A lack of robust, consistent disclosure of climate change risk in the municipal bond space clouds investor confidence in the market.
From lawyers to data providers to investors and analysts, the consensus is climate change disclosures are increasingly important for an industry also dealing with COVID-19 implications.
“The immediacy of credit problems from the pandemic has distracted the market, maybe a bit, from what is a more existential challenge from climate change,” said Matt Fabian, partner at Municipal Market Analytics. “Disruption from climate change is only going to get worse with time.”
This is the time to act, however, Fabian said.
“The volatility our market has just experienced, and might go through again, gives investors an excellent opportunity to shed exposure to issuers who aren’t taking the long-term risks seriously. And to increase allocations to governments thinking and acting more strategically. Investors should be doing their research, and acting accordingly.”
Others agree.
“The importance of climate risk to the municipal bond market is becoming increasingly clear, increasingly pressing,” said Evan Kodra, CEO of risQ, a start-up research and data provider that tracks climate risks of issuers across the country.
Kodra’s firm has been brought on to partner with Intercontinental Exchange (ICE), which also recently partnered with Breckinridge Capital Advisors, which has been a leader in climate change awareness in municipal investments.
RisQ provides climate risk data and analytics on the municipal bond market. ICE Climate Risk was launched by ICE Data Services and risQ to provide climate risk analytics and to enable the municipal bond ecosystem to incorporate climate risk into project and investment decisions.
“In a very short time, ESG has become a critical component of investment portfolios, and Breckinridge is at the forefront of those offerings,” said Lynn Martin, president of ICE Data Services. “The combination of our industry-leading evaluated prices and reference data together with geospatial data from risQ provides our customers with the ability to assess climate-driven risks in the municipal bond market in an efficient manner.”
While the market begins to account for more disclosure and increased awareness, signs of continued change in this direction are growing.
“We now see ESG certifications becoming commonplace in the deal setup of primary market offerings,” according to Will MacPherson, head of the Ipreo muni suite at IHS Markit.
“Investors are now actively using ESG and climate-related data to determine their engagement with primary offerings, and step one was to create the standardization, tracking and identification methods. Now that we achieved that, we expect the market to evolve into a broader discussion around ESG impact and improved disclosure, especially related to the growing field of climate-risk analytics.”
From a disclosure standpoint, Ballard Spahr attorneys William Rhodes and Kimberly Magrini, two Philadelphia-based lawyers, respectively a partner and an associate in the firm’s public finance practice, published a white paper on the subject in October 2019.
“I think you see certainly an increasing number of obligated persons and underwriters working on offering documents who are trying to address the issue,” Rhodes said in a recent interview.
Issuers and underwriters putting together offering documents often struggle to understand how climate change impacts the underlying credit, Rhodes said. They also may not be aware of the availability of certain relevant data, like regional seismic surveys, studies produced by federal agencies, and other resources that could inform the disclosure.
“It’s not easy for obligated parties to access all available information," said Rhodes. “I think that’s probably part of the challenge that we’ve seen.”
Magrini said the Securities and Exchange Commission has made clear that bond issuers should not over-disclose information, because doing so makes it harder for investors to get the information that matters to them. But issuers also have to be careful not to leave out climate change information that investors care about.
“Omission can also give rise to anti-fraud liability,” Magrini said.
Because of legal restrictions on the SEC’s ability to mandate the primary market disclosures of municipal issuers, lawyers often look to SEC enforcement actions to determine its standard of materiality on disclosure. Materiality is the key determination with respect to disclosure, and has been defined by the courts as any information for which there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision.
So far, no climate change disclosure enforcement actions have been brought in the muni space, but Rhodes said muni issuers and underwriters can find it useful to look to the corporate space and what the SEC has encouraged those issuers to disclose.
While disclosures don’t lend themselves to standardization because of the unique circumstances of each issuer and even each credit, Magrini said, the parameters of disclosure are becoming increasingly uniform across the space.
“We’re moving to a place where the type of disclosure is becoming standard,” she said, noting disclosures increasingly take the form of descriptions of known impacts and identified risks of climate change relating to the issuers' facts and circumstances and specific strategies planned or undertaken to mitigate those impacts.
All of these issues are being discussed across trading floors, board rooms and through letters to investors from the world’s largest asset managers. BlackRock has made climate risk their core focus. “Will cities, for example, be able to afford their infrastructure needs as climate risk reshapes the market for municipal bonds?” Larry Fink, CEO of BlackRock, asked
