Resilient Infrastructure - Part 2 Beyond Breaking Point

Our Resilient Infrastructure series examines how legal, regulatory and financial frameworks must evolve to help governments, investors and operators protect physical assets. In this instalment, we explore how to make existing infrastructure more resilient – and the risks for those who fail to act.

Ageing infrastructure is becoming more vulnerable with each tick of the climate clock, compounded by the growing risk of cyber-attack, terrorism and other risks not anticipated when the assets were conceived.

Warming rivers inadequately cool nuclear plants, hackers bring transport systems to a standstill, and rising tides and inundated rivers threaten or destroy assets located on neighbouring real estate.

The infrastructure underpinning energy, transport, water and communications are critical to economic stability yet many remain fragile and susceptible to changing threats. There is an urgent need to assess and reinforce these assets so the economies that rely on them can thrive.

Future-proofing, however, comes at a premium: while some market participants are on the front foot, others may need more convincing.

In the UK, the electricity and gas regulator has imposed resilience obligations on transmission system operators. "System owners now need to be innovative in relation to maintenance issues, otherwise they will not be paid," says Dr Silke Goldberg, a Herbert Smith Freehills Kramer (HSF Kramer) partner specialising in energy, infrastructure and ESG.

There are several components of the energy ecosystem that are increasingly vulnerable. Substations and underground cables are susceptible to heat stress, as recent weather patterns — especially prolonged heatwaves — have disrupted operations. Drought can also severely affect nuclear and hydro generation assets.

Infrastructure resilience isn't just relevant to design and maintenance. There is also the question of who bears the risk and cost when assets fail. HSF Kramer project finance partner Erin Wakelin explains Australia's experience. "Actions were brought against the owners of energy infrastructure following massive bushfires. However, most claims stemmed from impacts with assets, such as tree branches striking power lines, rather than asset failure itself."

Although asset owners may not be directly liable for extreme events, they are expected to take reasonable care in managing asset risks, especially given the significances of the consequences when exacerbated by extreme weather events.

How to audit portfolios for resilience: Scenario planning

More asset managers are turning to scenario planning to pinpoint vulnerabilities. "Scenario planning is the only way truly to assess what risks you're carrying on your balance sheet and which are transferred to insurers," says Sarah McNally, HSF Kramer risk and insurance partner.

Clients now simulate cyber-attacks and extreme weather events to test how insurance policies and contracts would respond. "The best scenarios aren't tied to the contract," adds McNally. "You start with a scenario and examine the ripple effect across other angles".

This approach helps operators identify contractual gaps and operational weaknesses before a crisis, according to Melbourne-based infrastructure partner Joseph Varghese: "Scenario planning can be applied beyond insurance – such as in public concessions or asset management subcontracts – to understand how resilience requirements could play out across the business."

Long-term thinking is essential. But many lenders and sponsors still focus on immediate contractual obligations and on previously-identified risks, rather than on predicted outcomes in a rapidly-changing climate and digital landscape. Although financiers are becoming more conscious of ESG risks, most are less adept at assessing resilience to future operating environments.

Incentivising resilience for investors

Despite the risks, private investors may need clear incentives to prioritise the resilience of their assets – particularly to threats which have yet to be confronted. "There needs to be an obvious benefit for investors. Without mandated requirements, factoring in the costs of future proofing may work against them – at least in the short term." Wakelin warns. "The return on investment is unlikely unless the measures are immediately and clearly necessary to protect the asset and the investment or to meet mandated requirements."

Changes to maintenance phase contracts

Resilience is beginning to filter through construction contracts, but not yet to contracts for long-term asset management. "We are seeing contractors ask for relief where there are extreme rain events, for example, which they might not have done 10 years ago," notes Varghese. "But I haven't seen climate-related risk filtering through to ongoing 10 or 20-year maintenance phase obligations."

More flexibility is needed. For example, public-private partnerships (PPPs) generally include strict requirements about modifications that can be made to an asset and the standard it must meet when handed back to the procuring entity. "It would be interesting to see whether some of that flexibility can be built into long-term contracts to allow asset owners to respond to resilience requirements," says Varghese.

Under current arrangements, if an operator proposes an improvement that enhances resilience, it will typically bear the cost. "We need to start thinking about whether there are contractual parameters around how you might deal with ongoing changes for the benefit of the asset and its users in the long-term," he adds.

Regulators may be more open to considering contract amendments when future–proofing and resilience is the key driver, rather than when changes are driven by current cost requirements or profit outcomes.

How flexible is the PPP model?

The PPP model has traditionally left little room for innovation once projects are under way. As Wakelin argues, "it's only now that stakeholders are starting to think about what resilience measures might be required to ensure that the infrastructure meets the required standards when it's handed back to the procuring authority."

Procurement models are evolving. Some governments have used staged concessions, where they fund early-phase resilience, then auction extensions once demand is proven. Tenors can also be better aligned with the expected life of assets as they endure harsher conditions: a 25-year amortisation schedule might not be the best fit for an asset that will require a major upgrade in 15 years.

Contractual structures and risk allocation must also adapt to changing environmental and technological factors. For example, rail networks in some markets are severely impacted by rising temperatures or storms, resulting in buckled tracks and washed-out culverts. Yet, under existing contracts, compensation regimes often treat extreme heat or rainfall as 'acts of God' (force majeure events), limiting flexibility and sharing responsibility.

This raises the question: should governments take greater responsibility for the impacts of extreme events — by funding resilience measures and sharing risk— rather than relying on force majeure clauses that shift the burden away from one party or another.

Regulatory reform and insurance gaps

Governments and regulators play a crucial role in setting the tone for resilience. Transmission and distribution system operators in Europe run 10-year scenarios, including varying levels of renewables and extreme weather events, but the nature of a changing climate would suggest models should run to 20 or 30 years.

There is a cost to ignoring the problem, as class actions have shown. In jurisdictions with weak regulation, litigation risk rises. "The less climate change-related regulation, the more likely it is you have a tort-based climate change litigation in that area,"warns Goldberg.

Insurance policies must evolve to match these exposures and to address likely future risks. "For most assets and risks, it's not a question of insured or not. It's about what quality of cover, for what risks, and on what terms," explains McNally.

Stakeholders should also understand their directors' and officers' liability cover for potential climate-related class actions. The best defence against class actions is a clear trail of prudent risk management.

Renewal or replacement?

Decisions about extending the life of existing assets depend on ownership structures,policy priorities and the availability of viable alternatives. In Australia, governments have asked private operators to extend the lives of coal-fired power stations to maintain supply, despite their declining financial viability and their carbon emissions producing nature. This situation highlights a fundamental tension: the need for energy security (and therefore resilience in assets which might otherwise be decommissioned) can conflict with long-term sustainability.

Data centres and sustainable plays

Across Asia, countries are embedding climate adaptation into infrastructure through planning, development goals, and regulatory reforms. The region is unlocking private capital for climate-resilient development through sustainable finance and harmonised ESG standards.

An area of accelerating developing is the emergence of Asian nations as data centre hubs. With hubs located in tropical climates, operators are addressing the risks posed to operations by extending infrastructure lifespans through innovations like recycled water systems and advanced cooling technologies.

As Adrian Wong, Herbert Smith Freehills Prolegis' Singapore-based head of projects, explains: "Increasingly data centre operators are distinguishing themselves in the market by making measurable advances in resilience and sustainability, a key driver for attracting investment and new customers."

Public and private assets at risk

In the US,adverse climate events – fromhurricanes to wildfires – have wroughtsignificant damage to public and private infrastructure inhigh-density across the continent.

"However, as with any challenge comes opportunity," says HSF Kramer real estate managing partner Dan Berman. "We can reshape ageing or obsolete assets, invest in infrastructure and use creative financial strategies to get there."

As insurers pull back from high-risk coastal zones and regulators tighten disclosure rules, developers, owners and those financing the projects need to consider the long-term implications of resilience."The question for many is whether they are investing early enough to protect value and reputation," adds Berman.

Toward resilient, future-ready assets

The age of climate disruption, cyber threats and political instability demand a new mindset for infrastructure owners and operators. That means integrating resilience into every phase – design, financing, operation and renewal.

The coming articles in this series will explore how new infrastructure projects can embed resilience from the ground up, turning today's challenges into tomorrow's competitive advantage; and what happens when things end in a dispute.

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.