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The Future of ESG Strategy in Municipal Finances

We often hear phrases like environmentally friendly, social and equitably beneficial, and financial transparency when it comes to assessing the forward-looking strategy of companies in both the private and public sector. However, in recent years, we have been hearing these phrases cross into local and state government operations such as debt issuances and other financial reporting.

The acronym ESG refers to ‘Environmental, Social, and Governance Evaluation’ often focuses on a local government’s ability to sustainably manage the future risks and opportunities related to its current governance structure along with opportunities to reduce its carbon footprint through the green projects/initiatives that will have a positive social or environmental impact; for example, renewable energy projects, smart infrastructure, affordable housing, and clean transportation.

In this article, we will take a closer look at the ESG efforts related to local government operations, the review of rating agencies, and how it can be mutually beneficial for both issuers and investors.

Be sure to check out our Education section to learn more about municipal bonds.

Understanding the Role of ESG in Local Government Operations

As the name suggests, ESG strategy is based on three areas: Environmental, Social, and Governance. In the private sector, these three areas have been heavily scrutinized over the years and companies have been more conscious about their operations and the communities they serve over their profit margins. The same in now spilling into the public sector and the three main areas are described below:

  • The environmental section of the ESG policy focuses on the company/local government’s carbon footprint when it comes to things like greenhouse & gas emissions, waste and pollution, water use, and land use
  • The social section of the policy determines the company/local government’s focus on things like workplace diversity, safety management, and the communities they serve as a whole
  • The governance piece of the policy primarily focuses on the structure & oversight of the agency, internal code & values, and financial transparency in its everyday operations

After assessing the company’s strategy or integration of the aforementioned steps into their daily operations, the assessment focuses on preparedness of how well the local government or company is prepared to combat the emerging strategic risks and how an event can impact their ability to function.

These strategic risks can be anything from water scarcity to climate change and inequitable wealth distribution. In the recent assessment published by S&P Global Ratings about ESG, it states, “The Preparedness opinion is a qualitative view of a company’s capacity to anticipate and adapt to a variety of long-term disruptions. To develop the Preparedness opinion, S&P Global Ratings analysts meet with a company’s senior management and a board member to establish their awareness and assessment of emerging trends and potential business disruptors, as well as associated long-term planning. Incorporating the views of board and management of a company’s top risks and its future direction both adds further dimension to the Preparedness opinion, and highlights to investors how the company’s strategy is likely to deliver long-term value.”

The same is applicable when it comes to local and state governments and their operations and labeling their debt issuances as such.

Be sure to check our Municipal Bonds Channel to stay up to date with the latest trends in municipal financing.

ESG Strategy for Local Governments

As the demand for green or ESG labels increases, more and more local governments are looking into the options for their current or upcoming projects to see if they qualify for the ESG label and how it can either save money for the issuer or be more marketable in the capital markets.

For example, a municipality facing an increased flood risk, due to climate change or otherwise, decides to upgrade their storm water management system and, given the proper disclosure, this issuance can qualify for the ESG label and potentially be more marketable. Furthermore, more and more ratings agencies are introducing their new criteria related to the ESG evaluations and assessing local governments’ initiatives and operations to see if there is a match between the two.

Another great example related to the ESG strategy comes from the transportation sector where many of the light rail services, around the United States, are going the electrification route, reducing their dependency on fossil fuels and relying on electricity. This is beneficial in two ways:

  • The environmental benefit with less/no emissions with the electrified service
  • The monetary benefit where light rail may be generating LCFS (Low Carbon Fuel Credits); these credits can be sold in secondary markets to generate additional revenues for light rail services

Looking at both aforementioned projects, the agency will likely be able to issue municipal debt to initially fund the projects and sell the bonds with the ESG label as long as the debt proceeds are being used to fund a project with an environmental or social benefit or the issuer provides societal benefit through their operations for an underserved population/group.

To learn more about different ESG strategies, explore our ESG Channel.

The Bottom Line

Although the issuance of green and/or ESG bonds are on the rise for municipal governments, the overall municipal debt markets are still pretty new to these concepts. With the federal government’s infrastructure revamp push, we will likely see a larger issuance of Green and ESG bonds in the near future.

Furthermore, the rating agencies will likely broaden their rating criteria to look beyond a single transaction but scrutinize the local and state governments about their overall ESG strategy when assessing the risk preparedness.

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Disclaimer: The opinions and statements expressed in this article are for informational purposes only and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned. Opinions and statements expressed reflect only the view or judgement of the author(s) at the time of publication and are subject to change without notice. Information has been derived from sources deemed to be reliable, the reliability of which is not guaranteed. Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professionals and advisers prior to making any investment decisions.

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Jul 21, 2021