The Climate Factor and Muni Market Resilience

This survey of public finance professionals will provide a peer-based perspective on how key players in the industry -- from issuers to investors, ratings agencies to bond counsel -- are factoring in climate and extreme weather-related events into the business of municipal bonds. It will look into how state and local governments are planning and building infrastructure as well as disclosing risks they face. It will delve into how investors are considering climate risk factors in their credit analysis and whether they are pricing -- or planning to price -- those factors into their investments in municipal securities.


Transcription:

Andy Nakahata (00:10):

Morning, thank you for the hearty souls who are here. The breakfast room still looked pretty full next door, but I'd like to just thank everyone for being here this morning and to start off day two of the 34th annual California Bond Buyer conference. If you missed my introduction yesterday, I'm Andy Nakahata, Co-Chair of the conference, and on behalf of myself and my co-Chair, Chas Cardall, just wanted to welcome everyone back. Looking forward to an exciting day and a half of discussions. And with that, I'd like to turn it over to Lynne Funk.

Lynne Funk (00:42):

Thanks so much, Andy. Alright, good morning everyone. Welcome to this morning's discussion of the climate impact and the muni market resilience. Just one second. I'm so sorry. I do have slides. I have slides and I need to grab the clicker. Sorry about that. Perhaps I haven't had enough coffee yet either. I'm delighted to welcome Kasper Brandt who is Senior Manager at Intercontinental Exchange, where he focuses on transition risk research and product development focused on the financial, social and environmental risks associated with the transition to a low carbon economy. So welcome Kasper. It's great to have you.

Kasper Brandt (01:25):

Yeah, thanks. Thanks for having me.

Lynne Funk (01:27):

Alright, great. I think this is a really important discussion sitting here in California where wildfire risk is rampant, private insurance is becoming harder to come by. We just witnessed two incredibly devastating and lethal hurricanes and it's hard to argue, I think, against the need for more information, data and preparedness for extreme weather events and climate change risks. So kick us off. I'd like to highlight some results of a survey that the bond buyer conducted late summer focused on climate and the muni market. And it gives some perspective on how key players in the industry from the buy side, sell side issuers and others. We had about 108 responses are factoring in climate and extreme weather related events into the business of muni bonds. And we thought it would be really interesting to discuss some of these results here with Kasper because given the large amounts of data that ICE has, and I'm going to let him take it away after I just introduced, the first question that we asked in the survey was really whether the risk of climate change are being adequately communicated to the public via media and market stakeholders. And it's a question that we think, keep in mind, we did ask these before the hurricane season, so maybe the responses would be different, but we did get the response was that 34, more than half percent, more than half of respondents think that somewhat too little attention or 18% said significantly too little. So Kasper, let's kick it off with you. What do you make of these responses and from your seat?

Kasper Brandt (03:10):

Yeah, sure. Thanks. Can everyone hear me okay? Cool. Yeah, I think these results do highlight a pretty important divide actually. It shows that some participants feel that the climate risks are being over-communicated, but there's also a big proportion that thinks there's a gap in this awareness. And I think in my view, it's not so much about how much media attention there is, but also how that's perceived, whether that's perceived as too much or too little, but also how these things are communicated and the quality and the clarity of this information being shared and how that's tailored to this audience.

(03:50):

I think one of the key challenges that's present is the conflicting narratives around climate change in the media, especially around this summer of year coming up to an election in the US where different groups might approach this issue from different perspectives and it makes it harder for stakeholders to find these clear actionable insights. And that I think can result in these types of mixed perceptions when some are feeling over informed and some are feeling that there's a lack of information. I think there's also a challenge in this communication that lies in catering to these diverse levels. Those that are less familiar with the climate risks need more accessible foundational information where the more advanced players might need more advanced analytics and data. So part of the work that we're doing at Ice Climate is trying to address this by doing a lot of thought leadership in this space where we do these initiatives that focus on demonstrating how the data is practical, the applications of this data, how it can be leveraged, the types of insights that can offer. And we publish this to the website to kind of try and aim to bridge this gap, but also spur dialogue and get feedback and questions and try to start that conversation a bit more.

Lynne Funk (05:16):

Excellent. That kind of leads to a question I want you to delve into data a bit more here. We ask respondents about the quality, quantity, ease of use of climate change data available particularly in credit risk. And the respondents were mixed bag. But I think one interesting result was if you look specifically at the buy side, 50% said data was average and 25% said low. And maybe the challenge, and you can tell the folks in the room is perhaps the industry is just unaware of what is out there and possibly how to use it. So what do you think from your seat as a data provider of the state of climate data generally for the public finance industry? And talk about what you do at ice?

Kasper Brandt (06:01):

Yeah, sure, thanks. I think actually one of the biggest challenges with climate data is not just how much is available, although it's becoming more available, but also ensuring that it's easy to understand this data and that there's a lot of transparency behind how these metrics are calculated and how people can use them. So I think this survey obviously shows that there's a significant number of participants that rate the data as average or even low quality, and that's particularly prominent on the buy side, which obviously highlights a gap. And I think while we've made a lot of progress in getting more data out there, I think it's still clear that we need to make that data more accessible in a more actionable, and that gap I think is part of what we're focused on at addressing at ice. And a big part of that actually comes down to building the right team with enough people from diverse backgrounds.

(06:56):

So part of our strategy is building that team, getting people in from academia, from finance, from catastrophe modeling, spatial intelligence, satellite data, all working together on these problems. I think that combination of expertise allows us to tackle the challenge from these different perspectives, making sure that the data that we provide is not just comprehensive but also practical to use for these participants. And just to highlight a couple of developments that we've made that I think are particularly powerful. One is that we've mapped climate and socioeconomic data metrics directly to the specific bond obligor boundaries. So whether that's a city, a town, a hospital system, a charter school or retirement home, I think one of the features of climate data, especially for Munis, is that the spatial complexity of the boundaries, the muni boundaries can get very intricate pretty quickly and the data that's often available is much higher resolution.

(08:01):

So that might be at the county or the track level or the state level even. And that's often misaligned to the boundary of the municipal bond itself. So the solution that we've come up with to solve for that is our geospatial intelligence platform. And that allows us to downscale a variety of socioeconomic and climate data sets and aggregate them directly to the specific obligor boundary itself. And that's made possible in part by our detailed data set of the built environment, which includes comprehensive coverage of both the commercial and residential buildings in the us, which is made possible by our acquisition of Black Knight. And the solution allows us to evaluate how climate risks like flooding, like wildfires in California or storms or other climate impacts might impact a municipality's property tax base or other critical infrastructure that's relevant for that municipality. But there's plenty of use cases around that too.

(09:07):

And another area that I think we've made quite substantial progress is in defining these obligor boundaries themselves and linking those directly to CUSIPs, which makes it quite easy for investors to link this climate data directly to their portfolios. And the way that we've done this is that we've had a team of analysts over the past five or so years paid in s Stackly ingest a lot of these obligor boundary data sets in some cases using QJS to directly map the boundaries from PDFs. But by doing that, we've built up a catalog of these boundaries linked to CUSIPs that covers more than 90% of the US muni bond market by market value.

(09:54):

And I think this linkage of climate risk, socioeconomic data bond performance, it's quite a powerful tool for the investors to act on. And just in terms of the types of data that we cover, we cover physical risks like hazards like floods, wildfires, coastal inundation, water stress, heat stress, and we combine all this with damage functions that help us to estimate the financial impacts under different scenarios. We also provide real time hazard tracking for our clients and that can link that directly to CUSIPs, which provides investors with notifications or real-time access to how things like hurricanes or wildfires can impact municipal boundaries that they might be exposed to. We also cover a lot of transition risk type data, which is more in my W warehouse, which includes things like scope one, direct emissions, scope two, emissions from power and scope three indirect emissions and consumption based emissions.

(10:57):

And we link all that stuff back to the obligor boundary. We can also do things like provide projections for energy consumption or things like that under different climate scenarios, and which is really great for understanding how shifts in energy policy or energy costs might impact the local economies and by extension, potentially performance bond risk as well. It also allows a calculation of allows for calculations of metrics like finance emissions for portfolio managers that want to do that. And just quickly on the way I think I see things moving forward from here, I think it's towards more integration with more traditional and market risk type metrics. I think there's a lot of climate scores and climate specific metrics out there, and we also provide a lot of data on what this might mean for asset values and cost of living for tax base. But I think the next phase is how do we think of these impacts and things like credit ratings or default probabilities and what does that mean for market values and how does that all get integrated into workflows? So I think there's a lot to come still, and I'm pretty excited about that.

Lynne Funk (12:11):

Okay. That's interesting. The questions I think this market often has, but one, we hear often that investors aren't pricing in climate risk very much at this point. And then from the issuer receipt they're like, when are we going to see maybe a pricing benefit for disclosing some of these risks? And I think the question also for the room is more data that comes available, might there be a penalty at some point for the issuer for not disclosing some of these things? And I think we might hear a little more about that in the future, but I do want to look at very busy slide here, but sort of what the respondents said as the top opportunities for investments in the US and water sewer, renewable energy, public power utilities. Can you talk about areas where you might see some potential for growth in investment from your seat?

Kasper Brandt (13:11):

Yeah, I mean I think it depends on the location and also the municipals debt capacity. And that debt capacity can be largely influenced by socioeconomic factors. So like a city like San Francisco or Boston might have the resources to invest in these types of areas because they also have access to better terms for borrowing costs, but there's also a lot of smaller, less affluent municipalities that don't have that same financial capacity, which is a major issue anyway.

(13:44):

I think there are some places that are ahead of the curve on this. I've read some examples. One is from Virginia Beach, which issued a nearly $600 million bond in 2021, and that issuance was done to protect against sea level rise and other climate impacts, which all of that research was backed by a quite rigorous cost benefit analysis. Apart from the classic renewable energy, public utilities, water, we are seeing less obvious opportunities as well to invest to mitigate this risk. So for example, there's this thing with school districts and air conditioning, there's a lot of research out there that shows that students who are exposed to higher temperatures actually also tend to get lower grades. And this I think highlights a hidden impact of the chronic physical stress, which might also indicate that there's a significant underappreciated opportunity for investment. So investing into bonds linked to things like HVAC systems might both have positive climate outcomes, but also other associated social benefits too.

(15:00):

Likewise, I think local governments can invest in or use municipal bonds to support projects like solar panels for schools, energy efficient buildings, green infrastructure, and as was the case for the air conditioning, I think these can have also substantial co-benefits too, take, there's an example that I read also from Batesville and Arkansas where a bond was issued to install solar at that school. And the energy cost savings from installing the solar was so significant that the savings were then passed onto the teachers to increase their salaries, which is also a pretty cool co-benefit too. And some of the work that we're doing at ICE also is to develop metrics that can help investors determine where these investments can also have a pretty big social impact too, and where we can look for opportunities where there's between climate and social wound and other things, and that allows for both climate mitigation but also improve things like access to healthcare or schooling or clean electricity and things like that.

Lynne Funk (16:09):

Sort of the human infrastructure some folks have talked about, I think. Okay. So we asked what folks thought in terms of the potential growth for investment in resilient infrastructure, how, sorry, messed that up. How confident were respondents in issuers, essentially in state loan governments making these investments. And as you can see on this slide, they're moderately confident. But then the thing I think I'd ask from your seat is this industry at our infrastructure conference, a trillion dollars annually was bandied about right that the US needs at least trillion of investments, muni bonds, and that seems very high, but when you look at what the respondent said in terms of moderate expectations for bond volume growth led by resilient infrastructure, where do you think is there opportunity here for this market for issuers in the room to really sell more debt right now to address current and future investment resilient needs or investors out there to buy it, I guess is maybe what I'm asking you?

Kasper Brandt (17:38):

Yeah, yeah. I mean I see the municipal bond market as a massive opportunity to both finance mitigation, also adaptation, reduce emissions impact, and also as I was alluding to before, improve social outcomes at the same time. And like you mentioned before, climate risk I don't think has yet been priced into the market. I think there's mixed perceptions on that, but it seems that it probably hasn't, but that also probably isn't going to last forever, which also issuers that might be facing higher climate risks in the future, it gives them an opportunity now to act before these things get priced in and it gets more expensive. And I think whether this shift happens in the next five years or not, I think it's crucial that the action's taken now sooner rather than later. So I think there's a huge opportunity to expand the municipal bond market, especially I think we've heard there's quite a lot of demand for tax exempt issuance and that hasn't yet been met. So I think that represents an opportunity for all parts of this market from the investors, the asset managers, the issuers, but also the public.

(18:49):

So I think it's really a win-win.

Lynne Funk (18:51):

One of the questions we also asked was about credit and how important is climate risk as a credit factor? And as you can see, about 28% said it was critical or very important, and 38% somewhat said somewhat important given the amount of data that you know can look through, how do you see this working its way through in disclosure, how are issuers disclosing this kind of?

Kasper Brandt (19:35):

I think lost my pace?

Lynne Funk (19:39):

No worries. It was a credit factor as if you're thinking like if I'm an investor and I look at the importance of climate risk, if I'm investing in something that's a 30 year bond, how much weight do I put on an issuer in today's market disclosing these things? And I think one of the things that we can look at even further in that, is it worth the cost to the issuer? Is it worth the cost? And I'm talking cost of disclosure, I'm talking cost of the actual project. And you have a mixed reaction here with that one. Is it worth the cost?

Kasper Brandt (20:19):

Gotcha. Gotcha. Yeah, I think the upfront cost for resilient infrastructure might be quite high, but I think the longer term payoff can be quite substantial, especially if we think about this over a typical 30 year debt horizon. But more innovative climate resilient projects, I think can significantly reduce climate risks in the long run. And given the growing awareness around these risks, I think there's an opportunity, an opportunity for investors to support projects that will likely benefit from the reduced climate related disruptions that can improve financial stability, support job growth in the economy. I think a nice case study of this is also this Virginia Beach example that I mentioned earlier, which in 2021 issued the 600 million municipal bond to address the climate risks to defend against sea level rise. And that area had already seen quite substantial damages from flooding and is also one of the parts of the country that is experiencing the most accelerated sea level rise. And the cost benefit analysis that was conducted through this issuant showed that this upfront costs of around 600 million could over the life of the bond avoid up to 8 billion in direct and direct damages. And also some of my colleagues at ICE looked into this a bit further. Now I've identified that one potential barrier for municipality is to be issuing such large bonds is also the risk of a potential credit downgrade and associated high borrowing costs too. But even for this example, my colleagues ran these numbers and it shows that even if it was downgraded to the below investment grade level, the benefits still far outweighed the additional borrowing costs.

Lynne Funk (22:18):

I think one of the things that we keep hearing is just when you think about the willingness factor, and yeah, you could Munis, the market could grow to a trillion annually, but is there a willingness on the issuer's part to take on more debt to risk a rating downgrade? And I think that that's the rub, right? It's like how do you balance that? Because presumably if you do get a ratings downgrade, your borrowing costs will rise somewhat. But I guess if you're thinking of a 30 year bond over the life of it, what happens if you don't address these? And in five to 10 years, the cost of that project grows even more. And so it's kind of really looking at what is the smartest way to invest? And I know, I imagine it's challenging for the issuers in the room, especially if you are answering to taxpayers, right? And you're saying, I'm going to get a downgrade and it's going to cost us more. What do you think? I'm sure the Californians who are thinking about 10 billion climate bond might frown on that.

Kasper Brandt (23:19):

Yeah. I also think there's numbers around a trillion dollars. It also just underscores just how big of a challenge this is, and not just the challenge, but also the opportunity of things if that kind of money's invested. I think the climate change to mitigate climate change impacts, it requires quite transformative investments too. Not just in repairing and upgrading existing infrastructure, but also in building new systems that are both resilient to deal with these impacts, but are also aligned with longer term sustainability goals.

(23:55):

And one of the things is the US has set very ambitious carbon reduction targets as well. For example, achieving net zero emissions by 2050 and meeting that target, I think will require quite significant changes across the number of sectors from energy to transportation industry, buildings, and agriculture. And that also opens up this opportunity, especially in these industries that are related to clean energy and grid modernization storage and low carbon transportation and sustainable agriculture. But also at the same time, we're contending with increasingly severe infrequent events like floods, hurricanes, droughts, wildfires, and a lot of the current infrastructure just isn't built to withstand that kind of stuff. So I think in the us, something like a quarter of the bridges were built before the 1960s and now we've got increased rainfall, more extreme heat, and it's just not built to withstand that kind of stuff. Also, a lot of coastal areas are increasing threats from rising sea levels from storm surges, and that's necessitating the construction of things like sea walls or flood barriers, elevating roadways, improving drainage systems and drought prone regions. The focus needs to be on reducing water scarcity through advanced infrastructure that can manage and mitigate these types of water stress impacts. So I think from an investment perspective too, this shift towards more resilient infrastructure isn't just about risk mitigation, but it's also this opportunity for longer term economic growth as well. And I think municipal bonds are quite well positioned to finance a lot of that.

Lynne Funk (25:49):

The original impact investment. Some folks say, do we have any questions in the room? I believe we do have a mic set up too early. Okay. Well, oh my gosh. Is there anything I didn't ask you you think that we should highlight in this conversation?

Kasper Brandt (26:17):

I dunno. I think one of the themes that has been talked about at this conference too is just I guess the real world impacts that investing into municipal bonds can have, it's one of the asset classes that you can really see that direct connection between what you invest in and out, the outcomes both socially and for example, investing in resilience, that kind of stuff. So I think one of the key takeaways that I've got that I've taken on also from listening to the other speakers is that it's a really important space, particularly within the US and it represents this quite significant opportunity for investors and for issuers and for the public to invest in these types of things that can help us be more resilient in the future and also do that in a more social and equitable way.

Lynne Funk (27:06):

As a fellow originally from New Zealand, you spent time living in London as well from a foreign view. And I'm asking in terms of a foreign investor thinking, US infrastructure, we do hear more about interest in investing in Munis. Do you get that sense too from your work?

Kasper Brandt (27:31):

I'd say so, yeah. I mean, one of the crazy things about coming from New Zealand and coming to the US is that we don't have this opportunity to invest directly in infrastructure projects that affect us locally. So I think just that in itself is an incredible opportunity and yeah.

Lynne Funk (27:51):

Okay. Alright. What was that? Thank you. Oh. Oh, sorry. I can hardly see. Yes, a question. Sorry.

Audience Member Larry Witty (27:58):

Hi. Thank you for your comments. I'm Larry Witty from Fitch ratings and I just had a question. Have you seen any kind of impact on the pricing side for municipal bonds regarding climate impacts? I know that sometimes when there's a natural disaster, sometimes investors need to sell their exposure in affected markets. I'm wondering with things like hurricanes and wildfires, if you've seen that on a grander scale and what you think it might happen in the future?

Kasper Brandt (28:31):

Yeah, I don't know exactly to be honest. I know I've looked at a lot of research that looks at, given the perception of climate change and the impacts that might impact certain municipality and that kind of bond, and with the data that's out there at the moment and relating that to how things are priced, there doesn't seem to be a signal between those impacts and any pricing or anything like that with the bond. I haven't personally seen any pricing impacts from real-time events, things like that. But I think that also remains to be seen as these things become more frequent and also as this type of data is more available and we spend more time actually looking at these things under a microscope.

Lynne Funk (29:20):

Thanks. Alright, Kasper, it was a pleasure. Thank you so much. And thank you everyone for being here. Look forward to a great rest of the day and conference. Thanks.