As politicians and fund managers spar over how public finance should respond to questions related to environment, social, and governance concerns, muni bond issuers on the front lines are quickly getting up to speed.
“Investors and regulators are looking for ESG disclosures about environmental, social, and governance factors that may affect municipal issuers credit and its ability to pay debt service,” said Cindy Harris, chief financial officer of the Iowa Finance Authority. “Rating agencies want to know how cities, counties, and states are responding to ESG related risks, and then we also have investors who are also looking to buy green bonds or social bonds that fund positive, environmental or social outcomes.”
Towards that end Harris is advising her colleagues in public finance to start looking at how their communities can frame bond issuance into an ESG portfolio. According to Harris, environmental can be covered with climate-related concerns like flood mitigation, wildfire prevention, and water quality. Social spills into affordable housing efforts and job growth. Governance connects to cyber-security and disclosures already being made in routine bond issuance.
Harris’ remarks came during the Government Finance Officer’s Association Minimuni conference which was recently held online. In addition to laying out the connections between ESG and bond-friendly initiatives, she also referenced how embracing ESG can pay off. The Iowa Finance Authority started issuing green bonds in 2015 and added a socially- targeted issuance in 2021 with the proceeds aimed at improving the state’s affordable housing situation.
The authority used guidelines from the International Capital Market Association and the United Nations Sustainable Development Goals as a template, but self-certified the bonds. The effort was launched in May 2021. “We were selling about $92 million of tax exempt bonds, and we had $262 million in total orders. So almost three times oversubscribed, and of those orders $51 million or about 20%, were ESG orders from six different accounts,” she said.
“We had orders for over 21 different maturities, so I was really pleased with that. I can’t necessarily quantify the exact pricing benefit, but the additional ESG orders created more demand which allowed us to reprice the bonds a few basis points lower. From my perspective, the social and green bond designations help you tell your story and market to investors who may want to invest in your social or green infrastructure.”
Harris also has a caveat to go with the success story. “While this bond sale went well, I have also done additional social bond designated sales, where we’ve had few to no ESG investors show up. “It’s been a mixed bag on the benefit of that designation, and a lot of that has also been more challenging in the volatile market environment we’re in.”
The three big rating agencies, Fitch Ratings, Moody’s Investors Service, and S&P Global Markets, have all developed rating systems to measure ESG and assign credit ratings. “The language is not clear,” said Leonard Jones, managing director in Moody’s Public Finance Group. “Is ESG an input or an output? We try to focus on the inputs in our rating agency. Do these ESG risks cause a credit impact? Investors want to be paid when they take more credit risk. From what I call the output, what are the bonds being used for? Are they being used for something sustainable, which may not affect the credit?”
Risk is something that has to be considered with a successful issuance. “ESG will touch your bond issue many times, and the key thing is that you really can’t just focus on one of those touch points you need to keep focusing on all the touch points,” said David Erdman, managing director of Baker Tilly Municipal Advisors, LLC. ”For any bond issue, whether it be designated or not, you’re gonna wanna take some time to disclose your environmental risk, your social risk and your government risk which generally relate to an access to credit. But if your community is doing something good which you want to highlight that.”
The future of ESG remains unclear as the possibility of SEC regulation creates concerns. “If we all work together to identify what needs to be addressed in the ESG world, we can show those who may think about regulating that we as marketplace can address this without regulations,” said Erdman.
Jones can see the possibility of the script being flipped from an ESG-flavored carrot to a stick.
“I’m actually waiting for the day where you pay a penalty for issuing bonds that are not green versus getting a penalty for issuing ones that are,” he said.