Earlier this year, the Government Finance Officers Association released the first of three environmental, social and governance best practices focusing on disclosure of environmental risk factors faced by state and local governments.
On Oct. 1, the GFOA Executive Committee approved subsequent best practices on the social and governance factors of ESG as well as a comprehensive best practice on voluntary disclosure.
There has been a long conversation in our market about how ESG concepts translate to municipal securities with numerous white papers, articles and approaches offered in an attempt to better define these concepts. Similar to action taken in 2019 to establish the Disclosure Industry Workgroup, the GFOA has taken a leadership role in our market to develop a pragmatic approach to encouraging meaningful disclosure in the area of ESG by state and local governments.
The overarching message being delivered in each ESG best practice remains consistent: Material ESG risks or factors having a nexus to credit or the ability to repay bonds should be disclosed in primary offering documents and, if appropriate, through voluntary disclosure.
The best practices focus on two aspects 1) the identification of ESG risks or factors; and 2) the policy actions taken to address those risks and factors. For example, if a Gulf Coast jurisdiction has identified a material environmental risk (meaning one that may have an impact on creditworthiness or the ability to repay its bonds) related to a flood event, the jurisdiction is also encouraged to disclose what policy actions may have been taken to address that risk.
Policy actions may be a range of things from simply acknowledging the risk, to commissioning a study of its impacts, to funding infrastructure improvements to mitigate the damage from the identified risk.
By identifying both the risk or factor along with policy actions taken to address the risk or factor, issuers can offer an additional dimension to market participants to consider in their analysis of the jurisdiction’s creditworthiness.
It is important to note that the discussion of ESG as it relates to the municipal markets is sometimes blended or conflated with similar but separate initiatives such as green bonds. Green bonds should be viewed as a type of transaction with the “green” aspect being applied to the underlying project funded by the bonds — not as an indicator of creditworthiness or ability to repay its bonds.
Said a different way, an issuer that provides comprehensive primary market disclosure about material environmental risks that may impact its creditworthiness is not necessary issuing a green bond by virtue of making that disclosure.
Similarly, an issuer selling green bonds, but conducting no internal due diligence on known environmental risks factors that may impact its ability to repay those bonds is not subscribing to ESG disclosure principles simply because the bonds being sold are deemed “green.”
Market participants should be clear of this distinction and not confuse the topics. To provide further clarity to the issuer community, the GFOA is working on a green bonds best practice which we hope to release in the next six months.
The concept of ESG is arguably most tied to the environmental component, which has a substantial body of work defining its risks, factors and characteristics readily available. Similarly, the governance component of ESG is largely reflective of information already provided by issuers in disclosure documents such as nomenclature of government organizational structures, legal authority to issue debt and financial reporting, including pension and Other Post-Employment Benefits (OPEB) information.
The social component of ESG as it relates to the municipal market is still being defined and the GFOA will continue to take a lead role in working with industry partners to further develop this area. We offer that social factors impacting state and local government credit quality generally appear in long-term trends in areas such as affordability of housing, income disparities and access to quality public education and healthcare. It’s critical that such trends are evaluated and understood by issuers and disclosed to the market when appropriate.
In summary, issuers are doing our part in advancing the conversation around ESG and how these important concepts should be analyzed and ultimately disclosed by state and local governments where appropriate. We remain committed to leading conversations around disclosure with market participants and continue to believe that the best way to produce meaningful disclosure to the market is through collaborative efforts with industry partners and issuer education initiatives.
Timothy Ewell is Chief Assistant County Administrator of Contra Costa County, CA and Chair of the GFOA Committee on Governmental Debt Management.