Financing smart, sustainable cities

We consider whether smart city strategies are a route to economic, social and environmental sustainability, and review some of the new players and products in infrastructure financing around the world.

More than half the world’s population currently live in urban areas, and this proportion will grow to around 70 per cent by 2050. Without an actionable urban strategy, cities face the prospect of increasing congestion and pollution, inadequate and unreliable energy, lack of basic public services and poor environmental management. Clear links between climate resilience and economic resilience are prompting cities around the world to embed sustainable principles into their city strategies, enabled in part by digital, smart city technologies. 

New technologies and digitalization, as well as customer expectations, are transforming how urban infrastructure and city utilities are planned, designed, procured, operated, financing and managed. ‘Smart’ city strategies that include data collection and analysis to improve efficiencies in multi-modal urban systems are increasingly being seen as a route to sustainable urban infrastructure development. The correlation between ‘smart’ and sustainable’ is well recognized in city resilience strategies across the world.

An example of a smart city strategy that embeds sustainability principles is Singapore, where the government’s core strategy is to develop tech-enabled solutions to address some of the challenges of urban density, transport, energy and water sustainability ¹. The city state is leveraging data and digital technologies, including artificial intelligence and autonomous vehicles, to enhance public transport and the deployment of sensors and IoT devices to make the city more liveable and secure ².

In the US, cities and states are increasingly using digital technology to reduce the city’s carbon footprint as well as to improve operational efficiency and services. In Washington DC, the city is upgrading its street lighting infrastructure with new, smarter technology including a remote monitoring and control system. The project also offers an opportunity to incorporate smart city technologies into the light facilities to provide broadband wifi, enhance cell phone services, information kiosks and sensors. This is similar in concept to Pittsburgh’s Smart Spine³ corridors, where street lights are being converted to energy-efficient LED lights and equipped with traffic detection and air quality sensors. The data from these sensors could be used to lower greenhouse gas emissions, shift energy loads, improve travel time across neighborhoods and inform zoning and other local policy decisions

In emerging Asia, where much of the population growth and urbanization is anticipated, there is considerable interest in smart city and sustainability initiatives, although these are not always integrated into urban infrastructure plans.

Bangkok and Jakarta both suffer from frequent flooding as well as congestion, pollution, and transport issues. In these cities, developing infrastructure that mitigates some of the worst impacts of climate change is a priority. In 2011, flooding in Bangkok caused US$45 billion worth of damage, of which only US$10 billion was insured⁴. Bangkok’s City Resilience Strategy⁵ includes multiple measures to improve flood resilience, including an integrated and robust urban flood defense system, structural modifications to existing drainage systems, and developing new water storage capacity. 

As a separate initiative, the Thai government is working to integrate digital technology, energy and transport to improve quality of life in the cities. Seven cities are currently taking part in a pilot project to develop smart city initiatives (including the development of high-speed internet infrastructure and free Wi-Fi in Phuket).

As well as discrete ‘smart city’ initiatives, and specific climate-resilience projects, there are a number of large-scale infrastructure projects planned by the Government which, once implemented, will make a major contribution to urban development. Several urban mass transit rail projects are planned in Bangkok, along with light rail projects in Phuket, Chiang Mai and Kon Khean. A high speed rail project connecting Bangkok with Rayong is planned. Most of these rail projects will be developed by means of Public-Private Partnership (PPP).

As in Thailand, the Government of Indonesia has smart city aspirations: in 2017 it launched the 100 Smart City project. To date, the projects have been largely focused around telecommunications infrastructure that deliver improved public services such as waste management and policing. These projects are relatively small; developing basic infrastructure such as mass rapid transport and water management systems remain a higher priority.

Sustainable urban infrastructure development is becoming more important in the Middle East, led by Saudi and the UAE. Plans to build a mega city in Saudi, powered by renewable energy and designed to offer residents a ‘connected lifestyle’, show ambition. Efforts are underway for new government buildings and schools in Dubai and Abu Dhabi to be more sustainable; and there have been some large solar parks projects in the region. The Dubai Government has also introduced the “Smart Dubai” initiative to make Dubai “happier”, more technologically advanced and more sustainable, although there is little detailed policy behind this. Without detailed sustainability policies and regulations in place, these grand plans may flounder. 

Financing the huge amount of infrastructure needed to meet the demands of growing urban population is beyond the reach of governments alone. Private sector financing will be increasingly important in closing the financing gap, particularly given widespread public sector fiscal constraints. The World Bank Group recently launched its Maximizing Funding for Development initiative which aims to mobilize private capital into infrastructure at every opportunity with a more systematic approach to unlocking finance at all levels. At the same time, investments in infrastructure assets either directly or as limited partners in specialised infrastructure, private equity, sovereign wealth or pension funds is a growth area across the globe and a number of projects, not least led by the Long Term Investment Project at the OECD are leading the way in standardization, classification and data aggregation to help quantify risk and mobilize institutional funds into infrastructure.

Project bonds continue their growth trajectory: growing demand from Asian and global investors has seen several bonds issued in the power sector. Singapore announced recently that it is looking to finance its long term infrastructure plan (including the Integrated Waste Management Facility, the Kuala Lumpur – Singapore High Speed Rail project, the Johor Bahru – Singapore rapid transit link and Changi Airport Terminal 5) through the issuance of infrastructure bonds. While commercial bank lending has made up the majority of lending to infrastructure projects in the Middle East to date, there may be more interest in bonds or sukuks if the proposed mega city projects impact on liquidity.

PPPs continue to grow as a delivery model in Australia, Canada, and the US and increasingly in emerging markets in Latin America, Asia and Africa. Risk allocation in PPP projects still presents challenges in emerging markets, something that development banks and IFIs are working to address. Value capture models are also being used or considered in Latin America (CEPACS in Brazil have been particularly successful), Australia and the UK as a way of financing urban infrastructure. 

The increasing importance of environmental, social and governance issues in long term infrastructure investment is apparent in the growth of the green bond market. According to the Climate Bonds Initiative⁶, the initial green bonds forecast for 2018 is US$250-300bn, more than 60 per cent growth on 2017 figures.  Investment in renewable energy continues to be the most common use of proceeds, although allocations to low carbon buildings, energy efficiency and low carbon transport (rail and urban metro) rose significantly in 2017.
In Australia, all four major Australian banks have established ‘green bond’ programmes — the ANZ’s ‘Green Property & Renewables Bond’ was the world’s first bond to be certified under the Low Carbon Buildings criteria of the Climate Bonds Standards. ANZ issued the bonds in May 2015, with an inaugural $600 million offer that was well oversubscribed. The proceeds were used to finance green properties (40 per cent), with the balance applied to wind and solar energy loans. Projects that benefited from the bond proceeds included wind farms in Taiwan and Australia and Brookfield Place Tower — a six-star low-carbon building in Perth.

Fiscal constraints in the US have impacted on the availability of municipal bonds for public infrastructure. To address this financing gap, many U.S. cities are looking to smart solutions to reduce capital and maintenance costs, incentivize smart private development, and localize infrastructure costs to those willing to pay for use. Examples include tolled lanes within freeways, congestion pricing, coordination of mass transit with end-of-ride car sharing, smart water meters and sensors to avoid catastrophic failures, crowd-sourced real-time transportation data, smart street lights, charges for non-tolled road use (to augment or replace diminished revenue from motor fuel taxes), etc. and, eventually, doubling the capacity of streets and roadways through smart vehicles.

While municipal bonds remain the principal source of capital for large scale infrastructure, increasingly cities are looking to concession arrangements and vendor financing of smart solutions by IT companies to shift performance and usage risks. Cities provide public rights-of-way and credit and, in return, receive private investments in public technology.

The municipal bond market is almost unique to the US, but other regions around the world are starting to explore it. Some local governments in South Africa have issued municipal bonds; others (eg Kampala and Dakar) have struggled with their less robust legal and regulatory environments. India’s Smart Cities Mission⁷ is actively promoting municipal bond issuance as part of its plan to improve water supply, transportation and sanitation in 100 cities by 2020. Bangalore and Ahmedabad have both issued municipal bonds. 

Over the past five years or so, Australia has seen an unprecedented investment by Federal and State governments in the infrastructure sector. Significant funds have been generated by a capital recycling program in which funds released from the privatisation of existing brownfield assets are reinvested alongside the private sector in critical new greenfield projects. Government recycling has fuelled a surge of new PPPs, including the A$2.1bn Sydney Light Rail Project, the Westconnex road PPP in Sydney, Social Housing PPPs, and Brisbane Cross River Rail PPP. This pipeline has attracted strong interest from overseas investors, particularly Canadian pension funds; local pension funds have also become very active as investors look to broaden their investment mandates.

In cities around the world, embedding sustainable principles into urban development plans — enabled by digital technology — is critical. The scale of investment needed to meet urban infrastructure demands is challenging, and mobilising debt and equity into urban infrastructure assets is the single largest and most pervasive theme across this sector.