Meet the investors trying to de-risk UK transition infrastructure

Amidst the vast investment demands of UK infrastructure, the widening gap between supply and demand is starkest in green energy and power where the government has set ambitious 2030 decarbonization targets.

Typically, such a supply-demand mismatch acts as a calling card for long-term investors who compete for the diversification, inflation linkage and shelter from cyclical downturns that developed market infrastructure offers. Yet in the case of the UK, many would-be investors in the energy transition are watching warily from the sidelines because planning policy, financing mechanisms and the need for market reform is crimping investable opportunities.

This could change if an engagement initiative that has successfully accelerated superannuation investment in Australia’s energy transition led by IFM Investors starts to gain traction in the UK too. The experienced infrastructure investor has joined forces with a cohort of pension funds in the UK and Australia including the Universities Superannuation Scheme, NEST and Border to Coast, Aware Super, Cbus Super and HESTA, to spell out to the UK government what it needs to do to encourage investment.

“The 20 recommendations we put forward are comprehensive and interlocking. Each recommendation is important and will help enable the right policy settings to drive investment,” says Luba Nikulina, chief strategy officer at IFM where she is responsible for leading the development of IFM’s global strategy.

What investors want

A key recommendation includes resolving the backlog in grid connection requests from renewable power providers. Something that has grown challenging from remote sites as more renewables come online and is now holding back clean energy development and wider economic growth.

“Investors must often bid for grid connectivity years in advance of building the wind or solar development. We ask our managers to ensure the grid connection is secure before we invest because the last thing you want is to cancel a project because there is no grid connectivity,” says Nadeem Hussain, Co-CIO and Head of Private Markets at blueprint signatory £30 billion local authority pool LGPS Central, where he oversees a growing 5-10 per cent allocation to infrastructure of which UK assets account for around a quarter.

In a Catch-22, he notes the shortfall in green energy has also begun to impact another corner of LGPS Central’s UK infrastructure allocation client funds want to invest more.

“We are open to investing more in data centres but the rapid growth in the sector means many are now securing whatever energy source they can which might not be renewable. We think this is a short-term solution.”

Elsewhere, the blueprint urges the UK government to streamline the planning process.

“Faster planning approvals are essential to nurturing clearer project pipelines and making UK infrastructure more competitive on the global stage,” says Jonathan Ord, head of investments, GLIL Infrastructure, another partnership of UK pension funds that invests in UK solar and wind assets.

In a bid to increase regulatory certainty, IFM’s recommendations call for policies like legally binding emissions reduction targets and regulatory integration between the UK and EU energy markets. “Making it easier to buy and sell energy on a Europe-wide basis also increases the investible opportunities in the UK market,” explains Nikulina.

As it is, regulatory chopping and changing like the government’s decision to push back the ban on the sale of new petrol and diesel cars from 2030 to 2035 shifted the risk return profile for investors in electric vehicle charging infrastructure. The problem is even more critical outside the energy sector. Investors including C$133 billion Ontario Municipal Employees Retirement System (OMERS) and £75 billion USS, cut their losses in troubled UK water utility Thames Water because of demands from Britain’s regulatory authority, OfWat, that they reduce their returns below the cost of capital.

“Infrastructure investors don’t want to see a regulatory change that materially impacts the economics of a project during their ownership,” says Hussain. “To date, we’ve managed to swerve exposure to more regulated utility investments.”

The list of investor recommendations grows more detailed when it comes to encouraging risky investment in large capex projects, an area IFM has deep expertise, and early-stage investment in new construction.

“Investors require mid-to-long-term power purchase agreements and/or extension of Contracts for Difference terms beyond 15 years to reflect longer project lives,” lists Nikulina who explains that the sharper risks in the next phase of the energy transition in carbon capture, low carbon fuels and floating offshore wind will also require much greater revenue certainty mechanisms.

“First-of-a-kind projects carry a unique combination of risks, including permitting sites for new technologies, technology maturity and scale, construction and supply chain risks, revenue uncertainty and risks associated with changes to policy and regulation,” she says.

LGPS Central still has a cautionary approach to greenfield infrastructure, admits Hussain. Although the asset manager has a value-add strategy, it will only invest in the construction phase if the developer not the investor takes the risk. But he says the government’s new financing institution the £7.3 billion National Wealth Fund could play a pivotal role encouraging more investment if it takes on early-stage risk.

Will it work?

In some respects, IFM’s engagement has already helped produce startling results. Witness recent reforms to how public sector net debt is calculated creating additional fiscal headroom for the government to invest. “We were pleased that shortly after our blueprint launched, UK Chancellor Rachel Reeves announced major fiscal rules reform to Britain’s debt rules that will permit the Treasury to borrow more for long-term capital investment,” says Nikulina who adds that engagement has already produced “a greater understanding of the government’s policy priorities” and “ongoing development” of the infrastructure and energy transition sectors.

Progress in Australia shows what’s possible in the UK. Energy transition policy recommendations written by IFM and eight of Australia’s largest pension funds for the Australian government were recently included in Australia’s Federal Budget 2024/25. In another example of meaningful collaboration with government in order to facilitate investment,  IFM is successfully engaging with Australian policymakers to help make social and affordable housing an investable asset class.

Asset owners have also thrown their weight behind IFM’s lead. “We encourage the government to improve the investor climate where we can, but in terms of direct influence over strategy, we encourage our investment managers to play a key role influencing policy,” says Hussain.

The belief that infrastructure partnerships help wield influence, not only with policy makers but also as a way to pool capital to target the biggest deals with like-minded investors is increasingly prevalent. Last year APG Asset Management, which oversees €577 billion ($595 billion) on behalf of Dutch pensioners and where a large internal team oversee a roughly €27 billion ($27.8 billion) infrastructure portfolio, announced a co-investment strategy with Japan’s ¥227 trillion ($1.5 trillion) Government Pension Investment Fund, GPIF, which has less experience in the asset class.

“We believe that joining forces will help to deliver long-term value to our beneficiaries and the broader society,” said Ronald Wuijster, CEO of APG Asset Management, which is also partnering with Swiss pension funds PUBLICA, City of Zurich, Kanton Aargau, and Credit Suisse to co-invest in infrastructure equity.

Nikulina, who now bangs the drum for change from IFM’s seat on the government’s British Infrastructure Taskforce (BIT), chaired by the Chancellor of the Exchequer, concludes that successful engagement rests on understanding the government’s priorities and finding common ground to “crystalise mutual benefits.” Open lines of communication and a preparedness for the long haul are key, as well as an understanding that policy makers can’t solve risks like inflation and supply chain constraints.

But she is convinced change is possible.

“I believe we can achieve the best outcomes when we work together and signalling our investment objectives can drive policy change.”

Presented in partnership with IFM Investors.