Stocks, IPOs, self-directed equities trading – based on most capital markets headlines, you’d think equities are everything these days. But that’s simply not so.
For this Earth Day edition of Noteworthy Notes, I selected a very recent analyst report that spotlights the intersection of municipal bonds and the future of ESG investing.
The author of this report, Jeff Lipton, is Managing Director and Head of Municipal Credit & Market Strategy at Oppenheimer & Co. Inc., where I have the privilege of serving as a Board Director.
Munis may not sound as exciting as equities, but they are vital to our broader capital system, and Oppenheimer has continued to go from strength to strength in building a leading position in the municipal bond market.
To see the full report, please visit the research notes section of Oppenheimer & Co’s website. – Cheers! Larry Roth
Municipal Bonds And ESG Investing Go Together Like A Horse And Carriage
As the investment narrative across multiple asset classes continues to focus upon what appears to be the formulation of a comprehensive infrastructure initiative of historic proportion, there exists the potential for more activist participation from the Public Finance community and the Municipal Bond market.
Over the past decade we have seen an expanding interest from the municipal securities investor base in ESG bond programs and we suspect that this trajectory will continue.
With a far broader application of an infrastructure agenda, opportunities to pursue a sustainable investment discipline rooted in the tenets of environmental, social, and corporate governance ideals align closely with the positive societal impact that has provided the historical framework for the contributions advanced by the municipal securities asset class.
In an ideal world, muni bonds and ESG investing generally both serve the greater good, in addition to creating value for investors. Put more simply, muni bonds and ESG go together like the proverbial horse and carriage.
Green Bond Issuance Expansion
As the investor audience for municipal bonds continues to broaden, both taxable and tax-exempt ESG investors can capture the above average credit quality and portfolio diversification attributes offered by municipal bonds. Consider the following:
- Climate change issues represent one of the key drivers of an eventual infrastructure package and we see this as expanding fertile ground for “Green Bond” issuance.
- Climate change risks are becoming a more primary investment consideration and we are seeing a broadening application of bond proceeds to combat these risks.
- The risks associated with all-encompassing wildfires and hurricanes are continuing to drive more public and investor attention.
Understand Potential Risks
Natural-disaster-related municipal bond defaults do not occur, and credit downgrades are a rare event.
But there are no guarantees that an administrative glitch that temporarily delays debt service payment will never occur, or that issuers with weaker credit may encounter undue downward pressure under such circumstances.
In these situations, it is important to understand an issuer’s pre-disaster credit profile in terms of budgetary flexibility, reserve balances, liquidity, and historical management responsiveness.
For most impacted municipal issuers, adequate financial resources and capital market access alleviate the immediate revenue disruption and overall credit burden brought about by a disastrous climate event.
But the occurrence and magnitude of natural catastrophes have elevated the call for preparedness and questions the availability of adequate financial resources to address such events.
Bond disclosures are improving with respect to climate conditions and remediation activity, yet transparency remains uneven and we must think about the frequency of “boiler plate language.”
Federal Reserve: Climate Change As An Economic Threat
The Federal Reserve has been identifying climate change as a clear and present threat to the U.S. economy for some time now with policymakers voicing their concern over wealth destruction, a further distortion of existing income inequalities, and even the potential for a permanent displacement of area residents.
The Fed’s thoughtfulness dovetails well with the Central Bank’s dual mandate of price stability and full employment as well as with its concerns for the well-being of our financial system.
Federal and state policies that are crafted to mitigate climate change are likely to impact prices, productivity, employment, and output with potential implications for monetary policy.
As part of our ongoing credit analysis, governance and the ability to respond in a timely fashion to a crisis situation have always been part of the process, but now these considerations can have a greater influence on liquidity and pricing for a broadening array of securities.
We suspect that demand from the institutional buyer base may be a driver of better disclosure and transparency and that over time perhaps the market will do a better job pricing in high levels of climate change risks, yet we think that existing technical factors likely mute such credit distinctions for now.
Universally Accepted Definitions?
Bloomberg tracks “Green Bond” issuance and since 2013 there has generally been visible advances with “Green Bonds” accounting for about 3% of aggregate issuance in 2020.
While growing in our popular municipal nomenclature, the “Green Bond” designation presently lacks a universally accepted market standard or definition according to the MSRB; perhaps this is attributable to the potentially broad environmental or societal impact.
The MSRB discusses “Greenwashing Risk” as the risk that bond proceeds from an issuance marketed as a “Green Bond” are not applied to eligible projects, exposing both issuer and underwriter to potential reputational risk.
In the absence of a universally accepted definition of what denotes a “Green Bond”, the risk of not being “sufficiently Green” may be always present.
The MSRB goes on to say that the use of bond proceeds for green projects does not generally create a contractual obligation with bondholders, thus giving investors limited recourse if the intended investment objective is not achieved.
This market commentary comes from Jeff Lipton, Managing Director and Head of Municipal Credit & Market Strategy at Oppenheimer & Co. Inc.