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Central Route of the South–North Water Transfer Project

Finance

Banks can ensure Asia infrastructure projects have positive social impact

Published 14 March 2022 in Finance • 5 min read

As Asia intensifies efforts to meet its growing infrastructure needs, increasing attention is being paid to environmental, social and governance (ESG) considerations. Banks and other financial intermediaries are therefore having to think hard about the sustainability aspects of projects that they choose to finance.

 

The Asia Pacific region needs to invest $22.6 trillion in infrastructure improvements over the 2016-2030 period to maintain its growth momentum, according to the Asian Development Bank. And this figure rises to more than $26 trillion, or $1.7 trillion per year, if climate change mitigation and adaptation costs are added, the ADB said in its 2017 report Meeting Asia’s Infrastructure Needs.

Meanwhile, ESG standards have become a huge topic in Asia in recent years – not least because of the high costs that result when these factors are ignored in infrastructure projects.

Investors are increasingly incorporating ESG factors into asset allocation decisions, and there has been  steady movement towards strengthening the ESG regulatory framework in many countries in the region.

This flourishing regulatory and market environment is creating new opportunities for banks and other financial institutions. The ESG segment of the bond market, for example, has expanded rapidly across the region with ESG-related bond issuance more than doubling to $69 billion in the first half of 2021. Bankers expect the interest in green and blue bonds, social bonds and sustainability bonds to continue the same growth trajectory for some time to come. And businesses or projects with robust ESG practices are attractive to investors and lenders because they generate higher returns, enjoy a competitive advantage and are well prepared to deal with uncertainty.

But there are also challenges and risks to be managed.

Asia is different to other parts of the world in that infrastructure projects are more likely to have much bigger consequences for the lives, homes and incomes of the people directly and indirectly associated with them. These projects may sometimes lead to the displacement of large groups of people and the loss of their livelihoods, for example. The working conditions of those employed on the projects and the health and safety impacts on the wider community also have to be factored in when taking the risk/return valuation into account.

Shangqiu–Hangzhou HSR
China plans to expand its high-speed railway network to 50,000km by 2025

The social impact of projects is therefore a key consideration in the region. For example, hydropower projects have the potential to expand access to electricity for the populations of many developing countries but often through the creation of reservoirs large areas of land are flooded, river courses are changed, impacting important biodiversity and resettling communities.

As financial intermediaries, banks have an important role to play in ensuring that an appropriate balance is struck between the environmental, social and climate aspects of projects, in what is commonly referred to as a “just transition”. At the end of the day, bankers and other financial institutions will only make money from these projects if they are done well. And being done well means taking care of ESG considerations, especially with regards to the people who are affected. Social and gender impact assessments must thus be a crucial element of projects in the region and should be included in the early stages of planning, and incorporated into corporate procedures, but too often they are missing.

Developers and their financial backers need to talk to the people affected and come up with opportunities for them. In particular, this means incorporating benefit-sharing packages that ensure that no one ends up worse off as a result of a scheme. If such packages are built into a project, then people will support it and become its cheerleaders on the ground. And this will provide the project with its social licence to operate.

Another important factor for banks to bear in mind in transparency and disclosure, including climate disclosures, and the budget allocation for environmental and social aspects of a project. Companies often do not put enough financial resources into this up front, resulting in much higher costs in the long run as unforeseen problems need to be fixed.

Central Route of the South–North Water Transfer Project
Starting point of the Central Route of the South–North Water Transfer Project by the Danjiangkou Reservoir.

When determining the feasibility of infrastructure or other projects, banks must consider a range of ESG and increasingly climate risks, within the parameters of more traditional risks. These include:

  • Credit risks, i.e. if a company is unable to repay a loan because of fines or penalties resulting from non-compliance with environmental and social requirements or loss of production capacity, for example.
  • Liability risks, which arise from legal complications or financial charges for rectifying social and environmental damage, particularly in the case of strict lender liability laws.
  • Reputational risks they as financiers might face if a project attracts negative media coverage or local resistance.

However, a challenge faced by banks is that they often do not have enough human and financial resources dedicated to ESG to enable them to fully understand and internalize these risks. They may also lack some of the technical ESG risk assessment skills required.

To address this gap in the market, the International Finance Corporation (IFC), which is part of the World Bank Group, has been working with financial institutions in the region, enabling them to do business in a sustainable way by promoting sound ESG practices. Supporting inclusive growth is one of IFC’s priorities in the region — where its long-term investments totalled $3.4 billion in fiscal year 2018 and it mobilized $3.6 billion for climate financing alone in 2021. In addition to its investments, IFC’s advisory services are also proactively geared towards building ESG capacity and awareness within financial intermediaries. For example, it has developed a comprehensive handbook and online tool offering guidance on deploying effective management control systems and implementing a robust Environmental and Social Management System (ESMS). Additionally, IFC provides support not only to financial institutions, but also regulators, industry associations, consultants working for the private sector, training institutions and other partners, on the development and implementation of environmental and social (E&S) risk management practices for the financial sector.

While there is no doubt that climate change, if left unchecked, would lead to a catastrophic future for the world, it also presents an opportunity for banks. IFC estimates that climate business can generate $23 trillion in investment opportunities, create 213 million cumulative jobs, and achieve 4 billion tons of CO2 reduction in developing countries alone. The role of financial intermediaries, especially in infrastructure projects, would be crucial in turning a looming disaster into a green growth story in a way that ensures a just transition for all the stakeholders involved.

Authors

Kate Lazarus

Kate Lazarus

Senior ESG Advisory Lead for Asia Pacific at International Finance Corporation

Based in Thailand, Kate supervises a team of regional IFC staff and consultants to deliver ESG advisory to the private sector and governments. She co-ordinates the ESG Landscape project, which carries out upstream assessments to pave the way for private sector investment, and also the Powered by Women initiative in Myanmar and Nepal, which aims to promote gender diversity in the renewables sector. Her areas of expertise include water governance, multi-stakeholder dialogues, renewables, cumulative impact assessments, human rights/conflict, environmental flows and benefit sharing.

Mahwesh Khan

Research Associate at IMD

Mahwesh Khan joined IMD in 2019, bringing over 15 years of experience in facilitating transformation journeys for companies and organizations. She works with IMD faculty on practitioner research projects and publications, as well as on delivery of advisory projects, focusing on qualitative analyses across diverse business domains. Her expertise lies in working with corporate boards and C-suite on governance and strategy diagnostics.

 

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