The ESG Muni bond market has significant potential

The ESG Muni bond market has significant potential

Proceeds-use bonds have been the most popular form of U.S. municipal bond issuance labeled environmental, social, and governance and this market segment has significant potential under the United Nations-backed Principles for Responsible Investment. .

The PRI said in a report, The ESG thematic approach in US municipal bonds, that the US municipal bond market is one of the largest and most liquid sub-sovereign bond markets and measured $4 trillion last year.

Households and non-profits hold about 40% of munis due to their tax-exempt status, which also leads institutional investors to treat US muni bonds as a separate asset class from corporate bonds. and sovereign, and to manage them often separately.

“Interestingly, the proportion of foreign investors in the muni market, although still low (at 2.9% of total outstandings), has increased in recent years,” the report adds. “A potential factor may be that EU and UK insurers receive favorable capital treatment under Solvency II rules for investments in municipal revenue bonds that fund infrastructure.”

The Commonwealth of Massachusetts issued the first U.S. green municipal bond in 2013, and the PRI said a new labeled bond market has developed, allowing issuers to earmark funds for projects that deliver specific sustainability outcomes. sustainability.

“However, the extent to which these instruments truly support sustainable finance depends on the strength and rigor of the standards used to issue the labeled bonds, as well as the underlying data and methodologies used to structure the bond,” adds the report.

Two-thirds, 64%, of municipal green bonds were externally reviewed in 2021, down from 73% in 2020. A lower proportion of social bonds, 52%, and sustainability bonds, 30% received external journals. According to the report, issuers can choose not to seek external review if they have difficulty committing staff, time and funds to these processes.

The main benefit of choosing to issue an ESG-labeled municipal bond over an unlabeled one is that it signals to stakeholders, including citizens and local authorities, the issuer’s commitment to sustainability. , particularly if the bond is part of a broader sustainability strategy, added The pri.

Another advantage can be the “greenium”, where the yield of labeled bonds is lower than that of unlabeled bonds because the former attract investors with a specific ESG mandate. According to the report, there is anecdotal evidence of multiple basis point greenium for taxable municipal bonds, but limited evidence of only one for tax-exempt debt.

Product use obligations have been the most popular form of labeled obligations to date.

“Although still in its infancy, this market segment has significant potential,” the report states.

In 2021, municipal bond issuers raised $45.9 billion through debt tagged with the use of proceeds, in the third consecutive year of growth over 70% year-over-year. As a proportion of total new municipal bond issuance, it also rose to 9.7%, from 5.5% in 2020 and 3.2% in 2019.

Source: PRP

Issuance is skewed toward the Northeastern United States and the West Coast, and the 10 largest issuers of product-use-tagged municipal bonds account for one-third, 35%, of total issuance.

The average face amount of tagged product use debt in 2021 was $86 million in 2021 and about $100 million in 2018, 2019, and 2020, compared to an overall municipal bond average of less than 40 million dollars per year over the same period. .

“Many U.S. muni bonds are self-labeled, and it is critical that issuers provide sufficient information about product usage, before and after issuance, as well as all available performance measures, to enable issuers to investors to consider how the funds are spent,” the report adds. “Whether bonds are self-labeled or subject to external review, investors should encourage greater disclosure of product use or steady progress towards sufficiently ambitious sustainability goals.”

In addition, PRI also pointed out that controversy in some US states, where politicians have pushed back on aspects of ESG integration in finance, could hamper the show.

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