While municipal bond issuance has dropped precipitously the past two years amid volatile markets, environmental, social and governance debt has steadily grown despite issuer hesitation to designate it as such and an ever-more acrimonious political environment emerges over it.
ESG issuance for the first three quarters of 2023 was at $27.970 billion, potentially on pace to beat 2022's total of $32.713 billion, according to Refinitiv data.
By comparison, in the first three quarters of 2021, $17.612 billion of ESG bonds were issued, per Refinitiv. In all of 2020, as ESG issuance began to rise, a total of $16.621 billion was priced, per Refinitiv.
As of mid-October, states and localities had priced $31 billion of ESG-labeled bonds versus the $40.5 billion seen in 2022, according to Bloomberg News.
ESG issuance makes up just a fraction of the total of all municipal securities priced in the market — $315.911 billion thus far in 2023, down from $344.251 billion through Oct. 31, 2022, per Refinitiv.
The lack of stronger growth in ESG debt is due to "both higher interest rates and lower overall issuance volume as well as the more contentious political connotations related to ESG-labeled bonds," said Alice Cheng, a municipal credit analyst at Janney Montgomery Scott.
The lower figures and the discrepancy of the data is also due, in part, to the lack of standardization and universal language for ESG and how various issuers designate their deals and how different investors view it.
"The lack of standardization is a very real problem that impacts all facets," said Ted Chapman, managing director and investment banker at Hilltop Securities.
There is a consensus among market participants, however, that a universal language or standard would benefit the market. Respondents to an August Bond Buyer survey in aggregate and by relationship to the muni market overwhelmingly agreed that
There are various metrics and standards that many issuers use to designate their issuances. Some issuers self-designate their debt as ESG, though that practice has fallen as greenwashing concerns have risen.
The muni market has "largely coalesced around the [International Capital Markets Association] Green, Social or Sustainable Principles when issuing labeled bonds," said Ruth Ducret, senior research analyst at Breckinridge Capital Advisors.
The ICMA framework follows four core components for issuer disclosure: use of proceeds, process for project evaluation and selection, management of proceeds and reporting, Ducret said.
Additionally, many issuers follow the United Nations Sustainable Development Goals and use the Climate Bond Initiative's climate bond-certified stamp of approvals.
"Issuers of labeled debt generally follow these principles and some also opt to use third-party verifiers which can increase investor confidence in a labeled bond," she said.
From an investor perspective, there is demand for ESG bonds, but it is mostly concentrated in select funds.
Barclays PLC noted in an April report said "most U.S. municipal bond investors, do not allocate their portfolios specifically to ESG bonds."
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Still, they noted that ESG funds "tend to have overweight positions in labeled securities, particularly green and sustainability bonds, versus traditional funds."
Most traditional municipal funds also invest in ESG bonds, "but their decision to put money to work is determined mostly by valuations, rather than any other considerations," Barclays said.
Where's the pricing benefit?
Some hesitation to issuing labeled bonds, "even where the use of proceeds has a clear environmental or social benefit, has to do with an issuer's traditional cost-benefit analysis," Ducret said.
At this point, she noted, there is a "lack of discernable price benefit to issuing a labeled bond in the muni market."
Labeling bonds as ESG has not been something that is materially and explicitly tied to improving issuers' cost of borrowing, at least not yet in the muni market, Chapman said.
"Maybe you can squeak out a couple of extra basis points, but I don't know if that's even a trend; those are more anecdotes," he said.
"As much as I would like to believe that a lot of investors care about ESG bonds, they pick the one that makes the most sense to invest in," Cheng said. "So meaning higher yielding, higher returns, are more attractive."
This is not lost on issuers.
"I'm frustrated that we were not seeing that [pricing] differential" for ESG bonds, said Nikolai J. Sklaroff, capital finance director for the San Francisco Public Utilities Commission, at The Bond Buyer's California Public Finance conference. He noted he's fearful if the market will ever see the differential.
"We are a small part of a global investing universe, and this effort with ESG began in the taxable market and began internationally," he said.
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The United States' counterparts in Europe are typically thought to be several years ahead of the U.S., Sklaroff said.
"In this regard, what is important to understand about how that whole universe got started was that people who wanted to affect change went to investors and said, 'You can do this without giving up yield,'" he said.
That's the premise that he said has been promised to the investing side.
"If only we grow this marketplace, if only we build the demand, we'll eventually have a pricing difference," he said.
Barclays noted in its April report that part of the challenge is the dearth of supply.
With the lower issuance overall, Barclays strategists noted "it is not surprising … that municipal ESG bonds mostly trade with a very small green premium (if any), unlike their corporate counterparts, at least on the Euro side."
Consequently, they said a "muni greenium will likely remain very small for the foreseeable future, at least until municipal investors become more interested or are incentivized to dedicate more funds to ESG bonds."
The costs of designating
The designation of ESG-labeled bonds hasn't historically mattered in a "meaningful way" to the issuer, said Matt Fabian, a partner at Municipal Market Analytics.
"It matters a little bit more to the buyer if it fits a portfolio need or an investing strategy or a marketing narrative," he said.
ESG bonds help "sort bonds slightly differently between investors, but the net impact to the issuer is minimal or nonexistent," he said.
"Issuers are generally disposed to seek a green or ESG label when it's appropriate," said Pat Luby, a CreditSights strategist, noting there is also the cost and time commitment of seeking out an ESG designation.
The cost can range from $10,000 to upwards of $25,000, according to Chapman, which is expensive for cost-conscious issuers.
Furthermore, Chapman said, "whether you pursue a second party opinion, whether you just choose to self-label and commit yourself to presale reporting and disclosure, potentially ongoing post sale, disclosure, that's a time commitment, that's a potential financial commitment."
Therefore, Luby said, it makes more sense for larger issuers who frequently come to market but less so for smaller ones who access the market every year or two.
The politicization of ESG
There are also political considerations to contend with.
ESG, according to some politicians and other government representatives, is a part of the financial markets' "woke" agenda, from the states
New laws in several states, including
In August of this year, the Securities Industry and Financial Markets Association, a trade association representing financial services firms,
The state is expected to respond with its motion to dismiss by Monday.
Wells Fargo and RBC Capital Markets were recently dropped from two separate Texas deals since state Attorney General Ken Paxton's began examining several banks' climate change practices.
"A lot of times issuers are trying to tiptoe around these political issues," Cheng said.
"The political climate does matter in so much as in some states, labeled bonds are viewed negatively by politicians or in the case of Florida, they are not permitted," Ducret said. "But in states like California where labeled debt is encouraged, lack of resources and price discovery are more influential."
This is why ESG-labeled supply comes from blue states, especially from California and New York, which together represent the bulk of the ESG universe, Barclays strategists noted.
Additionally, some other blue states, such as Massachusetts and Washington, have "more ESG bonds outstanding than some of the more active issuers of traditional municipal bonds such as Texas and Florida."
Some issuers, aware of the contentious nature surrounding ESG bonds, may try to market the bonds differently, Cheng said.
This could lead to bonds that have an ESG bent being called something else, she noted.
Cheng recounted an anecdote about a school bond deal with renewable energy component had to be renamed so it appeared it had nothing to do with renewable energy.
The non-ESG-labeled bonds were still issued and had good traction, but at the end of the day, she said, the organization recognized the purpose of the deal and why it was important but was unable to "name it anything remotely related to ESG."
Due to this, she said it's possible that there may not be as much of a slowdown in ESG as the numbers indicate due to issuers choosing to not label ESG bonds as such.
Potential for growth
Despite the slowing of overall issuance, market participants still expect that ESG may lead to growth for the industry.
One in three respondents to The Bond Buyer's ESG survey said they believed ESG is highly important to the industry, while a majority said it is at least somewhat important, and nearly half of respondents said they expected ESG to have a positive impact on industry growth over the next five years. Twenty-four percent said it would be a limiting factor.
Ducret believes there will "continue to be an increase in the percentage of labeled municipal bonds in the market."
The muni market "continues to fund projects that serve the public good with both environmental and social benefits and therefore lends itself nicely to the issuance of labeled debt," she said.
Additionally, Ducret noted there is "the potential that as market technicals shift, we could start to see a price differential between labeled and non-labeled debt which would drive more issuance."
"A recognized price differential for labeled debt vs. traditional non-labeled debt would drive more issuance in the municipal market as well as a de-escalation of the politicization of the label," she continued.
Listen to Breckinridge's Ruth Ducret
Outside of a general decline in issuance, Ducret does not expect a "proportionate decline in labeled bonds compared to the overall market."
If this decline happened, she said "it would largely be driven by either political reasons or a lack of resources available to issuers to produce the disclosure associated with this debt."
With the adaptation of more ESG labeling and disclosure regulations, Cheng hopes 2024 will be a better environment for investors who are looking for less greenwashing and putting more bond proceeds to their intended use.
"What you want in a bond sale is the broadest possible base of investors, and in a market like this one, in particular, this is when you really want to be appealing to as many people as possible," said Kim Nakahara, a senior research analyst and portfolio manager at Allspring Global Investments, at the California Public Finance conference.
While labeling bonds as ESG is a challenge, she said "it's also the reality of where our market is going."
