ESG Integration into the US Municipal Bond Market

While environmental, social and governance investment considerations have grown around the globe, the U.S. municipal securities market is just beginning to delve into the space in varying degrees. A Bond Buyer research report in Q3 2021 showed that out of more than half of respondents to an ESG survey, 56% rated ESG as important to the municipal industry with the greatest importance placed on the environmental aspect at 73%, followed by governance at 60% and social at 50%. Our panel will explore how ESG fits into the muni market.

Transcription:

00:00:08:05 - 00:00:33:10
Zachary Solomon

I'm Zach Solomon, Morgan Stanley. And I want to thank The Bond Buyer for having us and for putting together this esteemed panel today. And this panel is on ESG integration into the municipal bond market. I know this has been a topic of conversation already today, but this panel is 50 minutes dedicated specifically to it.

00:00:33:10 - 00:01:11:13
Zachary Solomon

So hopefully people will find it informative. We will touch upon the labeled green social and sustainability bond issuance. But I think we'll spend most of our time on ESG in the context of credit analysis conducted by both the rating agencies and investors. And I think it should be a pretty informative panel. So why don't don't I just turn it over to each panelist to introduce themselves, their roles at their respective firms and their contexts for being here and on this panel today?

00:01:11:13 - 00:01:13:14
Zachary Solomon

So why don't we start with Nora?

00:01:14:00 - 00:01:39:05
Nora Wittstruck

Great. Hi. Thanks for having me. And thanks, Zach, for moderating the panel today. I'm thrilled to be here. My name is Nora Wittstruck. I'm the ESG sector leader for S&P Global Ratings in our U.S. Public Finance Department. So my main responsibilities, in addition to being the primary analyst for New York City and New York City TFA. So it was great to see Marge and David and the comptroller.

00:01:39:25 - 00:02:15:24
Nora Wittstruck

I drive our analytical internal and external education on how ESG affects credit ratings and how we integrate that into our analysis. I do a lot of other things in our work with our sustainable finance team who have the expertise in ESG. So I am sort of a bridge to our analytical practice to translate that to credit ratings and then work on a number of publications as well designed to articulate our views to the market on ESG.

00:02:17:00 - 00:02:47:05
John McLean

I'm John McClain. I'm the executive director at IHS ESG. We actually have a product called Muni Quality Score where we  score out for ESG. All city school districts, states, as well as hospitals revenue side. This is a database that we built really from bottom up. We built it based on location using a very long list of data services and data elements.

00:02:47:21 - 00:03:08:15
John McLean

Currently, we use 77 different measurements to calculate a full ESG score. And we actually map where the operations are. So if you are a hospital, we map up to 50 different hospitals that contribute into your health system, scoring up each of the 50 giving them a weighting, providing an actual ESG score. We do that also for gas districts, MUDs.

00:03:09:08 - 00:03:28:02
John McLean

So we don't just map to Qs upon a one to one relationship for our database where the location is and what that issue is. We actually map up to multiple locations for operations that extend over multiple geographies So we score everything, even though legally I'm not allowed to say that.

00:03:29:08 - 00:03:30:23
Zachary Solomon

All right. Thanks, Brian.

00:03:31:08 - 00:03:38:20
Brian Luke

Good afternoon. My name is Brian Luke and I work at S&P. Dow Jones Indices. Not to be confused with Nora’s arm of S&P.

00:03:38:20 - 00:03:40:11
Nora Wittstruck

There is a Chinese wall.

00:03:40:11 - 00:03:40:23
John McLean

That's me.

00:03:41:18 - 00:04:15:21
Brian Luke

We look after the markets. And in the municipal land, we measure the market using our indices. The S&P Municipal Bond Index has over 200,000 individual Q-tips all the way down to state, local subsets and indices there. But also more prominently in the ETF market. The largest area of concentration for us by the National Anti Free Municipal Bond Index was the index chosen for the first municipal bond ETF.

00:04:16:01 - 00:04:25:10
Brian Luke

And that's a product we look after here at S&P Dow Jones. So happy to be here. Looking forward to talking about ESG in municipal markets.

00:04:25:24 - 00:04:26:11
Zachary Solomon

Thanks for that.

00:04:26:14 - 00:04:57:25
Patrick Welch

Hi. I'm Pat Welch and the head of ESG and credit policy at KBRA. I'm looking forward to this panel. I actually worked for a number of years at S&P and I know John and I have spoken many times about ESG related things. KBRA has a rapidly growing public finance credit ratings business and really looking forward to sharing with you how we're integrating ESG into our credit ratings.

00:04:59:11 - 00:05:20:22
Zachary Solomon

Great. Thank you. So as you can see, we have a great panel assembled here today. Why don't we start with Brian? So, Brian, The Bond Buyer survey late last year muni market participants revealed that over half believe ESG to be important to the industry. And the panel before us actually also came up, that half the people in this room also think it's going to be impactful this year.

00:05:20:23 - 00:05:29:04
Zachary Solomon

So how do you measure interest in ESG? And given your role, how would you say the muni interest in ESG compares to the more global industry?

00:05:30:00 - 00:05:49:13
Brian Luke

Yeah, it seems to permeate into all ends of the investment landscape. When I talk about muni ESG, we talk about other areas of ESG. In fact, all day I think we have had a panel that covered ESG in some way, shape or form. So it's great to be able to have a concentrated subset and talk about it.

00:05:49:19 - 00:06:34:00
Brian Luke

But statistically speaking, it's about $1,000,000,000,000 notional in the Green Bond space. And that's taxable and tax exempt only about $55 billion. And according to our municipal bond green bond index has about $4 to $5 billion outstanding and green bonds in that market. So when we're talking about the green bond market, that's really, by and large, the largest subset that we're we're focusing on that's something that is, you know, been firmly adopted, but is despite the growth of green issuance to the tune of 70% per annum from its initial inception in 2007, it's still a relatively small component of the market.

00:06:34:29 - 00:06:54:18
Brian Luke

It's 3% of the U.S. credit investment grade market. It's around the same percentage in the municipal market. But in Europe which is an area I think we should all look to in terms of progressive policies on Green bond issuance and ESG investing, it's about 9% of the European investment grade credit market.

00:06:54:18 - 00:07:11:19
Zachary Solomon

Thanks. So, yeah, that really tells us about the supply side. You know, using green bonds as a proxy for issuer interest in ESG but John, your clients are predominantly investors, right? So how would you gauge investors' level of interest in issuing.

00:07:13:12 - 00:07:38:26
John McLean

Investors are rapidly coming up the curve on ESG. And when we built it, we took the approach of we built a score. We do an equal weighted non-material weighted score. And investors appreciate that. But what they really want to do is they want to get their hands on the data. So when we licensed the scoring and rankings, we actually license out all the underlying data we use for those calculations.

00:07:38:26 - 00:08:03:21
John McLean

So then there's full transparency. Clients want to rip it all apart. And sometimes augment with their own data, either pension data or financials. We don't cover and build out their own unique scores, and that's fine. We encourage that. We do provide a score. They can use it. They don't have to. What we do is because we have a published methodology, there is a firm out there who claims that they first put theirs on the website like two months ago.

00:08:03:21 - 00:08:28:08
John McLean

We had it published two years ago on our website because we have a published website or a published methodology because we have full transparency we think, you know, here's your big take here, the ingredients and here's how we got the money to be a lot of clients. Going back to your question, rip it all apart. Take 80% of our data 75% of our data, one client, 20% of our data, and build out their own unique scores that are material to that.

00:08:28:28 - 00:08:32:13
John McLean

And that's what they can do when they have access to all the underlying data.

00:08:32:13 - 00:08:39:17
Zachary Solomon

It's just to be clear that these investors, when they're doing that, they're not focused on just label bonds. Right. And not just on ESG.

00:08:39:17 - 00:09:04:23
John McLean

You know, now labeling is new. We don't do labeling. We've had discussions internally. But if we would do that or not, there is self labeling. There's obviously one or two firms out there that do labeling clients. One and know and do their own due diligence and do their own deep dive. So if you're labeling that this is a social or sustainable investment and it's supporting new education infrastructure.

00:09:05:07 - 00:09:16:01
John McLean

Great. Show me the data. Why? So if you have low graduation rates, if you have high poverty, if you're trying to address those things, show me the data. That's where we have everything in those files and provide it to clients.

00:09:16:23 - 00:09:35:21
Zachary Solomon

Great. Thanks. So let's turn it over to the rating agencies here. We have two on the panel. So I think this is going to be insightful. So, Nora and Pat, how are your respective agencies integrating similar types of analysis, as John alluded to on the investor side? Perhaps we'll start with Nora.

00:09:36:15 - 00:10:05:27
Nora Wittstruck

Great. Yeah, this is something I do every day. But honestly, if you heard the keynote from the treasurer, he actually explains that almost as well as I do. One of the things that we do and have done since April of 2020 is we integrate a dedicated ESG paragraph in our issuer level research, and that is designed to help you guys as investors and market participants to recognize if we view something as material to an issuer's credit profile.

00:10:06:07 - 00:10:36:08
Nora Wittstruck

So for example, he actually mentioned, Treasurer Wooden, mentioned the changes that he has implemented with their pension funding and the legal and control framework around paying down their liabilities when they have surpluses on an annual basis. So that to us would now be viewed as sort of like a governance opportunity that they took to strengthen and manage their risks towards their long term liabilities.

00:10:36:23 - 00:11:07:02
Nora Wittstruck

So we do that. That would probably, I think that actually appears in the state of Connecticut report in the ESG paragraph. Secondly, what we do and what we really did last year was we implemented a ESG principles criteria that talks about how we have always looked at these factors within our sector specific credit frameworks. So if you're holding a government bond, if you're holding a public power bond or something like that, these have always been addressed within the framework.

00:11:07:02 - 00:11:44:14
Nora Wittstruck

And now we're sort of repackaging them, if you will, or rebranding them as ESG. So what's fundamental to governments and in actually a lot of not for profit enterprises is socio demographics and how demand for an airport or demand for where, you know, an entity entities service area for utility connections or education entities and enrollment, that's all part of what we call social capital and the governments or the entities relationship with the community or the service area that they that they operate within.

00:11:45:13 - 00:12:33:26
Nora Wittstruck

So that happened. And then we also last year published a tremendous amount of research on how our views of how ESG risks can affect credit quality. And we did that through basically three different ways. One way we introduced an ESG report card for states or for a region. So, for example, we released one on California governments and not for profit enterprises and the different types of risks generally that we think those entities in California face based on drought, based on hydrological volatility, based on, you know, affordability issues and the fact that that could all sort of lead to weaknesses within not only local governments within the state, but it can lead to operational challenges for utilities and other entities as well. 

00:12:33:26 - 00:13:17:19
Nora Wittstruck

The second thing we did was we released what's called an ESG brief, one of which is on cybersecurity. So I know that a lot of things came up about what is cybersecurity, how do we think about it? So we really view in that brief, you know, an issuer's preparation response and recovery from from an event can affect their risk management framework and basically mitigating these events through employee education and training and you know, software and, you know, whether it's VPN or multifactor identification, which we're all probably doing now as we log in remotely from our laptops.

00:13:18:19 - 00:13:51:16
Nora Wittstruck

All of that can help with mitigating cybersecurity. So and then the third thing we did as we developed we publish research around specific types of physical risk. So we published an article on how the drought in the 11 Western states, you know, it was really could lead to some issues for those communities, particularly when natural capital or water scarcity as we call it, you know, could affect how much growth an area can actually support if there's not enough water to serve the residents.

00:13:51:29 - 00:14:27:01
Nora Wittstruck

And then finally this year, actually a couple of weeks ago, we published a press release indicating that we would be implementing what's called ESG credit indicators in public finance. And the credit indicators are really designed to isolate the risk within the rest of the credit profile. So, for example, it's on a one to five scale. If we feel like an entity is inordinately exposed to physical risks, those that happen from hurricanes, severe weather, drought, those types of things, we might assign an E three to that particular entity.

00:14:27:10 - 00:14:39:05
Nora Wittstruck

And it's really designed to, as I mentioned, isolate that risk within our broader credit analysis. So those will be beginning to be implemented in U.S. public finance this year and into next year.

00:14:40:16 - 00:14:41:06
Zachary Solomon

Thanks our part.

00:14:42:16 - 00:14:45:03
Patrick Welch

So a KBRA.

00:14:45:04 - 00:14:47:06
Nora Wittstruck

Oh, no. No, I didn't. Sorry.

00:14:48:06 - 00:15:39:27
Patrick Welch

We've spent a lot of time trying to sort out exactly how we felt we can best serve the market on ESG. We did extensive investor interviews and through that feedback and also with issuers through that feedback, we decided very early on that we we are not going to do an ESG scoring product. The feedback we received was, and John, this is no offense to you and I mean that sincerely, but the feedback we received was that they can often be opaque in terms of methodology and they can be in essence, oversimplifying.

00:15:40:09 - 00:16:11:19
Patrick Welch

You know, the real credit story And so, you know, we what we learned from that process is that the best thing that we can do for the marketplace is to talk about how ESG intersects with credit risk and focus on that. Now, we'll talk a little bit later about data. And certainly there's a lot of data that people are interested in that, you know, that may go beyond pure credit risk or default analysis.

00:16:12:07 - 00:16:53:02
Patrick Welch

But leaving that aside, you know, our view is that we want to deliver to the marketplace the best possible opinion about how ESG factors might impact default risk. So our analysis is very bespoke in nature, and it's individualized. You know, issuer by issuer. There are not a tremendous number of ESG factors that if you know, on an isolated basis, that if you change the factor, it'll have a certain effect on the credit rating up or down.

00:16:53:22 - 00:17:19:10
Patrick Welch

There's not a lot of those factors yet. Now in time. And we'll talk more later about some of those that may in time become more like that. There are some, but there's not a lot of them. So the way we look at ESG is that ESG is a list of things that need to be managed. And so they aren't.

00:17:19:22 - 00:17:43:26
Patrick Welch

And on individual basis, something that may change your credit rating, usually but when taken together, they can give you a very strong view on whether the issuer has a good sense for the ESG risks that it's facing and whether they've identified them, whether they're and how they're addressing them. And that can also mean, by the way, opportunities not just risks.

00:17:44:27 - 00:18:21:09
Patrick Welch

So across each sector that we rate, we've developed a series of a number of questions under E, under S and under G that such they intersect with credit risk. So that if you pursue answers to these things, you will develop a credit profile through the context of managing ESG risk. And we think that that bespoke nuanced approach is the right approach to talk about credit risk like it is with many other credit risks.

00:18:22:16 - 00:18:46:00
Zachary Solomon

Thanks. So as everyone can hear from our panelists, there are different approaches, right? So what we heard on one of the previous panels, I think, was Dave Erdman, who said issuers need to know what to provide, what information they need to develop to address each of these different strategies. Right. So in your guy's estimation. What should issuers be doing?

00:18:46:03 - 00:18:57:00
Zachary Solomon

Right. What information should they be providing? What are they being judged on? Where should they be putting it right for both investors and rating agencies alike? Why don't we start with that and come back this way?

00:18:57:09 - 00:19:26:08
Patrick Welch

Sure. So it's a great point. A good question, because you know, as I said, we're not doing an ESG scoring product, but there is just this incredible demand for for information, for data and that's across, you know, all sectors. So, you know, we're highly focused on that. We know that we we sit in a very unique role, a position in the marketplace between issuers and investors.

00:19:26:27 - 00:20:05:10
Patrick Welch

We have access to information that some investors may not have access to with our interactions with issuers. And we have views that come from investors that some issuers may not be aware of. So that role can be really instrumental in helping to facilitate and help provide good data to the marketplace. And we know issuers and investors are incredibly interested in this evolving to a place where, you know, data is in a better place than it is today.

00:20:06:07 - 00:20:51:15
Patrick Welch

I mentioned that we talk, we focus on a number of factors. For any given sector in any given issuer, I want to highlight that we think there are three key factors that intersect with credit risk because they so broadly exist across the marketplace. And by the way, these factors, if you look back in time at investor surveys going back a decade and issuer surveys going back a decade, you'll see a fluctuation of the types of issues that are most important to investors and issuers from a risk perspective.

00:20:52:10 - 00:21:25:23
Patrick Welch

What's happened in the last year or so, this has been an alignment of the planets between issuers and investors in a way that never existed before. So if you go back in time, for example, cybersecurity used to be the number one issue what you have now is in these surveys, you'll see in the top five order of priority for both issuers and investors, you'll see financial risk, regulatory risk.

00:21:26:10 - 00:21:56:07
Patrick Welch

So those are two things that credit rating agencies have been doing and addressing forever. So that's part of what we do. But then three, four and five are interesting. Again, both issuers and investors agree with this. Three is climate change, both physical and transition risk for is reputation. What we at our firm called stakeholder preference. And five is cybersecurity.

00:21:57:01 - 00:22:14:28
Patrick Welch

So I just want to lay out those three. I don't want to talk about the myriad other ones that we look at those three cut across how we think those three intersect with credit risk. More than anything else. So we are really focused on data in those particular areas.

00:22:16:16 - 00:22:16:28
Zachary Solomon

All right.

00:22:16:28 - 00:22:18:04
Patrick Welch

So sorry. I want a little over.

00:22:18:07 - 00:22:24:26
Zachary Solomon

No, no, that's great. So those are three things issuers should be thinking about. How about Nora? What would you add?

00:22:25:06 - 00:22:49:00
Nora Wittstruck

Sure. So I think that, you know, we've already talked about disclosure a little bit. And I think the difficulty in coming to a conclusion that there are certain things that affect everyone holistically in the U.S. market is that we you know, we maintain ratings on 12,000 governments and about 8000 more, not for profit entities. And the risks vary depending upon geography.

00:22:49:09 - 00:23:17:03
Nora Wittstruck

They vary depending upon industry. And I don't disagree with perhaps comments about climate risks. So physical risks, those that are driven by hurricane or climate change, if you will, sea level rise, those types of things. Those actually drove last year, about half of our rating actions that were tagged with an ESG factor as driving a credit rating action.

00:23:17:03 - 00:23:45:10
Nora Wittstruck

So an outlook change or rating change or credit watch action. So I definitely think issuers understanding those risks and how they relate to your organization are as important to be disclosing in the offering document. And our analysts at S&P will be asking you about these risks. If you are in a potentially vulnerable area. I think what the difficulty becomes is that it's very obvious that coastal entities probably maintain this risk.

00:23:45:10 - 00:24:08:26
Nora Wittstruck

But we also see chronic flooding and those types of events that occur on a regular basis as being also a very big concern and actually is sometimes much more expensive to deal with if it becomes a chronic particular risk. And so those types of more nuanced types of risks, if you will, are a little bit harder to understand.

00:24:08:26 - 00:24:32:20
Nora Wittstruck

And it's really on us as credit rating analysts to be articulating that in the credit report when flooding is a concern for your location. The other thing is that I think we could have all the data in the world and because we have a very qualitative or sometimes qualitative view of management based on what we know about the portfolio, based on what we hear on the rating call.

00:24:32:28 - 00:25:00:13
Nora Wittstruck

You know, I don't think you can just underscore ESG with data. You always have to have. We're always maintaining a qualitative view as well and understanding what they're doing to mitigate these risks. So I think, you know, there's things already in the offering document that could be helpful to disclosure, whether it be if you have a financial emergency act and how that can help stabilize your financial position in times of emerging risks like a pandemic.

00:25:00:24 - 00:25:25:12
Nora Wittstruck

You know, there's lots of data on social risk that you guys already disclose, particularly if the bonds are backed by property taxes. You're already disclosing population, income information, tax based information. So a lot of that is already captured under social capital in our view. So I think social capital, as I mentioned at the top of the panel, is also material for issuers in this space as well.

00:25:25:25 - 00:25:29:05
Nora Wittstruck

A lot in addition to the climate risks that Pat mentioned.

00:25:30:29 - 00:25:32:09
Zachary Solomon

Great. John, you want to weigh in?

00:25:33:07 - 00:25:59:08
John McLean

Sure. So there's a lot to unpack here. First of all, it is our calculation for ESG is really premised on the fact of transparency. There's nothing, nothing opaque. It's not a black box. It's fully disclosed. We provide, again, all the underlying data we use. We source data. We don't screen scrape data. But we take data well beyond what we've touched on here.

00:25:59:20 - 00:26:22:24
John McLean

So when you talk about coastal level sea like sea level rise, yes, we cover that. We talk about fluvial flooding. Yes, we capture that. When you talk about Hurricane Harvey that sat over Houston for how many days raining, the flooding that occurred wasn't from sea level incursion was from the rains and the levees that broke in. Harris County has 13 Superfund sites.

00:26:23:08 - 00:26:48:24
John McLean

No one here is talking about that. When you flood a Superfund site, you get toxic crap. We'll call it everywhere. It doesn't just sit in one place. You pollute the underground waterways or the rivers when you have flooding that occurs on Superfund and Superfund sites, but also coal ash empowerment. So when the same hurricane, when Florence went through North Carolina, you had the LV Sutton plant, Duke controlled.

00:26:49:16 - 00:27:12:10
John McLean

They had CCR, which is coal combustible residue or coal ash underwater that goes into the waterways. This affects the people. This isn't talked about by the credit rating agencies. This is talked about by us. We do data. We don't interpret the data. We show you what the data is and what the data scores. How you want to use that data is entirely up to you as an investment advisor, as an index provider.

00:27:13:09 - 00:27:28:02
John McLean

And we are now looking to sell this data, license this data to the issuers, because for the issuers to answer some of the questions, they don't know what the crime rate is. They don't know what it was in 2009. We know all that data because we get that from the FBI. We rebuild that data, we clean it up.

00:27:28:02 - 00:27:57:09
John McLean

And we presented at city, town, village level and county and state and so if we provide that out to the issuers, they now have the same template, the same score, the same data as you would in Sunny Isles. Florida, just north of Miami, as opposed to Chicago or New York or Boston. They would all have the same template of data, the same scoring mechanism and they could pass that data on to the credit agencies and discussions to the underwriters.

00:27:57:22 - 00:28:16:12
John McLean

And to be completely you can regulate, essentially self-regulate the municipal industry by having full disclosure of ESG right away. Doesn't mean it's perfect. Doesn't mean that we cover too little or too much. It is what it is. We cover a very broad data set. We've just added abandoned oil and gas wells. Why? Because we look at methane leaks.

00:28:16:13 - 00:28:38:17
John McLean

No one talks about them from the satellites. They can track methane plumes, large disclosures, large releases of methane, not the ongoing leaks of methane. Average oil well is 30 tons of methane in its lifetime leaking. And there's thousands and thousands and thousands of oil wells. California Kern County has 25,000 abandoned oil and gas wells. That's not in the credit ratings.

00:28:39:06 - 00:29:01:08
John McLean

So we look at data. We're fully transparent. And we update quarterly and we try and push the envelope to find more and more data. Is it in the top five that people would say applied? A credit rating is not a hope because we cover so many pieces of data. But in that big, broad set of data we have is the five that the agencies are talking about, plus the 95 that no one is talking about.

00:29:02:25 - 00:29:23:08
Zachary Solomon

Great. So I think if I could editorialize for a second, it sounds like to me that, you know, issuers can go to the data providers. They can go to their most recent rating report. Right. And they could start to see what it is, what the issues are that they should be disclosing on as a proxy. Right.

00:29:23:08 - 00:29:42:23
Zachary Solomon

And that's very much the role of the rating agencies. And I think, you know, that's our view as well. Morgan Stanley is that issuers should be collecting that data and attempting to address it proactively in their offering documents on their websites and in the instances in which they feel they're doing an exceptional job addressing one of those risks.

00:29:43:01 - 00:30:04:01
Zachary Solomon

That's a great time to label. Right. Because now you say we've identified this risk. The investors have identified it for us, the credit rating agencies have identified it for us. And here's what we're doing about it. And we find that that has incredible investor reception when we talk about, oh, did we get any ESG orders for this green bond issuance?

00:30:04:13 - 00:30:21:25
Zachary Solomon

And I think that leads to the next question for Brian, which is do you agree with that? Right. In the cases in other portions of the green bond market? Do people actually see exceptional ESG investor order performance when they take a really concerted effort at that question?

00:30:22:17 - 00:30:46:02
Brian Luke

Yeah, and I go back to the issuers and the investors paradigm where you have these issuers. And I think the self-proclaimed or identifying what the use of proceeds is, is your ticket to the game. If you want to get closer to the field of play independent validators of that data are going to remove that acute risk of greenwashing that investors are so concerned about.

00:30:47:11 - 00:31:14:12
Brian Luke

That's why we use the multi-label approach for our green bond indices to make sure that the green label is indeed validated and reviewed before it's perceived to be an investable index. But going back to your second point about what is the premium or premium of the investors in the marketplace, we've actually done some analysis across the market.

00:31:14:12 - 00:31:42:19
Brian Luke

And it's really quite interesting when you look at the evolution of the green bond market and it's this intersection of growth of supply that's created a maturation of the market. So you can actually independently analyze how the green bond premium is. And, you know, going back to Europe, you'll see that the green bond premiums that we observed were wider a couple of years ago, and now they're much tighter and in some cases run on top of each other.

00:31:42:26 - 00:32:06:23
Brian Luke

When you look at some of those agencies, foreign agency issuers, and what does this mean? Well, when we look at the U.S. credit market, we see a similar pattern, albeit maybe two years later. So the U.S. credit market has issued quite, quite a bit of green bonds, the spreads initially on average, we're looking at about 15 to 20 basis points, a premium agreement that's shrunk considerably.

00:32:07:18 - 00:32:32:07
Brian Luke

Now, in the municipal markets, it’s slightly different. We all know munis are different doesn't necessarily apply. But when you construct as we have and my colleague Kaleena Soto's here has done some great analysis on this building, triple-A credit curves, green and vanilla bonds. The green bonds have actually initially showed up to be a premium of about 12 to 15 basis points a year.

00:32:32:07 - 00:33:05:21
Brian Luke

And two years ago, just as of last December, that premium has shrunk to about four basis points. So investors are picking up whether it's supply and demand dynamic, that's it's clearly being met. Right. Issuance is growing. There's more green bonds out there for the marketplace to absorb. But that timing is showing that there's actually more acceptance, more more evolution and it's actually observable across not just in the municipal market, but observable across the U.S. credit market, observable across the European credit market.

00:33:06:02 - 00:33:17:04
Brian Luke

The continued adoption and influence about that is going to continue. I think what we've seen in the data yeah.

00:33:17:04 - 00:33:40:19
Zachary Solomon

So I think that's a really great observation. And we're seeing it outside of the bond market, there's definitively green. It fluctuates and it's continuing to consolidate. And so that's something I'm sure the issuers like to hear. Although it's not as prevalent. My underwriters would never let me say you're going to get five basis points but, you know, that's definitely something issuers would be excited to hear.

00:33:40:27 - 00:34:01:21
Zachary Solomon

I think they should also consider that there's a downside to not addressing these risks. Right? Shouldn't issuers be somewhat concerned about a pricing penalty from investors or even rating downgrades? Maybe not now, but in the future if they're not addressing these issues, perhaps. Pat, we'll start with you again.

00:34:03:07 - 00:34:51:09
Patrick Welch

So the way I'd like to answer this question on Greenham is two, to go back to focus on one of the things I mentioned earlier, which is stakeholder risk. I mean, really, you know, a premium is an expression of the collective view of what you're doing as an organization, as an issuer. And, you know, it's our view that from a credit perspective, that stakeholder risk, reputation, risk, what people feel about you and what you're doing on any given broadly on ESG or on any given ESG factor is something that we think is huge.

00:34:51:09 - 00:35:25:09
Patrick Welch

We think it's going to be bigger in the future. We think some of it comes from social media platforms. People can mobilize in wide numbers and they can mobilize rapidly. And so, you know, we think in some ways a green is a reflection of how stakeholders feel about you. So if there's an issue that some particular part of your constituency has a big problem with, that can bleed into the pricing of your bond.

00:35:25:21 - 00:35:49:03
Patrick Welch

So, you know, for KBRA, that stakeholder risk is incredibly important and we think it's going to grow. Let me give you one example, and this is not a public finance example, but it illustrates the point about stakeholder risk. So there's a lot of people in the world who are interested in diversity of companies, diversity of boards, for example.

00:35:49:25 - 00:36:20:17
Patrick Welch

And, you know, in Europe, that's been a long running issue. So there's no real credit research at this point. Now, that may change. That tells you that a board of directors that lacks diversity is a higher credit risk just doesn't exist, that the data doesn't show that. But how could a non-diverse board impact a credit risk of an issuer?

00:36:21:08 - 00:36:44:12
Patrick Welch

Because stakeholders might say I'm not buying your product, I'm not investing in you because I don't like the lack of diversity on your board. So stakeholder risk can touch any issue beyond ESG and any ESG issue. If people mobilize in a certain direction and that can be positive as well, then you can have a greening Europe.

00:36:44:27 - 00:37:13:24
Nora Wittstruck

So I think what Pat is sort of articulating, which is what we think at S&P, is that the risk has to be material to the credit profile. So to result in potential credit weakness or potential uplift in your credit rating as well. And when that materiality becomes sufficient to show weakness in your ability to pay your operations and debt service, then it rises to the level of the ESG paragraph.

00:37:13:24 - 00:37:39:12
Nora Wittstruck

It rises to the level of a credit rating action. And I think that that is what investors are most interested in. They are interested in when they are going to lose value on their investment. And so it really becomes this articulation of the material OTTI of the risk. And to be honest, the issuers in the municipal market, for the most part, are very nimble.

00:37:39:12 - 00:38:00:19
Nora Wittstruck

We saw that through the pandemic. They were very nimble to change their operations, to transition their workforce to remote. I mean, luckily, the federal government stepped in and helped with a lot of offsetting a lot of the costs. But I think in general, municipal issuers are used to managing risks. That's what they do. They’ve done it for their communities, you know, forever.

00:38:00:25 - 00:38:30:14
Nora Wittstruck

And so I think that, you know, when we see you like a hurricane affecting an issuer because they don't have enough reserves on hand, to offset the initial cleanup costs before FEMA comes in and can help them with that, you know, that's a material risk and can lead to a downgrade. So I think for us, it really is evaluating how the material risk is within the broader context of all the other tools that they have to manage those risks.

00:38:31:13 - 00:38:42:13
Zachary Solomon

Yeah. So John, are you seeing this? Are you seeing investors use your data to to effect these investment decisions and where the capital is flowing?

00:38:43:27 - 00:39:09:15
John McLean

Yes. So let me just touch on two things that came up. Yeah. Certainly clients of ours are using the data. They're using it to not only build out broad ESG scoring, but also to build out sustainable funds or impact funds and in-house that they're offering to their clients. When we talk about diversity, we don't track racial diversity at each firm because the data is just not there.

00:39:09:27 - 00:39:30:07
John McLean

So we went back to the actual census data and figured out a way to build out what we call very unique to what we do. Racial employment parity and gender employment parity We actually look at those who are looking for work on the participation ratio against those who actually received employment and where you match up. We draw a curve where you match up.

00:39:30:07 - 00:39:55:29
John McLean

If you match your curve perfectly, zero score where you're negative. If you're over employed in one race, underemployed, obviously in one or more races, That's your delta. That's your negative score. So we track things like that because they're very important. We're very you going to think about what we're doing? Data is very bottom up if you don't want to live in a place where employment doesn't reflect the population, either on the gender or racial basis, then you're moving somewhere else.

00:39:56:22 - 00:40:15:23
John McLean

These are the people that pay for the bonds. This is the tax base that's going to move because crime's too high, because climate change risks are too high or the employment parity is just not there. So we are very bottom up. The bottom line is how many people live where you're going to live to pay the bonds that you've issued for schools or for sewers or for water.

00:40:16:08 - 00:40:37:07
John McLean

It's not paid by tourists. Generally. It's paid by those who live there. So, yes, we do all the census and demographic data, but we also try and look at and peel back the onion where things don't look, including we now track male female pay gap because it could be different. It could be actually negative. It could be. So we do it every single place across America.

00:40:37:16 - 00:40:56:16
John McLean

But yes, your question, clients are seeing the data like the data. They may rejig it, they may take portions of it, but they're using it to build out their own scores and their own funds. In their own unique methodologies because they certainly see some things that are more impactful. They may want to do a materiality waiting, which we don't do very.

00:40:56:21 - 00:41:24:22
Zachary Solomon

So Brian, let's scale back to the macro level to finish here. Do you see those capital flows happening on the investor side? And if so, are they affecting the way issuers address their capital plans and borrowing plans? Right. Are they saying, well, do I need to know here's my risk. So I need to actually, you know, fundamentally design this transit system differently or, you know, and raise capital on that basis?

00:41:24:22 - 00:41:27:12
Zachary Solomon

Are you seeing those dynamics at a macro level?

00:41:28:13 - 00:42:00:20
Brian Luke

Not really in the meeting market. I mean, I would speak more broadly, but you're not seeing that full adoption yet. And the reason why I say yet is that when you look at overall fixed income flows, capital flows into fixed income assets, last year, around half of that went into ESG type products. Okay. When you look at the equity markets, the flows that were coming out as far as the stock market was rallying and clients were rebalancing out, they were still getting positive flows into ESG equity products.

00:42:01:05 - 00:42:25:06
Brian Luke

So you're still seeing a tremendous amount. And one thing that I would point to is that it's not just about a decision that a board is making an investor decision, but it's also a top down push, a regulatory push. And you're seeing that in Europe where investors are choosing to have environmental decisions weighed into their portfolios built from the indices themselves.

00:42:25:21 - 00:43:04:05
Brian Luke

Constructed so that they're built and tailored for that specific use case. And that's a huge, massive driver of those flows in the municipal market. We're seeing some more adoption, some growth of green bonds, but it's more of a cannibalization. MTA issues a tremendous amount of green bonds, but they're already in rapid transit, right. Why not issue some green bonds? Will we see that development across other markets where they have the choice to have a use of proceeds that qualifies as an ESG investment?

00:43:04:11 - 00:43:27:05
Brian Luke

From a perspective of a green, social or sustainable type investment? Is that going to be played out not just in certain pockets of utilities or transportation, but is it going to play out and broadly provide a universe where you can now create an overall set that tailors to that investor outlook?

00:43:28:26 - 00:43:52:01
Zachary Solomon

Yeah, I think that was very well said by all of our panelists. Why don't we see if there are any questions? Hopefully we didn't get all the ESG questions out on the previous panel. Anybody there's one. Go ahead. I think that might come before you. Okay.

00:43:55:00 - 00:44:28:09
Audience Member

That they were not thinking, you know, they feel like they've been very innovative so maybe they're trying to do something quite different Oh, wow. All right.

00:44:30:26 - 00:45:00:05
Audience Member

Well, I know you're flat out there, and they don't believe you're there's no way regardless like that in any way they.

00:45:04:11 - 00:45:34:08
Zachary Solomon

Let me just repeat the question in summary for those on the webinar. So the question is that she has a client that has an innovative approach to incarceration correctional facilities that takes into account all sorts of, you know, newer strategies to reduce recidivism and other issues. But third party certifiers in the issue market said you know, you can't sort of you can't do a social bond for anything that relates to jail.

00:45:34:08 - 00:45:36:18
Zachary Solomon

So they want to tackle that one.

00:45:38:29 - 00:45:48:07
Patrick Welch

That's a good example of why we aren't doing any labeled bonds. Be honest with you, there's a lot of subjectivity or opinion yes.

00:45:48:09 - 00:46:11:21
John McLean

I you know, I don't know what to say. You know, as we as I mentioned before, we don't do interpretive, so and we don't at this time do screening or verify I'm astounded that a firm would say no when they're supposed to be removed from the fact and just supposed to be, you know, arm's length doing a review that's either sustainable or it's green or it's not.

00:46:12:02 - 00:46:41:02
John McLean

I understand there's all kinds of I'm Canadian, but I understand all the politics regarding raising projects for prisons and guns through Texas and Citibank, etc., etc. So I'm not sure what the solution is, but I'm astounded that if you're if you're, if you promote yourself as a verifier or a screener like a firm that would certify, you should put that up front and not have clients find out as you go along that you have restrictions on what type of issuance you would cover.

00:46:42:25 - 00:47:13:15
Zachary Solomon

Thanks. Yeah. I'll give you a reaction from my perspective. I think that as you see from the panel here, ESG is an evolving topic. Right. And there's an element of the market and market participants that take pretty staunch lines and say, this is what we will and won't do. But I think as we've seen the evolution of the market over the past almost ten years in munis, you've seen those initial reactions change.

00:47:13:19 - 00:47:40:09
Zachary Solomon

Right. And they ultimately result and end up on a spectrum. So an easier example, perhaps, than incarceration is just the energy sector, right, where there's quite a lot of debate in Europe in particular, about the transition from fossil fuels. And it's quite present in today's news from the transition of fossil fuels into lower carbon fuels and ultimately zero carbon energy sources.

00:47:40:10 - 00:48:06:15
Zachary Solomon

Right. And so in the beginning stages of the green bond market, you very often only saw renewables. And many of the large oil and gas conglomerates said, well, there have to be transitory options in particular markets, in particular situations. And I think that evolution has changed the way certain investors and certain market participants think about certain sectors. So I wouldn't rely on any one source telling you what is and what isn't.

00:48:06:15 - 00:48:13:09
Zachary Solomon

And, you know, let the market determine Any other questions? We probably have time for one more.

00:48:16:13 - 00:48:20:15
Audience Member

That generally in some places.

00:48:22:25 - 00:48:49:11
John McLean

No actual places where I know it's not hypothetical, so I'm waiting for the mike to kick in because we do like we do data bottom up, so we do all the locations. So when we do city data, we take everything you can get from census for every 10,500 towns, villages, cities. And because you have small census designated places, cities.

00:48:49:22 - 00:49:11:07
John McLean

Sometimes it is negative. It's not always what you would expect, but usually the exceptions are very small places, middle of essentially nowhere, you know, 500 population or less. But that just shows we calculate data no matter how small the city or village of town is. If we can get that data. So there are negative.

00:49:11:27 - 00:49:16:28
John McLean

I was surprised, but I did actually come through the data and double check it. And yes, it's true.

00:49:19:11 - 00:49:28:12
Zachary Solomon

Okay. So we'll, we'll end it there. On the power of data. It's a big part of the issue market and where it's going. So thank you everybody for your time today. Thank you. Thank you.

00:49:28:13 - 00:49:28:27
Patrick Welch

Thank you.