S – Social
GFOA has developed a suite of best practices addressing each element of ESG. This best practice focuses on the “S” – Social factors of ESG and makes recommendations to governments on how best to identify social factors impacting their jurisdiction and determine whether those factors impact credit quality. GFOA’s best practice for developing ESG Disclosure focused on the “E”— Environmental risks provides a framework for considering whether to provide disclosure information that can also be used to evaluate disclosure for the “S”— Social factors. One important distinction between “E” risks and “S” factors is the lack of consensus within the municipal finance space about what factors would fall under the “S” umbrella that may constitute important information related to credit analysis, which could leave the issuer in the position of having to decide what social factors, if any, may have a meaningful and relevant connection to its credit quality or the willingness or ability to repay its bonds. Determining which “S” factors to include in its offering documents or voluntary disclosures can be challenging but this best practice provides guidance on how to identify information, which should be provided in connection with the offer and sale of bonds or any voluntary disclosures related to an issuer’s identified “S” factors.
GFOA recommends that issuers identify social factors that may have a material impact on its credit quality or the payment of its bonds, if any, and disclose information related to these social factors. Issuers should also explain how these social factors, if any, may affect the credit quality of its bonds and what policies or programs it has to address these social factors.
There are many factors that could be considered under the broad category of “S” — Social that may impact your community now or in the future. As noted above, credit analysts, investors, and rating agencies have not coalesced around what factors in the “S” category will be important to their credit analysis, investment decisions, or credit ratings. Therefore, it is important for issuers to consider the social factors that are challenging their community and decide if any have a connection to repayment of their bonds or could negatively impact operations or financial position over the term of its debt. If an issuer determines that these factors do have a nexus to debt repayment or could have a material adverse impact on operations or finances, it should provide information about these factors in its offering documents and any voluntary disclosures to the marketplace.
Specific examples of social factors that an issuer may want to consider include:
- Availability and affordability of housing for vulnerable populations
- Demographic changes and population trends affecting demand for services or tax base
- Income levels, wealth, and income disparities
- Affordability of government services, tax rates, or eroding tax base
- Labor relations challenges, union contracts (and any long-term fixed costs—OPEB and pensions)
- Availability, access, and quality of community health services
- Quality of public education and vocational training; educational attainment
- Labor force, employment/unemployment, and job opportunities
- Internet access and affordability
Like other elements of ESG, social factors have always had some impact on communities, and governments have responded by creating programs and policies to address the impacts on its citizens and community. The recent interest in ESG affords an opportunity for governments to highlight and clearly communicate to the municipal market which social factors it considers important to its ongoing vitality and identify and explain what programs and policies have been created or enacted to address the social factors determined by the issuer to be important. The process described in developing environmental disclosure can generally be applied to considering disclosure of social factors. Issuers can review the GFOA best practice on “E” Environmental Risks for information on the process for developing disclosure. However, below are some additional elements for consideration when evaluating disclosure of social factors.
Identifying Social Factors
First, consider what information is already included in offering documents through the “S” factor lens. Although it is not likely categorized or labeled as a social factor, your government may have been disclosing information that is now considered “social”’ under the ESG umbrella. For example, many governments provide information related to changes in population, personal income, employment/unemployment, or other demographic trends in the official statement. Identify this type of information already being provided and consider if there is any additional information or explanation that could provide context for how “S” factors are being addressed, particularly if trends are negative.
When considering “S” factors, consider trends reflected in data or metrics that may have a long-term impact on credit quality. For example, civil unrest related to specific events is likely temporary and may not have a permanent or material impact on a government’s long-term finances or operations. Accordingly, information relative to a specific and temporary event may not be material for purposes of disclosure. However, new programs or policies enacted in response to such events may provide the investment community with insight regarding the likely impacts of such events over the longer term. Therefore, it is important to assess the duration of the impact of an “S” factor, i.e., whether it is temporary or permanent. Governments should consider the duration and permanency of the social factor. Look for trends that pose a challenge to population growth, property values, educational attainment, employment opportunities, or other factors that may impact the long-term growth and prosperity of your community and may provide the revenue source for debt service repayment.
Social Factors and Nexus to Credit
After you have identified the “S” factors that are important to your community, consider if there is a nexus to the repayment of your bonds or underlying credit quality of your government and its bonds. This can be particularly challenging with “S” factors because in most instances their connection to credit is indirect or only becomes apparent over the long term. Also “S” factors can be complex, politically charged, amplified by the news media, and sensitive to address. If it is determined that an identified “S” factor may have an impact on the repayment of your bonds, then it is important to determine if the potential impact could be materially adverse. If both a nexus to credit and materiality are established, then the “S” factor should be disclosed and when possible, quantify the impact. For example, instead of identifying all social factors that may have some minor effect, it is more informative to discuss factors that could have a material impact on the issuer’s ability to repay its debt.
Disclosure of “S” factors is most informative to investors and the marketplace when it contains identification and discussion of the factor and an explanation of how the associated trends may impact finances, operations, or bond repayment overtime. For example, if the income level of your residents has been steadily decreasing over a period of years, explain how a continuation of the trend would impact personal spending habits, the jurisdiction’s economy and tax base; and ultimately, potential challenges to repaying debt. It would also be important to include any strategies the government has deployed to mitigate or combat potential negative consequences related to “S” factors. Connecting the dots between the identified “S” factor and credit quality is particularly important as long-term financial impacts related to “S” factors may not be readily apparent.
Primary market, annual continuing, or voluntary disclosures related to ESG factors should be carefully considered by issuers and discussed with their bond counsel, disclosure counsel, and municipal advisor. The suite of GFOA best practices provides a framework for addressing disclosure and meeting market expectations. In those cases where issuers determine that information related to ESG factors is meaningful, relevant and material to its credit quality, then disclosures on ESG factors should be made. Many issuers maintain investor websites and investor relations programs designed specifically for analysts and investors to enhance the transparency and marketability of their bonds. If the issuer believes there is value in providing additional information in this manner, then it should consider providing it voluntarily.
Resources and Other Related GFOA best practices
- Board approval date: Friday, October 1, 2021