The New Frontiers in Real Assets & ESG: takeaways of the panel hosted during Natixis CIB Private Debt Forum

The 2nd edition of Natixis CIB’s Private Debt Forum held on September 21st, 2023, was an opportunity to reflect on the current state of private debt funding from a large number of panelists, all senior representatives from debt infrastructure funds to broad alternative strategies.

One of the panels, which was entitled “New Frontiers in Real Assets” and which was hosted by Orith Azoulay, Global Head of Green & Sustainable Hub, Natixis, and Hervé Chopard, Head of Partners and Servicing, Natixis, highlighted that private capital has a key role to play in the energy transition.

The funding needs for the transition are enormous. For example, the figures published by the reinsurer Swiss Re in its report “Decarbonization tracker: Progress to net zero through the lens of investment” in October 2022 state the financial industry would need to scale up its funding from $1.2 trillion est. in 2021 to an average of $5-10 trillion per year between 2022-2050 to meet needs associated with energy transition. In relative terms, this means that about 10 -20% of the funding gap is currently being covered to meet the 2050 goals.

While banks are expected to play their part in funding the shift from fossil-fuel to cleaner alternatives, non-banking financial institutions, such as private debt capital are also in high demand to acutely bridge the funding gap.

Indeed, private debt, which spans from corporate debt to real estate to infrastructure, has potential to fill that funding gap: its illiquid nature and its inherent risks are particularly fitted to finance assets for which publicly information is limited.

Infrastructure obviously has a bright outlook in that context. As put by a panelist during the Forum, private debt investors have a responsibility to finance the decarbonation notably through the extension of sustainable infrastructures. In the face of energy transition, infrastructure opportunities are flourishing. Three categories particularly stand out:

i Transport represents about 42% of the funding gap. Opportunities in that asset class encompass the emergence of EV, the production of batteries along with charging infrastructures, low carbon H2-based fuels, growing energy and modal shifts.

ii Buildings represent 24% of the funding gap, with an investment need in energy efficiency (11%) and in electrification (13%), which includes the development of efficient equipment, onsite renewables, heat pumps or district heating.

iii Industry accounts for 5% of the funding gap to date, with high expectations in carbon capture and energy efficiency capacities.

Energy production, though now considered mainstream, still represents 29% of the financing gap. Its main drivers include switching to low-emission energy generation and fuels (renewable energy, low-carbon fuels, and nuclear energy although still subject to debate/controversy[1]) and ramping up the required accompanying infrastructure (electricity grids and energy storage).

A credible energy transition will necessarily require financing a wide shade of green activities and assets within the infrastructure space. These include three types of activities:

i “Green listed activities”, which contribute substantially to one of the six EU environmental objectives, starting with climate change adaptation and mitigation.

ii “Transition activities”, for which there are not technologically and economically feasible low-carbon alternatives, but that support the transition to a climate-neutral economy.

iii “Enabling activities”, which are designed to enable other activities to make a substantial contribution to one or more of the objectives.

To differentiate these categories and to scale up investments in energy transition, investors need to access ESG data. However, as discussed in some of our previous papers, investors are still facing a significant gap in the provision of reliable ESG data.

The demand for ESG data is driven in part by growing sustainable finance regulations for both banking institution as well as non-banking institutions, including alternative asset classes.

Regulations have spread over the last 5 years with a first action lever being: disclosure. Disclosure requires data that can cover ESG risks management.

In that respect, European Union  regulations include EU CSRD for corporates, EBA Pillar 3 on ESG/Climate risks for banks, EU Sustainable Finance Disclosure Regulation (SFDR) for investors, and generally speaking for both financial undertakings (i.e., asset managers, credit institutions, investment firms, insurance undertakings or reinsurance undertakings) and non-financial undertakings that qualify as “In-scope Entities” to include additional information in their non-financial statements on how and to what extent their activities are associated with environmentally sustainable economic activities that are aligned with the EU Taxonomy Regulation (Article 8).

Recall in the European Union a taxonomy has been set up to help direct investments to the economic activities most needed for the transition, in line with the European Green Deal objectives. This classification system defines criteria for economic activities that are aligned with a net zero trajectory by 2050 and the broader environmental goals other than climate. Under the Taxonomy Regulation, the Commission had to come up with the actual list of environmentally sustainable activities by defining Technical Screening Criteria” (or “TSC”) for each environmental objective, starting with climate change adaptation and mitigation, through delegated and implementing acts.

So called “TSC” are the detailed conditions to determine if an economic activity make a “substantial contribution” to the EC climate change objectives while “Do Not Significantly Harm” (or “DNSH”) another environmental objective. As such, the EC provides a list of eligible  activities with specific thresholds and metrics that helps identifying and certifying the alignment of an asset/project with the taxonomy.

Yet, multiple assets/projects or more generally economic activities which are instrumental to the energy transition, are not covered by the EU Taxonomy.

In this context, private investors have developed ESG investment process based on their interpretation of their own/respective ESG disclosure requirements. In turn, they are expecting from sponsors and lenders a plethora of data, which demand tend to drown issuers in non-standardized questionnaires. The latter are often structured around the key data point of the SFDR Principle Adverse Impact (or “PAI”) Template but often go far beyond.

As discussed in one of our recent articles on ESG integration in private debt, some investor-led initiatives aim at filling the ESG data gap by providing standardized ESG reporting tool for borrowers, such as the ESG Covenant Package and the ESG Integrated Disclosure Project.

Natixis CIB’s Green Weighting Factor (GWF) is an internal business monitoring and capital allocation tool that monitors Natixis’ climate strategy. It links analytical capital allocation to the degree of climate and environmental performance of each financing. It then determines the color (rating based on 7-level scale from brown to bright green) of each asset depending on the environmental impact of the object being financed.

In that regard, the GWF aims to compensate for the lack of global, quantified data on multiple scales.

First, it provides data for BPCE Group’s Net Zero Banking Alliance (NZBA) disclosure, which is based on CO2e-based metrics that target an alignment of the bank’s portfolio to a net zero trajectory by 2050.

Indeed, as a member of the NZBA, and in line with its commitments to align its portfolios trajectory with its 2050 carbon neutrality objective, Groupe BPCE publishes in December 2022 its 2030 interim targets for the energy sectors. The emission intensity of activities financed by Groupe BPCE in the power generation sector will be below 138 gCO2e/kWh (the International Energy Agency's target in its Net Zero Emissions by 2050 scenario) by 2030. In addition, Groupe BPCE will reduce by 30 % between 2020 and 2030, the carbon emissions from the end-use of the Oil and Gas (O&G) production activities it finances.

In addition, the GWF, which is currently under expansion, will help Natixis’ private debt investor clients identify EU Taxonomy criteria for eligible assets/projects as well as for transition enabling activities by providing systematic assessment of the compliance to the TCS and, when possible, provision of information relative to relevant DNSH criteria.

The GWF will also provide to investors other essential data for ESG reporting, starting with SFDR PAI mandatory KPIs[2], and including three types of carbon metrics: physical carbon intensity (ex: CO2g / kWh), absolute carbon emissions (ex: CO2 tons), monetary carbon intensity (ex: CO2g/M€) which allow the calculation of the carbon emissions of a financing, but also of the carbon footprint of a portfolio of mono-sourced assets by Natixis, thus accompanying its clients in the steering of their own carbon neutrality strategy and in the achievement of their respective net zero targets.