Sustainable Infrastructure as the backbone of the European Green Deal

In the context of the European Union's ambitious climate objectives, Infrastructure is undoubtedly the asset class that is expected to capture most of the fundraising for the energy transition. While such expectation will lead to important opportunities for an assets class having proved strong resilience in previous years, it will also constitute an important challenge for the sector as investors and stakeholders’ scrutiny on the non-financial objectives for Infrastructure funds, driven by institutional investors, is gaining in importance. 

To reach carbon neutrality and become the first carbon-neutral continent, the European Union (EU) in its Green Deal, agreed to unprecedented targets to decarbonize its energy system which accounts for more than 75% of EU’s greenhouse gas emissions, including a reduction of its emissions by 55% by 2030 bringing them at the level of 1990. This objective relies on several important goals such as increasing renewable energy capacity and enhancing energy efficiency for which sustainable infrastructure funds are expected to play a pivotal role. However, sustainable strategies are gaining popularity across all alternative asset classes, including infrastructure. Limited partners and more specifically institutional investors become much more demanding and go well beyond the disclosures foreseen in the Sustainable Finance Disclosure Regulation (SFRD) for Article 8 and Article 9 funds when analyzing the expected non-financial return of their investment. This additional layer of ESG reporting increases the requirement for voluntary assurance, often seen as the best option to get an independent level of comfort on the sustainable nature of an infrastructure fund.

This article offers an overview on the impact of the European Green Deal on infrastructure funds and highlights the evolution of the European market as compared to North America. It also discusses the significance of sustainability analysis and reporting for investors resulting in greater demand for voluntary assurance.

Greater and greener European focus delivering strong returns 

The difficult global fundraising environment affecting all private asset classes naturally also impacted infrastructure funds. The Investment data company Preqin Ltd estimated a total amount raised of EUR 20 billion as of October 2023, only 12% of the 2022 record year’s amount of EUR 168 billion and 15% of the five-year annual average of EUR 130 billion. 

At the same time the European infrastructure market has grown considerably, powered by EU’s climate goals and green transition efforts. This trend is supported by the number of infrastructure funds targeting Europe which, still according to Preqin, has grown by 59% over the previous year and by total Assets Under Management (AUM) for Europe-focused funds which maintained their upward trend to reach 37% of global AUM as of March 2023, just 6% lower than North America-focused funds. 

In addition to this greater European focus, the infrastructure market also witnessed important changes, driven by the European Green Deal’s ambitious goal of carbon neutrality by 2050 which significantly impacted the market: 

Rising Renewable Energy Investments: European infrastructure funds are increasingly targeting renewable energy and important investments in offshore wind parks, solar energy projects, and hydrogen technology align with European goals for decarbonization and energy security. 

Expansion of Digital Infrastructure: As digitalization drives economic development, European has rapidly expanded data centers, 5G networks, and fiber optics. The European Commission’s push to enhance digital capacity has further propelled this growth, meeting increasing demand for data and connectivity.

Advancements in Sustainable Transportation: Investments in transportation infrastructure, such as electric vehicles, charging stations, rail systems, and urban mobility solutions, have grown in response to European policies focused on reducing emissions in transportation, a key contributor to Europe’s carbon footprint.

In terms of performance, Europe’ strategic emphasis on sustainable infrastructure combined with the strength of its energy markets and elevated power prices, boosted the return of funds with exposure to energy and infrastructure assets. Preqin’s analysis of Internal Rates of Return (IRR) from 2019 to 2022 highlights a significant performance gap between European infrastructure funds, which achieved a median IRR of 14.1%, and North American infrastructure funds, which had a median IRR of 8.6%. European infrastructure funds not only delivered higher IRRs but also provided competitive risk-adjusted returns, especially in core and core+ strategies. These lower-risk approaches have gained traction as they appeal to investors seeking stability in a volatile economic environment. In contrast, North American funds faced greater exposure to fluctuating public market conditions, which impacted overall returns.

Sustainability as a key investor requirement 

For many institutional investors the analysis of non-financial performance at appraisal has become an essential component of their Due Diligence which shifted from a “nice-to-have” to a “must-have” following EU’ Sustainable Finance Action Plan signed in 2018 and the two implementation waves of the SFDR on March 2021 and January 2023. 

Gabriele Todesca, Head of Infrastructure Investments at the European Investment Fund (EIF), EU’s largest Limited Partner (with over EUR 1 billion of commitment to EU infrastructure funds in 2023) confirms this trend “Sustainability is at the core of our investment activity, particularly when we invest in infrastructure funds. This is true for the whole market, but particularly for a policy-driven investor like the EIF. Most of the resources managed by the EIF are from public-sector investors, who have a strong focus on policy objectives including decarbonization and the green transition. They are also very sensitive to potential “greenwashing” practices in the industry. For these reasons, when making investments in funds, the EIF focuses a large part of its due diligence work on the sustainability-related aspects of the projects. For this, the EIF benefits from the support of an in-house technical department that assesses the strategy, the target sectors and the approach to the target sector, to ensure that investments are carried out in a sustainable way. Sometimes we have to exclude certain investments from fund’s strategies or request that if done, they’re done in a way that complies with sustainable practices that we define.’’

With an increasing demand and opportunities for European sustainable infrastructure combined with a bigger scrutiny on the sustainability components of their investments, SFDR disclosures and especially for Article 8 funds, are not always enough to provide investors with the required level of comfort on the impact their investments. Therefore, more and more infrastructure funds are issuing various types of sustainability reports, such as Greenhouse Gas Emissions Report, Sustainability Report or Carbon Footprint Reports, the to the attention of their stakeholders.

What does the future hold?

Looking forward we identify two significant trends which will impact the infrastructure fund market in the coming years.

First, we believe that the growth trajectory of EU-focused infrastructure funds is expected to continue, driven by EU's climate targets and energy transition efforts, which call for an increase in renewable energy capacity and enhancements in energy efficiency. This could lead to European’s AUM to surpass North American-focused funds and become the first market for infrastructure funds but also the most appealing one thanks to strong and stable return. This could expand the investor base of the segment beyond institutions by attracting more private investors and high-net-worth individuals.

Last, in this rapidly evolving environment marked by stakeholders in demand for reliable and robust sustainability information, voluntary assurance in the form of limited or reasonable assurance reports, will emerge as a crucial mechanism for enhancing the credibility and transparency of non-financial reporting. Independent third-party verification, ensuring that the reported data are accurate and reflective of the funds’ true impact on sustainability, will certainly have a positive impact on fundraising, reputation and performance thereby fueling a virtuous circle.