United Nations’ Principles for Responsible Investing (PRI) Notes Data Challenges Limit US Municipal Bonds Growth in ESG Portfolios

The United Nations building in New York City, home of the UN security council.

A report by the United Nations’ Principles for Responsible Investing (PRI) stated that many US municipal bonds (Muni) are ideally suited to investors’ ESG-themed strategies. Even those issues that are not labelled green could potentially be included because the projects they fund often have a sustainability benefit.

Muni bonds play an important role in funding public services and infrastructure; hence they are fundamentally well positioned for responsible investment strategies. Muni bond issuers affect the quality of life of most Americans and will be key in the transition to a low carbon economy. An absence of data on the impact investors have on the debt’s sustainability outcomes may be hindering their increased use.

The PRI said that it is difficult to measure the influence that investors have on projects likely to help the environment and social issues.

“Investors will have different sustainability objectives, and sufficient data on outcomes may not be available,” the report, entitled “The Thematic ESG Approach in US Municipal Bonds”, stated. “In addition, it is unclear how to link an investment in a Muni bond to any given outcome achieved by a municipality.”

The report listed four broad tailwinds:

  • Muni bonds are well placed for a thematic ESG approach. First, they fund services and infrastructure that have the potential to affect in a very tangible way environmental and social outcomes for people living in those communities: in other words, the public good. Second, the variety of muni bonds – across different sub-sectors and with different structures – provides multiple ways for investors to contribute to sustainability outcomes.
  • Retail investors increasingly seek to contribute to sustainability outcomes.
  • The opportunities to fund climate-related projects are growing. The rising frequency and cost of natural disasters put greater focus on the resilience of local infrastructure. The federal government has introduced a US$1.2trn infrastructure plan, which may increase Muni bond supply where issuers decide to borrow against the federal funds they receive. Tax credits under the Inflation Reduction Act may also stimulate some municipal bond issuers to finance green projects through tax-exempt debt.
  • Focus on racial justice has moved up the investor agenda. This trend sharpened in the wake of protests over George Floyd’s death in 2020 and disparities made apparent by the coronavirus pandemic. Recent research has highlighted how municipalities’ financial and funding policies are linked to racial and wealth inequalities, for example Municipalities issuing bonds that cover settlement payments following claims of police brutality as witness recently with the death of Tyre Nichols.

The report aims to help investors frame some key issues around the thematic approach in the US Muni market. It advocated that many traditional Muni bonds are inherently suited for the thematic approach. However, the growing labelled bond market is making such a fit even more apparent, and helping investors improve their assessment of and reporting on the environmental and social outcomes of their investments.

The PRI highlight that many US Muni bonds are self-labelled, advocating that it is crucial that issuers provide sufficient information on the use of proceeds, pre- and post-issuance, as well as any available performance metrics, to allow investors to scrutinise how funds are spent.
They go on to state that investors should also carefully assess labelled Muni bonds that are verified by an external reviewer: even if the process that accompanies these bonds is more rigorous, it is neither a prerequisite for, nor a guarantee of, positive environmental or social outcomes. Whether the bonds are self-labelled or carry an external review, investors should encourage greater reporting on the use of proceeds or regular progress towards adequately ambitious sustainability targets.

Engagement has a big role to play for thematic investors in either labelled or unlabelled bonds. By engaging with issuers, investors can convey their expectations and secure enhanced data disclosure. At the same time, issuers can reduce their cost of funding if better transparency and openness to dialogue make their bonds more attractive.

Going forward, the PRI will work to create more opportunities for investors and issuers to meet on ESG topics in the Muni market. The PRI also plans to explore the extent to which its research on the US sub-sovereign market applies to countries outside the US.

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