Build What Better: The Greening of Municipal Bonds

Transcription below:
Mike Scarchilli: (00:00)
Hi, this is Mike Scarchilli editor in chief of the Bond Buyer. This month, we're doing something a bit different. We have a new podcast, the future of infrastructure. It's a series of deep dives into us, infrastructure opportunities, investments, and impact for our first installment. I'm pleased to welcome investigative journal, Peter Keating in this four part series build what better Peter will break down the most important topics of the new landmark infrastructure deal. You can listen to it here on the bomb buyer podcast. And if you like what you hear subscribe to the future of infrastructure. So you don't miss any crucial insights from our next installment,

Peter Keating: (00:45)
New federal priorities in the infrastructure investment in jobs act, growing awareness of climate change, the coronavirus pandemic, recent political protests, all of these and more contributed to a rising interest among municipal bond issuers and investors and financing, public projects that specifically target environmental, social and governance concerns. We'll talk with two experts about where ESG stands and the surprisingly sparse rules governing participants in this market. I'm your host, Peter Keating and welcome to build what better a bond buyer podcast that will explore the future of infrastructure in America. To set the scene. I talked with Jennifer Brooks, an associate in the public finance sector at the law firm ballad spa. She recently co-authored a report on ESG disclosure in municipal offerings. What makes a bond green?

Jenni Brooks: (01:47)
Sure. Uh, bond is designated as green typically when it is financing a green project, and that can include a world of different types of projects related to clean energy water, you know, making your real, so the water runoff works better. Things of that nature. So really the green bond designation is designed to indicate that this is a green project and that's what the proceeds are going towards.

Peter Keating: (02:13)
Is there a clear consensus in the industry as to exactly what it takes to qualify as green?

Jenni Brooks: (02:20)
Uh, one of the key ones is the green bond principles, the international capital markets association, or ICMA. They worked with corporate and other municipal issuers investors and various underwriters to develop these green bond principles. And so that's kind of one of the key benchmarks. Uh, they're also certified climate bonds that are even a little more stringent in their reporting label, but the thing that makes municipal bond a little unique is that an issuer can self label. Um, they can take a look at the project themselves and determine this looks like a green project and our end, and they might allude to the green bond principles, or they might not at all. So that's why the disclosure is so important as to why this bond should be considered green. And one thing issuers can do is they can enlist third parties to create opinions or other verification reports that speak to the green nature of the bond

Peter Keating: (03:13)
What's required right now. Legally in terms of disclosure, is there, are there any requirements beyond what would be required for standard credit analysis

Jenni Brooks: (03:25)
At this time? There is not, you know, there are always the anti fraud provisions of section 10, B five, or rule 10 B five from the securities exchange act of 1934. And that relates to any primary market disclosure. So the baseline that you need to be truthful is always in the background, but at this point there's no regulatory, um, regime regarding this. It seems as though we might be moving in that direction, the SCC has given indicators that it's considering, uh, providing guidelines, at least for the corporate market. And while that wouldn't impact the municipal market directly, it provides good analog guidelines for municipal issuers. If we end up with guidelines,

Peter Keating: (04:03)
Now you mentioned social bonds like green bonds. These are, this is debt that aims to either finance or fund projects with some kind of social objective. That seems like it might be even more tenuous in definition than green or environmental bonds. Is it the same issuing situation and verification situation there?

Jenni Brooks: (04:27)
Uh, yes. The markets look very similar at this point. Although I'll say that the social bond label is a little bit newer in terms of its use, but similarly, the ICMA has developed social bond principles. And as with the green bond, suppose that focuses on the common types of projects, which could be basic infrastructure access to essential services, affordable housing, things of that nature. Um, but again, like with green bonds, I municipal issuer can self designate and determine on their own whether their bonds should be labeled as social.

Peter Keating: (05:01)
So does this all grow out of the same impulses that socially responsible investing did about 20 years ago? And secondly, what if those goals clash? I mean, when it comes to public projects, I mean there, there could be issuers that let's say self designate as a social bond, something that is used to build a prison, let's say,

Jenni Brooks: (05:22)
I do think this new focus on ESG investors and folks wanting to know where their money is going is a logical outgrowth of that socially responsible investing movement from about 20 years ago. I think as people know more, they might care more about where their money is going and they're making indications with where they're putting their funds on the side of whether these labels can perhaps abuse as too strong, a word, but not give a full picture. That is, there is real potential for that. Given the ability to self designate and I've spoken with one external verifier in particular, who says they would think really long and hard before they gave a social bond label to, as you mentioned, a prison project, there could be some benefits on that side. You know, many of our nations prisons are not in great shape, could use more space, you know, better ventilation things of that nature. But, uh, I don't know that social bond label would be seen as appropriate in that instance and not all investors would agree. Many investors are becoming more sophisticated and are looking for the data to back up a label, which is one thing that the verifiers can provide. Is that data neatly packaged?

Peter Keating: (06:33)
What kind of data would that consist of most, most commonly is the names and descriptions of projects or, or do you think the data would include actual estimates of impact of where the money's gonna be spent for

Jenni Brooks: (06:48)
Your general greener social bond? It will depend a lot on the nature of the project being financed. It could show, you know, reduced storm wall runoff, things of that nature. Uh, there are particular types of green and social bonds that do focus on impact in particular. And those are environmental impact bonds and sustainability linked bonds. And those bonds, uh, have really high metrics in order to issue them. And they focus a lot on ongoing reporting and that ongoing reporting can impact the yields paid on the bonds or even the interest rate on the bonds. But that's kind of a, a next level to all of this.

Peter Keating: (07:33)
Has there been any difference in pricing or yields showing ups as of now on, on average, is there a difference or any kind of environmental or social bonds getting any kind of edge out of this

Jenni Brooks: (07:46)
Anecdotally? Um, I've heard many instances where an issuers going out with a green issuance and a non labeled issuance, and they're seeing increased investor participation on the green side. I think we're still a little bit new to have the strong data to back it up. I did find several studies when working on our firm's recent white paper that are starting to show a little bit of a, a difference in spreads. Um, but at the end of the day, these are a pretty new form of bonds.

Peter Keating: (08:14)
We'll continue our discussion after this short break and we're back municipal debt accounted for 15 billion of the green bonds issued in the United States in 2020. That was 25% of all green bond issuance. And it's up from just $4 billion, only five years earlier. So what's driving all the increased attention. And where are things headed? I got further perspective from Emily Brock. She's the director of the federal liaison center at the government finance officers association. Well, so

Emily Brock: (08:49)
There is, uh, definitely a new, um, horizon before us in 2022. So if we look backwards that the past 24, uh, 18 months, we see a lot of congressional action, um, that was aimed at not just the rescue of, uh, communities, uh, for overcoming the pandemic, but also recognition of, of, of ensuring that communities have the possibility of leading toward a more sort of resilient, uh, future. Um, and by that I'm talking about the coronavirus relief fund, the Krissa act, and of course the American rescue plan act, all of which had significant fiscal policy measures that were put in that allow for communities to invest in of course, um, ensuring that there are pandemic needs met, but also some flexibility, like the ability to invest in and use the money to generate, um, infrastructure in water, storm, more water, uh, sewer and broadband infrastructure.

Peter Keating: (09:59)
There seems to be a move toward thinking more about environmental and social equity concerns.

Emily Brock: (10:07)
A lot of communities have done a significant amount of activity to address environmental concerns and social on the ground for years, for decades, for, for, for a very long time. Now, how astute have those communities been in articulating what they've already been doing for a very long time in their official statements? Not so great. sort of the translation between what communities are actually doing on the ground and how they're communicating that through the OS to the investors could have used, you know, a little bit of help, especially in the wake of the prevalence and popularity of impact investing and sustainable investing that led many issuers to consider designating or labeling bonds to attract investors. So making sure that there is the information that the investors want in offering documents is certainly a challenge that G F O a has taken on recently. Um, we have created a suite of best practices that are ESG environmental, social and governance disclosure related that gives issuers who have done again, significant addressing of, and dealing with ESG concerns for years and years and years, but puts it in investor speak and allows for those disclosures then, for investors to understand what's happening at the local level, from an ESG perspective,

Peter Keating: (11:49)What is new in those practices, either procedurally or substantively that wouldn't already be in disclosures of material risks or credit analysis or balance sheets. I mean, if I build a bridge, which is more likely to be flooded now, because temperatures are rising, uh, what would I be disclosing that's new information relative to those environmental hazards that I wouldn't have had to disclose before, or, or that I would've been disclosing in some way that wasn't clear enough before?

Emily Brock: (12:27)Yeah, well, part of it is sort of just, you know, colloquially getting the finance director out of the finance space and kind of walking around, going to the public health department, going into the engineering group and really kind of looking at risk factors that may or may not have a nexus to the credit. And so in terms of something new, for example, again, it is really putting pen to paper on things like those environmental concerns that may have reached a level that is attributable to the nexus of credit. Um, making sure again, that in, in articulating those risks that, um, that the investors understand not just the risk, but also the policy that's in place to mitigate that risk. Those types of instruments are actually instruments that are, um, entered into, by issuers with a specific designation of how they're gonna be using those bonds like green bonds for a sample they're generally issued for new and existing projects with environmental benefits.

Emily Brock: (13:40)Social bonds generally are issued to raise funds for new and existing projects with positive social outcomes. And we've also heard in the field, the term sustainability bonds, where could be kind of a hybrid where are issued to finance green and social projects that help an issue or attain certain sustainability goals. In all cases, the issuer is communicating to the market that not only will the bonds be used for those goals, but also ongoing continuing disclosure responsibilities will be attainment of those goals and, or, um, a better understanding again, of how the bonds are being used from a broader sustainability perspective. So again, while, while there's a bright line between the disclosure of ESG risks and designated bonds, both of those are being entered into, um, of course, more frequently now than they ever have been. Do you think

Peter Keating: (14:41)There will be, uh, industry standard definitions of green social or sustainable bonds,

Emily Brock: (14:51)Especially in the context of, of disclosure objectives in the market. So for example, G F O a hosts, a monthly call called the disclosure industry work group, we call it dig for short. Um, and we talk about all of these dis disclosure issues, and we have published, um, several, not just commentary to the SCC, but several new documents that allow for issuers to have the tools to make voluntary disclosures. And, uh, most recently it was COVID voluntary disclosures, and of course, we're, we're tackling ESG right now. If you ask if there would be a, um, a standard or of information that, of course the beauty and the curse of the municipal bond market is that we are so wide. We are so varied. We have big issuers, small issuers, we've got water systems, we've got comu, we've got, um, county cities and towns and states and everywhere in between that has access to the market. If we, once we start to standardize disclosure, information gets lost information that would be helpful to investors could has the potential to get lost. And so therefore we like to instead give issuers the tools, um, to broaden, to open, to provide that is specifically relative to their community that would help provide information to their investors. Do

Peter Keating: (16:20)You have an example or two of, uh, someplace that's already doing that or has adopted these, this, this template, um, and it, and it's working well if people wanted a concrete example.

Emily Brock: (16:31)Oh, sure. I've seen, um, uh, lots of good green ESG disclosures coming out of the states out of Wisconsin, outta Florida. Um, but also, um, lots of great disclosures from local communities in my, in my home state of Virginia, um, where you've got communities that are again a addressing a wide lot of ESG issues, uh, in my hometown of Alexandria, Virginia for one. So, um, I think, I think as we start to look, um, we shall see that those, the ESG disclosures are more widespread than we had originally thought. For sure.

Peter Keating: (17:09)Now you talked about the bright line, uh, we've been discussing for the past few minutes disclosure requirements and how a one size fits all requirement may actually lead to, to less useful information beyond the disclosure. On the other side of that line, you talked about the labeling of, of projects and issuance as green or sustainable or social based on the goals they're trying to, to achieve. That seems a little bit like a wild west to me right now. There, there seem to be a lot of designations, a lot of, um, a lot of consultants, a lot of certification it's, it's almost, I mean, it feels to me like it's gotten to the point where I walk into the supermarket and you see something labeled organic or natural, and you feel like you should buy it. You might even feel like you should spend more on it, but the terms don't necessarily have the meaning you think they do

Emily Brock: (18:07)Peter that's, that's a great observation. Um, it is a little bit of the wild west. Um, I think of course, when we see maybe issuers who haven't engaged in it, you know, they're looking at that and they're saying, oh my goodness, this is a lot of new, new information. A lot of it is, uh, sort of hybridized or sort of collective information from a lot of international approaches to green investing, like with the ICMA. So, so when we talk about it, yeah, I mean, I think there are beginning phase issuers where, um, you know, the investor doesn't quite know that, you know, the city of Emily is, is interested, interested in entering into a green bond. And so why is the city of Emily interested in entering into a green bond, perhaps there's political objectives, perhaps there's sustainable objectives, perhaps there's, um, stakeholders in our, in, in the community that are interested in issuing green bonds for a specific purpose.

Emily Brock: (19:09)So I might, you know, issue them be because of self-satisfaction or I'm just curious, perhaps it's convenient because I have a water authority that needs, that meets specific EPA reporting requirements that makes it easy to label it a green bun. So that'd be like a beginning phase issuer. Um, a more intermediate approach would be, you know, investors or kind of interested in the designated bonds that, you know, you've got a world of them out there that are kind of looking and thinking. And, um, you know, the expectation is that, you know, Emily has issued green bonds in the past. And so therefore is interested in issuing them in the future. So I might be motivated to issue green bonds or social bonds from expect the community, um, especially the investor community. Now on both of those cases, a self certification often suffices, uh, for the interest in those bonds. Now, a more experienced designated bonds issuers, like say for example, the, uh, MTA, um, you know, in, from the, an investor perspective, the expectations are established. There is a high demand, uh, for his Bo his bonds, um, for the MTA bonds, there's also, um, probably international interest possibly in those bonds, whether they're taxable or not. And so, you know, of course the motivation of, of, of a frequent designated bonds issuer, do they self-certify or do they hire a consultant from a third party verification? I wonder

Peter Keating: (20:39)If you look at all this and, and think of think whether we've moved beyond, have we progressed from the era, let's say around 20 years ago, when the term was socially responsible investing and, and people who were investing were looking for ways to advance social objectives while still making money by investing in a particular subsector of the market?

Emily Brock: (21:04)I think that we are, we we're beyond where we were 20 years ago, where it was kind of a hype term. We have a little bit more tools of the trade to embrace a systematic way to sort of normalize this in our market. And, and of course it helps that industry participants are kind of thinking of ways to make that happen. However, what I would say is there are a lot of fundamental things that still need to catch up with the craze. Um, number one, there, there really is no discernible pricing differential for issuing, um, labeled bonds just yet. Not that we can tell, of course, everyone points to a few key, um, deals that have happened in the past. It's not widespread. And so of course, we'd love to see that we certainly would love to see pricing differentials because that adds kind of the motivation or the motivating tool for the issuer. Of course, you know, when they, when they do save money, ultimately they save money for the jurisdiction, which means they save money to provide public services for the community. So, I mean, they're, they, there is a fundamental, I think, rationale there to make sure that this is a thing that's gonna stick.

Peter Keating: (22:20)It's been just an introduction, but I hope you've enjoyed this. Look at how municipal issuers are tackling environmental and social concerns and what information they need to provide. Thanks to our guests, Jenny Brooks, and Emily Brock for participating and to our production team and to you for listening, I'm Peter Keating.