21 December 2021

ESG Considerations In Project, Energy And Infrastructure Finance

Milbank LLP


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Long before Environmental, Social, and Governance ("ESG") entered the corporate world's vernacular, these principles were very much present in various aspects of project development...
United States Corporate/Commercial Law
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Long before Environmental, Social, and Governance ("ESG") entered the corporate world's vernacular, these principles were very much present in various aspects of project development and in the policies and procedures of owners and investors. ESG in project finance has always been key to understanding risk, due to the long-term nature of the investment. Now, the increased prominence of ESG presents a new dimension of investment, credit, and even reputational risk for a range of projects, from infrastructure to energy assets.

A report released by S&P Global Ratings in 2020 confirmed that lenders and investors financing projects face similar, and in some cases more pronounced, ESG risks as compared to traditional companies.1 With ESG at the forefront, companies bear responsibility not only to their shareholders, but also to the public and the planet. A focus simply on the "bottom line" of short-term profitability and shareholder returns is not tenable. Since projects are long-term investments in the infrastructure, industry, or public services of a community, investors must consider the long-term stability of a project and its effects on a broad set of stakeholders, including employees and local communities. Projects depend on buy-in from the local community and adaptability in light of pressing climate risks and changing regulatory environments. ESG risks are particularly pronounced for projects related to fossil fuels and coal power, where new and anticipated regulations could constrain operations and impact viability, ultimately undermining their long-term investment rationale.

Public policies increasingly favour investments in energy and infrastructure projects that further environmental and social justice goals by mitigating the impacts of climate change, decarbonising the energy and transportation sectors, and improving both clean drinking water supplies and digital broadband connectivity in historically underserved or low-income communities.2

At the same time, investors and shareholders are demanding greater ESG transparency and accountability by means of ESG risk assessment, measurement, and reporting to better understand and address the impact of their investments. This is evidenced by the recent shakeup at Exxon, where an activist hedge fund proposed an alternative slate of Exxon directors and, with the aid of proxy advisors, institutional investors, and fund managers focused on ESG concerns, gathered enough votes to seat two directors who they expected to affect corporate policy to better mitigate and manage the climate change impacts facing the energy sector.3

Project companies increasingly leverage interest in ESG to maximise opportunities to obtain financing or to obtain favourable financing terms. ESG is a key consideration and top of mind for investors, according to a study conducted by Harvard Business Review of 70 senior executives at 43 global institutional investing firms, including the three largest asset managers - BlackRock, Vanguard, and State Street.4 In fact, ESG investing has been seeing record growth in 2021, and the head of BlackRock's iShares has predicted that ESG-driven investing will grow to $1 trillion by 2030.5 To meet this investor interest, there has been a proliferation of green and sustainability bonds and other ESG financial instruments. Project companies and investors of these instruments should use tailored ESG reporting frameworks that take into consideration the risks and opportunities specific to their project.

ESG Considerations and Risks for Investors, Lenders, and Project Companies

The three factors of ESG - environmental, social, and governance - describe considerations that go beyond traditional financial criteria and relate to sustainable growth, environmental and social impacts, and the governance arrangements of the project company. There are other terms used to express similar ideas to ESG, including the "triple bottom line" (also known as the "three P's", which are profit, people, and planet), "corporate social responsibility", and "socially responsible investment". In project finance, although the term ESG is not always used, it is highly present in various aspects of project development and in the policies and procedures of owners and sponsors. For example, since 2003, many financial institutions (including banks) have implemented a risk management framework known as the Equator Principles for determining, assessing, and managing environmental and social risk in project finance.6 As of November 2021, more than 125 financial institutions have adopted the Equator Principles. The Equator Principles are primarily intended to provide a minimum standard for due diligence to support responsible decision-making based on the careful assessment of risk and can trigger a need to conduct certain actions with respect to any environmental or social issues that have been identified. The Equator Principles apply across industry sectors, including renewable energy, and have helped spur the development of responsible environmental and social management practices in the financial sector and banking industry.

Characteristics of Project Financings that Enhance ESG Risks

Project financings have particular characteristics that provide protections to creditors - such as all-assets pledges, structures, and covenants to reduce volatility in project cash flows and waterfalls prioritising debt servicing over equity distributions - that allow project companies to have higher leverage ratios than traditional companies while maintaining similar credit quality. Nevertheless, project finance lenders and investors are exposed to similar or enhanced ESG risks. Projects that involve infrastructure and construction work can have effects on the environment and require interactions with local stakeholders. Costs associated with compliance with environmental regulations and coordinating with local communities may impact projected cash flows in the operations phase of a project. To the extent that project risks are allocated to third parties, reducing commercial and technical risks, a credit analysis should identify the extent to which those third parties may be exposed to ESG risks that could affect costs, revenues, or supply chains.

ESG issues are important for debt and equity investors in project companies. Failure to properly address these issues can adversely impact the development and performance of projects vulnerable to ESG risks and weaken a project company's credit position and profitability. ESG factors can also create financing and refinancing challenges for projects the asset life of which is uncertain, particularly considering new environmental regulatory pressures.

For example, S&P in 2020 downgraded the senior secured debt of the operator of a coal plant in West Virginia, noting that as investors increasingly shy away from coal projects, it may become more difficult to arrange an extension or refinancing of the debt facility. Even after the company's restructuring and emergence from bankruptcy later in 2020, Moody's assigned a lower subprime rating to the company's debt in 2021, reflecting the company's overall weak credit position in light of risks associated with decarbonisation and the energy transition, anticipated federal regulatory policy that could adversely impact the coal sector, and increasing investor concerns relating to ESG factors, all of which contributed to elevated refinancing uncertainty and liquidity risk for the project.

Negative social and governance events led S&P to downgrade debt issued by an owner and operator of a highway project under construction in Lima, Peru to speculative grade due to the resulting erosion in the risk profile of the project. From a social perspective, protesters destroyed a new toll plaza facility over concerns of toll charges and their impact on wealth inequality and affordability. Subsequently, the municipality of Lima suspended toll payments at the facility, which resulted in a loss of revenues. From a governance perspective, one of the company's sponsors had been involved in a probe for paying bribes in Latin America to win concessions. The project's relationship to this sponsor carried reputational risks, which in turn affected its ability to secure additional financing.

Environmental, Social, and Governance Considerations in Project Finance

ESG considerations are relevant to all types of large, long-term infrastructure projects, from highways and bridges to energy projects (including renewable energy projects), rail lines, and water or water treatment facilities. Additionally, ESG factors can be interrelated and sometimes inversely related. When a coal power plant is shut down for environmental reasons, for example, there can be cascading impacts on social issues if the shutdown results in layoffs and unemployment for local communities.

Environmental considerations have always played a central role in project development and primarily relate to the siting of projects and proper disposal of materials after a project is decommissioned. The "E" can also overlap with the "S" in the areas of local community relations, environmental justice, preservation of archaeological and cultural resources, and Indigenous rights.

  • Project siting impacts may be temporary or permanent in nature. For example, the siting of temporary construction access roads may disturb wetlands or other sensitive habitats. Other impacts may be more permanent, such as harm to protected species. Projects and associated infrastructure (such as transmission lines for energy projects) can require a large amount of acreage, which is often agricultural or other prior undeveloped land. Project development can require tree clearing, regrading of the land, and dredging/filling of wetlands. Temporary or permanent access roads or staging areas need to be placed, and ground disturbance such as excavation and filling for foundations must occur. These activities may disturb the habitat of a variety of wildlife depending on location, such as fish and other aquatic species for hydroelectric dam projects, and in some instances, projects may even result in intentional or incidental animal death. Also falling under the umbrella of environmental are impacts to safe airspace travel; some types of projects can cause sight hazards or disrupt flight patterns for aircraft, especially if located in proximity to an airport, and have the potential to disrupt national air defence networks. In many jurisdictions, a project will be required to comply with a statute, such as the National Environmental Policy Act in the United States, that can trigger the need for a comprehensive review before issuance of certain permits or other governmental action. These laws require that a project company thoroughly review the environmental impacts of the proposed project and mitigate those impacts to the extent possible. Project companies should be mindful to comply with all other environmental laws, including those that regulate sensitive resources such as wetlands and protected species.
  • Community relations, cultural resources, and Indigenous rights are critical aspects of determining how and where a project should be sited. ESG reflects an increasing social awareness of the impacts a project may have on the surrounding community. For example, if a project is located in proximity to important cultural or Indigenous resources, sovereignty concerns should be assessed and mitigated, with Indigenous community involvement throughout the process. The Equator Principles specifically require that all projects affecting Indigenous Peoples will be subject to an informed consultation and participation process and must comply with the rights and protections for Indigenous Peoples contained in relevant national law, including laws implementing host country obligations under international law.7 Appropriate mitigation can include performing studies and surveys of the area and preparing mitigation and preservation plans.
  • The concept of environmental justice more broadly strives for the fair treatment of all people when considering the siting of projects. There are legitimate concerns regarding project siting near vulnerable communities and the associated risks of pollution and disturbances resulting from noise, runoff, excavation, and other features of project operation and development. This is compounded when a community already has several similar projects within its borders. Projects are almost always subject to an approval process that requires an opportunity for public comment, which can raise these concerns and result in a better project with fewer community impacts.
  • Proper disposal and recycling of materials at the end of the project life cycle is an oft-overlooked project consideration. Decommissioned project components must be disposed of in ways that preserve the health and safety of the physical environment and of individuals and communities. The Equator Principles can trigger the need for a decommissioning plan, even if not required by a host country's laws.

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1. Diego Weisvein, How ESG Factors Have Begun To Influence Our Project Finance Rating Outcomes, S&P Global Inc. ( January 27, 2020), available at 

2. See, e.g., H.R. 3684 - Infrastructure Investment and Jobs Act, Public Law No. 117-58 (passed into law November 15, 2021), available at See also Allan Marks, Biden Signs Infrastructure Law: Here's How It Will Streamline $1 Trillion in Spending, Forbes (November 16, 2021), available at

3. Jennifer Hiller and Jessica Resnick-ault, The Two New Exxon Board Members Poised to Shake up Insular Culture, Reuters (May 26, 2021), available at On the point of the increasing influence of proxy advisors in the ESG context, see Neil Whoriskey and Allan Marks, Corporate Governance & Proxy Advisors: "Who Watches the Watchers?", Milbank LLP Law, Policy & Markets Podcast ( January 29, 2021), available at

4. Robert G. Eccles and Svetlana Klimenko, The Investor Revolution, Harvard Business Review (2019), available at

5. Lizzy Gurdus, ESG Investing to Reach $1 Trillion by 2030, Says Head of iShares Americas as Carbon Transition Funds Launch, CNBC (May 9, 2021), available at

6. Equator Principles EP4, Equator Principles (2020), available at See also Matthew H. Ahrens, Munib Hussain, and Ryan Harman, The New Equator Principles - Climate Change, US Application and What EP4 Means For You, Milbank LLP, available at

7. Guidance Note: Evaluating Projects with Affected Indigenous Peoples, Equator Principles (September 2020), available at

The article was first published in the ICLG - Environmental, Social, & Governance Law 2022.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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