This article is part of The Bond Buyer’s multi-platform series on the future of infrastructure:
In this four-part series, The Bond Buyer looks at the changes this infrastructure moment could bring to landscapes and markets across the nation. It includes four longform feature stories running every other Tuesday for the remainder of 2021, beginning November 16th and concluding December 28th; a four-episode companion podcast series beginning November 30th; and a live video December 28th on our 'Leaders' channel, all hosted by the author.
As 2021 draws to a close, the Martha's Vineyard Land Bank can take pride in what it has accomplished over the past two years. Even as a real estate rush pushed average home prices beyond $1.6 million on the Vineyard, an 88-square-mile island that sits south of Cape Cod, the organization kept up a 35-year-long fight against overdevelopment. It paid $15.1 million to purchase a majority interest in a 304-acre oceanfront property from Caroline Kennedy and her husband Edwin Schlossberg — the biggest acquisition in its history. It created or enlarged a variety of other preserves, and has now conserved 3,882 acres, or 7% of the Vineyard. Its goat program still has free manure available for pickup.
The Land Bank, which projected revenues of $10.9 million in 2021, is funded partly by a 2% transfer fee paid by anyone who purchases property on the island. (In 2021, first-time homebuyers could exempt the first $595,000 they paid from that tax.) But it also got a $35-million shot in the arm by selling bonds, rated AA and with a range of maturities and coupons, in 2014. The Land Bank — which has since refinanced but still pays about $4.5 million a year of debt service — marketed those instruments as municipal green bonds. "Municipal," of course, means the bonds were issued by a local authority and pay interest that's exempt from federal taxes, and in this case, also from Massachusetts state taxes. And "green" means … well, wait. Just what does "green" mean?
At a time when it's easy to see why investors are increasingly interested in portfolios that reward sustainability, and why the issuers trying to lure them, the advisors managing their money and the companies selling them information are, too, it can be surprisingly difficult to quantify what they're all trying to chase. For example, the Martha's Vineyard Land Bank aims to preserve properties "unique for their aesthetic, agricultural, wildlife and passive recreational features."
The debt it has incurred has indeed helped local environmental preservation. But as the Climate Bonds Initiative (CBI), a leading evaluator of green debt, points out, "[I]t has minimal climate benefits." Moreover, a Thornburg Investment Management analysis last year stated: "We believe part of the purpose of this issue may be to preserve the ocean views and land values for owners of some adjacent properties." Do bonds that benefit the beach houses of centimillionaires and don't reduce carbon emissions deserve a green tag?
Ask questions like that in the world of environmental, social and governance (ESG) investing, and you will find a lot of guidance, but very few binding answers. Particularly when it comes to municipal debt, issuers face few disclosure requirements or standardized evaluations of their products. And there's more at stake in their reporting than semantics. To fight the massive threat of climate change effectively, the United States needs robust, efficient municipal markets that connect investors who have ESG goals with projects that are developing genuine advances in clean energy, sustainability and resiliency, not just attractive sales campaigns. They're not here yet, and in this final installment of our series on the future of infrastructure, we will look at just what's holding them back.
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Green investing, broadly defined, is the flow of capital toward instruments issued specifically for environmental- and climate-related projects. It's been surging since the risks of climate change became broadly clear in the 2000s, and particularly since the 2015 Paris climate accords called for nations around the world to sharply reduce greenhouse-gas emissions. Globally, $354 billion of green-labeled bonds — mostly corporate — were issued in the first three quarters of 2021, up from less than $50 billion in 2015, and more than in all of 2020. This year has also seen record levels of equity issuance and merger activity by companies expressing a commitment to sustainability.
The municipal bond's essential purpose is to fund public projects, but green debt hasn't taken off in the muni market as quickly as in European or corporate markets. Municipal green bond issuance in the U.S. grew from almost nothing a decade ago to $16.3 billion in 2020, and now accounts for about a quarter of all of the country's green debt. But that's still just 3% of all muni issuance. As a July report by Morningstar put it, "This growth is impressive but represents merely a drop in the bucket … green munis [are] growing, but still a tiny part of a niche market."
Interest is there. In an October
The Municipal Securities Rulemaking Board (MSRB) — which is currently seeking comments about ESG disclosure — says green debt should fund projects with material, positive net benefits for the environment. But issuers themselves can label their bonds "green," and it's typically up to them how to construe those guidelines and what to disclose about their products. "There are always the anti-fraud provisions of Rule 10b-5 from the Securities Exchange Act of 1934, so the baseline that you always need to be truthful is always in the background," says Jennifer Brooks, associate at the law firm of Ballard Spahr, who recently co-authored a white paper on ESG disclosure in municipal offerings. "But at this point, there's no regulatory regime regarding this."
That means investors have to be concerned about "greenwashing," where issuers affix green labels to offerings that don't actually produce substantial environmental benefits. This has already become a serious problem in places where trading volume is higher than for munis. In 2018, BNP Paribas told the Wall Street Journal that 45% of bonds calling themselves "green" in emerging markets and 22% from developed economies would fail to meet inclusion standards for the green funds it managed. The CBI has excluded hundreds of bonds from its global Climate-Aligned Bond Index in recent years, most comically including two Taiwan Power Company offerings that spent revenues on coal plants. In March, Tariq Fancy, former chief investment officer of sustainable investing at Black Rock, wrote in USA Today: "In many instances across the industry, existing mutual funds are cynically rebranded as 'green' — with no discernible change to the fund itself or its underlying strategies — simply for the sake of appearances and marketing purposes."
But even the good-faith designation of green bonds can get murky, because issuers and underwriters often face complicated issues and decisions that go beyond the bounds of typical credit analysis. Can a utility claim credit for producing green energy at a new site if it's still burning fossil fuels at another? Is it enough for a project's design or construction to incorporate green principles, like a LEED-certified building, or must it generate ongoing environmental benefits? What metrics should measure those benefits, and how much carbon-emission reductions must they show? What happens when environmental goals clash — if, say, parkland is cleared away for a nuclear reactor? How broad should an analysis of a project's impact get — should it include an assessment of its impact on local citizens?
The problem isn't that there are no answers to questions like these. It's that there are many answers from many sources — the CBI promulgates best practices, the International Capital Markets Association (ICMA) provides guidelines, the United Nations has published sustainable development goals, and more than 50 companies around the globe now offer verification of green-bond designations. But their metrics don’t always apply to the specific needs of the municipal market. They don't often merge easily into a one-size-fits-all green light or red stop sign. And they're based on disclosures that still aren't mandatory.
"ESG is really more art than science," says Lisa Abraham, senior ESG fixed-income analyst at Brown Advisory. "You can't just take a third-party rating. You need to understand what's driving that rating, and the priorities that could be competing against one another. It does require you to look under a hood."
As a result, another phenomenon that's actually the opposite of greenwashing has also cropped up in the United States: Municipal issuers are putting bond proceeds to work on environmental and sustainability projects without ever labeling them as green at all.
Many local authorities are already investing in greener energy, public transit and cleaner water — and are about to see a wave of federal money come their way. At the same time, these agencies are often working within stressed budgets, and lack the resources to figure out what additional processes to track or results to disclose to certify their bonds — or to pay consultants for answers. Particularly for smaller issuers, it's not always clear the benefits of adopting a comprehensive new marketing strategy will outweigh the costs. "A lot of communities have done a significant amount to address environmental and social concerns on the ground for decades," says Emily Brock, director of the Federal Liaison Center at the Government Finance Officers Association. "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."
On June 16, the House of Representatives did pass — by the narrowest of margins, a vote of 215 to 214 — the ESG Disclosure Simplification Act of 2021. This bill would require issuers to disclose ESG metrics (as defined by the SEC) in their financial statements, and to include "a clear description of the views of the issuer about the link between ESG metrics and the long-term business strategy of the issuer." This, or something similar, is what's required to standardize transparency among public companies and local authorities and ultimately give municipal green bond investing a chance to scale up. The legislation, however, is almost certainly doomed in the Senate. Even before the House vote, every Republican on the Senate Banking Committee signed a letter to the SEC arguing that "federal securities regulations are not the appropriate vehicle to advance climate change policy goals."
Municipal issuers may be even less inclined to go explicitly green because investors don't seem to reward them for doing so. Research into taxable instruments has generally found that green bonds trade at a slightly higher price, and therefore a lower yield, than unlabeled but otherwise matched bonds. In such a scenario, investors pay a "greenium" for the knowledge they are financing projects related to the environment, and issuers save on interest costs. But that doesn't hold for munis. "Comparing green securities to nearly identical securities issued for non-green purposes by the same issuers on the same day, we observe economically identical pricing," Stanford professors David Larcker and Edward Watts wrote last year in the Journal of Economics and Accounting. "The greenium is essentially zero."
Refinitiv recently studied the 20 biggest municipal green issues of the first half of 2021, such as New York Metropolitan Transportation Authority (MTA) bonds. It found the same thing. "We observed no … greenium paid for a tax-exempt green bond compared to its non-green counterpart," it reported in October. "There does not appear [to be] much, if any, spread differential for muni green tax-exempt deals at the moment."
Maybe as a group, municipal bond investors feel that fighting climate change is basically as good a public purpose as any other, but no better. Perhaps they believe tax-exemption already cuts issuers a break. Could be that the U.S. market, where an average of just 30,000 to 40,000 municipal securities, out of about one million bonds outstanding, trade per day, is fragmented and illiquid enough that it will take time to change. Whatever the reason, municipal offerings are missing out on the upward spiral many activists and some investors are hoping to see. Just as enforceable disclosure requirements would allow investors to judge which issuers are worth rewarding and encourage bad actors to leave the market, a greenium would show municipal issuers there's an advantage to financing sustainable projects, and would encourage more of them to enter the market. But at the moment, neither exists.
Ultimately, if encouraging sustainability makes issuers and their projects stronger, they will encourage sustainability. "I think we're seeing factors traditionally considered ESG risks tie into fundamentals," says Abraham. "If you're building a bridge today that won't be viable in 15 years, that should be factored into its pricing. We are looking at climate scenarios, environmental approvals, and also where that bridge is being built and whether it's displacing any communities."
Of course, self-negation is the great paradox of any socially responsible investment. Once divesting from South Africa helped make apartheid untenable, it was no longer necessary. In the long run, issuers who ignore climate risks when building roads or tunnels or airports will see their projects crumble and watch cheap capital flow elsewhere.
But you know what they say about the long run.
