The honeymoon phase for environmental, social and governance considerations in the municipal market is beginning to wane, giving way to a more thorough and dynamic vision for how issuers and market participants can deal with the hotly-politicized concept.
ESG was building steam before the pandemic, but has now become so overly-politicized that banks, underwriters and issuers are stepping away from the vague umbrella of ESG commitments and focusing more concisely on the risks many of these considerations pose.
"ESG is dead, long live ESG," said Michael Gaughan, executive director of the Vermont Bond Bank, speaking during The Bond Buyer's 2024 National Outlook Conference. "ESG 2.0 is really about actual risk analysis rather than impact analysis."
The beginnings of ethical considerations in financial decisions began with Quakers in the 19th Century with their reluctance to invest in industries such as tobacco, slavery and weapons. But modern considerations really began in the 1960s, Bernard Bailey, managing director of Assured Guaranty said, when endowments and corporations began questioning their investments in tobacco, carbon-related products and investments in what was then apartheid South Africa.
In more recent times, the United Nations took a large step to codify the investment strategy in 2006 when it introduced the UN Principles for Responsible Investing and in 2015, nations made big commitments to reverse the effects of climate change with the Paris Agreement.
In the few years before the COVID-19 pandemic the strategy coalesced into many banks and large financial institutions designating ESG funds, making their own climate and resiliency commitments. But in recent years, questions over what the designation actually means has made ESG investing, and ESG designations generally a widely consequential political issue that is changing how many state issuers do business.
"It's been a really, really difficult exercise to get to where we are today," said Ben Watkins, director of the Florida Division of Bond Finance. "And what I mean by that is the whole ESG label, and what does it really mean, is what we wrestled with for the last three, four, maybe five years and at least from where I sit, what I believe is we're in a pretty good place," he added. "We can leave the things behind that are meaningless and tend to be more ideological and political statements and move on with the substance of what it really means to be resilient."
The State of Florida has outlawed the use of ESG factors by state and local governments when issuing bonds, but for the state where natural disasters are a regular occurrence, Watkins said they've been focused on resiliency for three decades.
"Where we've come along in Florida is to embrace the positive aspects that are going to help us on a go-forward basis and rejecting things that tend to be more hot-air with no substance behind them," Watkins said. "We're fine talking about resiliency, talking about infrastructure, but we don't feel the need to be marketing something that's not substantive."
The Government Finance Officers Association provides the muni market with a best practice on ESG disclosure, which Watkins said is a good resource. But the muni market has long touted itself as the "original ESG market," as many of the considerations within ESG such as climate risk have always been a consideration. Some of the market's developments, such as labeled bonds, have garnered some dubious reception.
"The green bond labeling has never really made sense to me," Gaughan said, despite the Vermont Bond Bank executing a green- labeled bond offering shortly before he came on board. "In my thinking, the compliance risk wasn't worth the very ambiguous pricing benefit. Folks will bend themselves in a pretzel describing a couple of basis points of benefit. But what does that mean long term?"
There have been conflicting accounts of whether green-labeled bonds offer a pricing benefit. Proponents of labeled bonds often say that if it doesn't, a green label can at least
"I think you haven't seen a pricing differential," one audience member said. "Wait for it, you will. There's been a lot of talking about doing things differently, or not doing things the way we're used to doing them," they added. "Maybe when that silver tsunami hits and we're all cynical and retired, the younger people, for whom ESG is absolutely a concern, will absolutely start to see pricing differential."
But in many areas, ESG type commitments can help certain goals be met. New York State has made a commitment to have 70% of its energy come from renewable sources by 2030 and just completed an offering at the end of last year of its Green Transmission Revenue Bonds.
"How do we think about ESG? Everything we do is geared towards that because we're helping the state and our customers reach these goals," said Adam Barsky, executive vice president and chief financial officer of the New York Power Authority. "It's not ideology or religion, it's the law and we have to comply with that law to reach those goals," he added. "We continue to work on projects that will not only enable the state to reach those goals, but provide resiliency by doing a lot of transmission upgrades that are underground versus above ground, which will be more resilient against extreme weather events and things of that nature."
Barsky noted that as an issuer, labeling bonds is just the first step in trying to provide the best information to investors and also as a way to stay competitive.
"We are marketing, we're competing, we want to say, if you're going to look at our bond versus somebody else's bond, all things being equal, if you're convinced that we're thinking forward, we're taking actions that are going to make us a better institution, twenty or thirty years out the future versus somebody else, or we're avoiding potential liabilities or where we are less likely to have a major cyber event, I want them to invest in and pick my bond versus somebody else," Barsky said.
But others don't see the need to stay at the top of the market as necessarily a good thing.
"Labeling bonds, whether it's green bonds or social bonds, is at best a marketing gimmick, and in its worst case, it's just a political statement," Watkins said. "The positive side of all of this has been a focus on risk assessment, because that's really its substance, what it's all about and what it was intended to do. "
ESG could also be viewed as a way of trying to reinvent the wheel, or trying to look at the wheel from a different perspective, when much of the risk assessment related to climate has always been a consideration for ratings agencies.
"We've always talked to Florida about hurricanes, we've always talked to California about wildfires," said Nora Wittstruck, managing director at S&P Global Ratings. "It's not different, right. It's not a different thing that we're talking about. It's the transparency of what's happening."
This retreat from ESG declarations and a refocus on credit analysis and data, what Vermont's Gaughan describes as "ESG 2.0" may be more difficult to talk about in general terms.
"My fear is that as we move to a data-driven type of analysis on credit, that story becomes muddled and there are less opportunities for issuers to describe the story of what's going on, and coming from a rural state, that's a particular concern," Gaughan said. "Because now more than ever, describing our responses to climate, in terms of climate resilience and adaptation are extremely important."
