Issuers, rating agencies are direct targets of anti-ESG bill in Florida

Florida's most prominent issuer official is on board with pending legislation to limit the ability of issuers around the state to shape the municipal bonds they sell.

House Bill 3, which cleared two committees this week, would prohibit bond issuers from issuing an environmental, social, and corporate governance bond or paying for a third-party verifier that certifies or verifies that a bond may be designated or labeled as an ESG bond.

"This means muni bonds cannot be labeled or designated as ESG bonds, green bonds or social bonds," Ben Watkins, director of the Florida Division of Bond Finance, told The Bond Buyer.

It's one provision of a larger bill designed to broadly limit state investments perceived as pro-ESG as the Republican majorities in the state legislature rush to enact Gov. Ron DeSantis' agenda.

The likely Republican presidential candidate is appealing to the right-wing base with attacks on "wokeness," which one DeSantis administration official defined in a courtroom as "the belief there are systemic injustices in American society and the need to address them," and has become a GOP shorthand attack on liberals and liberal policies.

Despite some evidence to the contrary, and foreclosing the possibility that market demand may continue to evolve, Watkins echoes the DeSantis party line that ESG designations for municipal bonds are worthless.

"Since there is no pricing benefit from labeled bonds, issuers cannot spend public funds on verifiers since there is no tangible benefit from selling ESG-labeled bonds," he said. "Issuers should not be spending money on marketing gimmicks in selling their bonds."

DeSantis is positioning himself as leading the red state charge against ESG policies, an effort that thus far has mostly sought to punish investing firms that have tried to meet market demand for ESG-labeled products.

The bill also threatens to upend the rating agency model by barring contracts with a rating agency "whose ESG scores for the issuer will have a direct negative impact on the issuer's bond ratings," according to a legislative staff analysis.

HB 3's rating agency language has one municipal bond market veteran worried.

"The issue for us is not about woke or not woke or about ESG or not ESG. It is about the role of a credit rating agency and it is about how the $4 trillion municipal bond sector uses credit ratings," David Kotok, chairman of Cumberland Advisors, wrote in a recent market note. "Wokeness or anti-wokeness is irrelevant for credit."

He said that during his career, he has been involved in giving financial advice regarding municipal bond issuance involving billions of dollars.

"In every case, there was extensive disclosure required, along with detailed projections articulating the risks involved and the rationale behind the credit rating. That is what the Florida intervention with rating agencies threatens," he said.

Watkins supports the bill's approach to issuance and rating agencies.

"HB 3 is the legislature establishing policies and guardrails in Florida regarding what are acceptable policies and practices on investment decision-making and issuing debt which appropriately excludes social, political and ideological considerations," Watkins said.

Watkins cited the role rating agencies play in the ESG arena.

"When the rating agencies developed and rolled out their ESG scores, they said their ESG scores do not impact an issuer's credit rating. We are holding them to their word so that ESG scores do not in the future creep into directly impacting issuer credit ratings," Watkins said.

Kotok stressed there was a need for raters to be fully independent.

"If a rating agency ever succumbs to political pressure about what to say, we as professionals can no longer trust that agency," he said. "In our business we need the truth, and we need risks to be clearly and honestly discussed. If we don't get that, we don't buy the bond."

"By applying arbitrary ESG financial metrics that serve no one except the companies that created them, elites are circumventing the ballot box to implement a radical ideological agenda," DeSantis, who has two Ivy League degrees, said when the anti-ESG legislation was announced in February.

A lot of red states have been enacting anti-ESG and laws against so-called "boycotts" of GOP-favored industries, said public finance attorney Neal Pandozzi, a partner at Bowditch & Dewey.

"They're doing this, in their view, to deal with underwriters and investment banks that they feel have an ESG agenda that's contrary to the way the state views the issue," he told The Bond Buyer.

He said it has been driven so far by red state politicians, but noted the recent introduction of a California bill.

"This basically says we only want to work with investment banks that pledge not to work with the firearms industry," he said. "Although that bill's language needs to be fleshed out — I can't say it's been solely being done in the red states."

He said people have now become familiar with how anti-boycott and anti-ESG legislation works, prominently in Texas.

He said Florida's legislation goes much further than the Texas laws.

"The way the bill is drafted now, I would be concerned as a bond lawyer about giving a V-B-E [valid, binding and enforceable] opinion on Florida bonds if this bill were to go into effect as it's currently drafted, because the language and defined terms are just so broadly drafted, very sweeping, very encompassing in the way that they look at ESG," said Pandozzi.

It also remains to be seen how an issuer could offer bonds with the bond definitions in the bill drafted so broadly, he said.

"If I had to encapsulate my concern about this Florida legislation in a nutshell, as a bond lawyer, that would be it," he said, adding that he hopes "like the Reedy Creek bill, it will go through some further refinements to address this sort of sweeping, broad language."

Rhode Island-based Pandozzi has two decades of experience in bond law.

"I worry broadly about this whole red state-blue state civil war over ESG," he said. "The dichotomy it creates for underwriters of having to attest to their compliance with the Texas, Florida, Wyoming side of it, the 'Thou Shalt Not Boycott the Firearms Industry and Fossil Fuels Industry' versus to then have to certify to California that you do and you're not doing business with these industries."

He said it could potentially split the industry in two.

"Are you going to have one set of underwriters who can just do red state bond issues and one set of underwriters that can just do blue state bond issues?" Pandozzi asked. "That's not a good outcome. I'm worried about the increased borrowing costs resulting from less competition among underwriting firms and a smaller investment pool."

The Florida League of Cities is taking a wait-and-see stance.

"We are monitoring the bill, however we do not have a current position or comment on HB 3 at this time," a League spokesperson told The Bond Buyer.

Florida, where borrowers including Tampa and the Brightline passenger railroad have tapped the green bond market, is poised to be the first state to bar state and local issuers from floating green bonds, according to attorneys who are tracking bills.

"We're seeing an explosion in this area, and this [legislative] session is where things really went ballistic," said Lance Dial, a partner at Morgan Lewis.

The firm, which has tracked state-level ESG legislation since last July, found that so far 12 states have enacted ESG statutes, and that there are 67 pending statues in 28 states. Of the 67 pending bills, 50 are anti-ESG measures and the rest are pro-ESG.

Some states have several bills in play. Oklahoma, for example, has 18 different bills on the topic, the firm said.

"It's definitely a hot issue for clients," Dial said, adding that companies and investment managers are increasingly fielding requests for information from states about ESG factors.

Simpson Thacher & Bartlett LLP

State-level ESG legislation is likely to ramp up heading into the 2024 presidential election, said Leah Malone, partner and head of the ESG and sustainability practice at Simpson Thacher & Bartlett LLP.

"The activity has picked up significantly even in the past two to three months," said Malone, who co-authored a March paper that examines how states are shaping the ESG regulatory landscape. "It's a trend that's snowballing very quickly."

What emerges from statehouses is likely to end up in courthouses.

"Once you start to change the fiduciary duty standard at a state level, would that lead to future litigation? Potentially," said Malone. "The case law in this area is built up over decades and once a law comes into effect that targets one way that fiduciary duties are being exercised, that's going to create a lot of confusion."

Dial agreed that the issue will likely end up in court.

"There's going to be a direct conflict at some point that will eventually lead to an impossible situation for investment managers," Dial said, adding that a lawsuit would likely be brought by a trade association or business group as opposed to an individual investment manager.

On the federal level, President Joe Biden is expected to wield his first veto to strike Congress' measure to overturn a new labor rule that allows retirement plans to consider environmental, social and governance factors in their investment decisions. The rule applies to privately held retirement plans.

Meanwhile, House Financial Services Committee Chair Patrick McHenry, R-N.C., has created a Republican ESG Working Group to review the administration's ESG-related proposals.

On the regulatory front, the Securities and Exchange Commission has significantly ramped up its scrutiny of ESG-related disclosure by private companies, with a final rule expected this spring.

"There's a theme there, with the states saying what we need [investment managers] to do and not to do, and the SEC is saying it wants more disclosure, so it's going to be easier for states to connect the dots," Dial said.

Pandozzi said that whether it's Texas or California, people have the right to make decisions that they feel are right for themselves.

He said that going with a preferred political viewpoint could wind up costing taxpayers more from an economic aspect, such as increased debt service, if competition is decreased.

"I just want to make sure that the people in these states understand the economic aspects of it," he said. "That this can increase your borrowing costs and that's going to have an effect on how far your tax dollars go. As long as people understand that and go into it with open eyes that's the potential outcome of these types of policies, then that's fine."

Kotok stressed that "we're not telling the state or local jurisdiction what to do. That is not up to us."

"It is up to the citizens in each jurisdiction to determine if they want to incur these types of costs that are imposed by market forces as a response to culture-war politics," he wrote, adding that in the final analysis, it was the customer who remained at the top of his mind.

"Professionals in the financial arena, and particularly in independent money management firms like Cumberland, do not succumb to threats or distractions from the political culture war extremists, left-wing or right-wing," he said. "We're hired by our clients to call it as we see it and to represent our clients."