Infrastructure projects have traditionally been viewed as stable investments — this is now being upended with the inclusion of technology. Innovation is rapidly picking up pace across all asset classes and raises the issue of technical obsolescence to a new level.
The impact is profound in the development of smart cities. As municipalities re-imagine their infrastructure — investors will need to understand different risk profiles and be comfortable with a new degree of uncertainty. New solutions will be needed to match investors’ expectations and liability structures.
A new generation of solutions are emerging that shift infrastructure from a top-down, centralised approach, to a user-focused, decentralised model with increased agility — and potentially lower costs. The ‘unpacking’ of large infrastructure projects into a number of smaller, more flexible future-enabled projects is starting to become the norm.
Investing in ‘future-enabled’ infrastructure
The reality is that nobody truly knows what the future will hold and how cities, users, and governments will respond. Projects will need to anticipate a broad range of technological developments while allowing for flexibility of application to meet the changing demands of users.
New management frameworks are needed to account for technology risks, specifically technological evolution. Cyber risk is also very important.
A new generation of solutions are emerging that shift infrastructure from a top-down, centralised approach, to a user-focused decentralised model with increased agility – and potentially lower costs.
The debt and equity equation
Financial institutions are beginning to include sustainability and social considerations in their lending or investment criteria. For example, some are moving away from investing in extractive industries; others are pledging specifically to support clean energy initiatives.
But there remains a gap between the debt mentality of debt issuers and the equity mentality of the proponents of sustainability solutions. We need to bridge that gap and find ways of fully embedding the social or environmental dividends of an investment into the equation. These need to become the third dimension in financing feasibility assessments.
Risks, rewards and repayments
Of course, no one could ask a financial institution to make uneconomic decisions. The numbers have to add up. Getting their capital and interest back is really where their world begins and ends. The social or sustainability benefits of an investment, however, need to take on the right weighting that reflects their wider economic potential. After all, if we can create truly smart and integrated cities, they will generate productivity and wealth creation possibilities that could pay for themselves many times over: a true social dividend.
On the other side of the coin, equity investors also need to play their part. Frequently, there seems to be a focus on how clever the technology is rather than on what it actually does — and how it will pay its bills. There has to be an economic case to persuade the lender, just as the equity owner has to accept that their returns will always be subject to greater fluctuations and risk.
The bottom line is that any borrower has to be able to repay their loan — that is one thing that certainly won’t change.
Smart solutions don’t have to cost vast amounts of money. It’s not necessarily about creating enormous new infrastructure – it can be about how we interact with the infrastructure around us, which includes taking an outcome as opposed to an output focused mind-set.
Smart means useful and data-driven
For equity investors or owners, another fundamental point is that what they are developing shouldn’t just be smart for smart’s sake. It has to deliver a benefit to the citizens of a city. Whether it drives better quality of life, economic efficiency, better health outcomes — there has to be a societal benefit. Smart solutions are fantastic if they deliver a positive difference. If not, they are irrelevant.
Of course, smart solutions don’t have to cost vast amounts of money. It’s not necessarily about creating enormous new infrastructure — it can be about how we interact with the infrastructure around us, which includes taking an outcome as opposed to an output focused mind-set. An illustration of this is the car navigation system Waze – and other applications like it — that deliver real-time journey and trip-planning information using sensing technology.
As this example underlines, much of what smart cities will be about revolves around data. The operators in a smart city will collect data, curate it and use it for their decision-making. It will be about data driven decision-making not ‘rules of thumb’.
A transformation of the risk landscape
New and emerging technologies might help lower the capital needed — and credit risk involved — but at the same time other factors could push in the other direction. Climate change has one of the greatest possible consequences, with the risk of catastrophic weather events likely to become an increasingly relevant factor in pricing. In fact, all of the risk equations we know today will change.
The technological risks, security and privacy risks, the very financing needs of tomorrow’s generations — all these factors will change and mean that new approaches are needed.
We are already seeing new financial products, oftentimes enabled by technology, designed to support the sustainability agenda such as ‘green’ or climate-themed bonds. Although quite new as an asset class, they are growing rapidly. However, it remains early days. We need to make sure that there is a balance between the low cost/low risk of funds and the equity returns.
We can’t just do what we’ve always done
This question of balance remains key. We need to get the lenses through which risks are viewed right so that the lowest viable cost of capital is achieved for the borrower and society at large. If we ask the two sides of the debt and equity equation to take too much of each other’s risks, we’ll end up with suboptimal solutions.
In short, if we do things the way we’ve always done them, we’ll get the same answers that we always have.
Other articles in this edition
- Diversity and tax become key components of ESG
- Creating trust in ESG data in real-time
- New way of looking at climate risk for physical assets
- Natural disasters: From protection to prevention
- Towards consistent and comparable ESG reporting
- The COVID-19 evolution of capitalism
- Embedding ESG into banks’ strategies
- Preparing for climate-related disclosures
- Promoting ESG in Asia Pacific
- Creating an impact management framework
- Overseeing the transition towards a greener future
- The politics of ESG: Where are governments heading?
- The beginning of the ESG regulatory journey
- Leading towards a sustainable future
- Central Banks respond to COVID-19
- A new view on value