is true, reports Sánchez, who adds: “All our evi­dence sug­gests that invest­ments in resilience make sense in terms of the projects’ net present val­ue.” 

The pos­i­tive finan­cial return for infra­struc­ture investors is evi­dent in the deci­sion by Mott Mac­Don­ald, Stan­dard & Poor’s and HSBC to col­lec­tive­ly assign more than 20 employ­ees on a pro-bono basis to the CCRI’s work on cash flow mod­el­ling. 

“I’m not fooled into think­ing that they’re doing it because they like my face,” Sánchez says. “They’re doing it because they can see that this is real­ly strate­gic for them.” 

To test the robust­ness of the mod­el­ling tech­niques in prac­tice, a group of six data providers asso­ci­at­ed with the coali­tion are con­duct­ing in-depth analy­ses of five key infra­struc­ture projects around the world. 

The CCRI’s stan­dard­ised analy­sis is designed to pro­vide a clear assess­ment of the cli­mate risks asso­ci­at­ed with each project, plus a detailed cost-ben­e­fit analy­sis of the poten­tial resilience mea­sures. 

“The beau­ty of the method­ol­o­gy is that it pro­vides a menu of incre­men­tal invest­ment actions and mod­els the impli­ca­tions of dif­fer­ent com­bi­na­tions of these in terms of their capex, oper­at­ing expens­es and so forth,” he explains. 

Sánchez acknowl­edges that the CCRI’s mis­sion to accel­er­ate invest­ment flows in cli­mate resilience still has a long way to go. One key pri­or­i­ty is to help providers of finance and insur­ance to intro­duce inno­v­a­tive new prod­ucts that are bet­ter suit­ed to pro­mot­ing resilient invest­ments. 

As part of that goal, he has set his sights on mobil­is­ing $5bn in infra­struc­ture invest­ments that use the CCRI’s cli­mate risk assess­ment method­ol­o­gy before the end of this year. 

The clock is tick­ing. “Just one minute’s delay”, Sánchez warns, “and all that we’ll be able to do is focus on min­imis­ing an absolute dis­as­ter.”