ESG refers to three key factors that affect a government’s credit profile, including an exposure to climate risk and other Environmental factors (“E”), long-term Social factors (“S”), and Governance issues (“G”). ESG factors represent areas affecting the long-term sustainability of a community. Both investors and rating analysts have increasingly utilized outside resources to assess ESG risks for municipal issuers. Governments play an important role in that overall assessment by providing specifics about their ESG challenges and action plans and in doing so, increasing transparency to the entire municipal market. ESG disclosure provides governments the opportunity to tell their story of what they are facing and how they are addressing the issues, a point of view that is valuable to the broader municipal market.
Municipal bonds serve as a vehicle for “impact investments” and many investors want more information on the impact their investments can have. Since bond ratings and investor demand have a significant bearing on the pricing of municipal bonds, it is generally in the best interest of a government to provide this disclosure directly to the investment community through primary offering documents. The increased focus and awareness from investors can also be the catalyst for encouraging more governments to increase on-going efforts to identify and address environmental risks and enhance their readiness and resiliency.
Issuers of governmental securities should be aware that there could be credit rating differentiation depending on their approach to addressing ESG factors. Without clear ESG information—either through a rating agency report or disclosures—potential buyers of municipal bonds are likely to conduct their own ESG analysis, which may not include all relevant information or context that a government can provide especially regarding steps taken to mitigate these risks. These factors should serve as motivation for governments issuing municipal bonds that are still questioning if ESG should be considered for their disclosure practices, to invest the time to explore the subject, consider its application, and communicate their efforts to address challenges, specifically with regard to climate change and other environmental risks of the ever-changing world. The importance and content of ESG disclosure will vary depending on the geographic location and unique demographics of each government. In cases where a government does not have any E-environmental concerns or risks, the government should consider discussing that position in their disclosure documents.
Start with the E—Environmental
Developing a best practice for all ESG factors at once is impractical, so this recommended practice focuses on the E-environmental factor. Guidance regarding the S-social factor G-governance are not addressed in this recommended practice. However, governments should note that most broad subjects under the G-governance umbrella are routinely included in rating agency considerations and offering documents. For example, information regarding governance framework (elected bodies), governmental decision-making (votes), transparency (public records laws), financial management policies and practices (MD&A and pension disclosures/funding) is generally included in offering documents used in the municipal market. However, the strategies outlined below to develop environmental disclosure can be generally applied to the other factors—S and G—as well.
The Government Finance Officers Association (“GFOA”) recommends that governments evaluate the development and disclosure of information regarding the primary environmental risks applicable to municipal issuers and their bonds in their preliminary and final official statements used in connection with bond sales and in other voluntary disclosure. Governments should also disclose plans developed, strategies deployed, actions taken, and infrastructure built to address the environmental risks, which will vary depending on the geographical location of the issuer.
Specific examples of environmental factors that an issuer should consider discussing (which will vary depending on the geographical location of the government) include:
- Inland flooding, tornadoes, drought, snow and ice storms and other extreme weather events
- Climate change affecting agriculture, infrastructure, major industries and tax base
- Frequency and intensity of wildfires
- Frequency and strength of hurricanes and flooding
- Sea level rise in coastal communities
- Water supply, both and quality and quantity
- Diversity of power generation sources and transition plans by providers
The increase in the number of extreme weather events in recent years has raised public awareness about climate change. Investors and rating analysts are not just looking to see if risks are present, but also want information regarding what plans a government has to address these risks. Most environmental risks are generally self-evident based on where an issuer of governmental securities is located, although for conduit issuers, the risks depend on both the borrower and issuer. Any information a government has regarding estimates of the potential economic impact on its tax base or other identifiable and quantifiable risks may also be helpful to investors and rating analysts. Also, investors and analysts are keenly interested in information on how issuers are addressing or planning to address climate change and other risks identified.
Identifying Environmental Risks
The first step in developing disclosure information for E-environmental is to identify the primary environmental risks applicable to your government or its bonds. Please note that disclosure information for E-environmental will take time to assemble and prepare. For that reason, even if governments are not planning a bond issuance in the short term, governments should consider compiling relevant information when practicable in anticipation of a future bond issuance. Most importantly, addressing environmental disclosure is a matter that should be discussed with your bond counsel, disclosure counsel, and municipal advisor.
- Issuers should start by identifying leaders in their government that have expertise in the area of climate or environmental risk. This could be an official in the public works department, the emergency manager who is charged with preparing for or responding to natural disasters, or a resiliency or sustainability officer.
- Identify the primary environmental or climate risks for your area. Start by addressing likely risks, and risks with the potential for the most material impact on your government or the credit worthiness of your bonds rather than attempting to identify every risk that could occur in your jurisdiction. Later, less likely risks, and risks with less impact on the government can be addressed.
- Consult bond offering documents of peers and neighboring governments for environmental disclosure that may also be relevant to your jurisdiction. Environmental and climate risks are often regional. Governments in close proximity may already be disclosing environmental risks which may be used as a guide to identify and inform your environmental risk disclosure. This is especially true for smaller jurisdictions that have constrained resources. Smaller governments may find it more efficient and cost effective to make use of planning and disclosure materials of larger governments within the same region.
- If your jurisdiction has identified environmental risks, can they be quantified? Is there information available regarding the impact of these risks on your tax base, pledged revenue stream, finances, economy or other measures that may be used to inform investors? There are service providers in the environmental risk identification space that can provide data that may be helpful in quantifying the potential impact of climate risks. If quantitative information is provided, any forward looking data or projections should be accompanied by the appropriate cautionary language because natural disasters are, by their nature, inherently unpredictable events.
- If no expertise exists at the local level, governments should take a broad survey of issuers making environmental disclosures. Additionally, all states have a hazard mitigation plan that may help identify risks. The US Global Change Research Program, operated by 13 federal agencies produces the National Climate Assessment and the National Risk Index that can be helpful for identifying primary risks in your area.
- As noted above, there are many consultants, experts and businesses that specialize in identifying and evaluating environmental risks, but they are not required for developing adequate disclosure of environmental risks. These service providers may be useful in connection with preparing for climate change and environmental risks, but their value to your government should be independent of helping develop disclosure.
Environmental Risks and the Nexus to Credits
- Once environmental risk factors have been identified, a government should consider how these risks, if actualized, could impact its operations and financial position. Governments should also consider the potential impacts for each credit or enterprise because the potential impact may be quite different depending on the nature of each credit or enterprise. Disclosure should be tailored to be helpful and informative to the municipal market.
- If the government itself, the revenues that secure the credit, or the infrastructure being funded with bond proceeds, could be materially impacted by an environmental disaster, extreme weather event or climate change, it is recommended that these risk factors be disclosed in relevant offering documents used in connection with bond sales. Additionally, any data that is available to quantify the potential adverse impact of the identified risks being actualized should be disclosed. Quantitative data regarding the potential impacts should be accompanied by appropriate cautionary language.
- Providing available information regarding risks and mitigation or adaptation efforts is considered good investor relations as rating agencies, analysts, and investors are increasingly looking for and assessing this information in making credit and investment decisions. Consider identifying emergency mitigation and response strategies perhaps already in place using data regularly collected (examples located in Resource Document: Identify Resiliency and Emergency Response Strategies).
Governments that have identified E-environmental risk factors for disclosure are encouraged to identify both the analysis of environmental factors, such as climate risk, and the policies adopted to address those risk factors. Governments that are contemplating preparation of primary market or voluntary financial information should discuss the issue with their bond counsel, disclosure counsel, and municipal advisor.
General template for your Primary Market disclosure
A good starting point for the primary market disclosure is addressing what your governmental knows and is currently experiencing, and what steps it has taken to address these factors and risks. Examples of policies adopted could include local ordinances, climate action plans, greenhouse gas reduction strategies, and other policy documents. Analysis of climate risks include studies conducted by state, regional or local governments discussing risks and mitigation strategies of climate events that my impact your entity.
Below is a checklist of Disclosure Considerations to assist in preparing Primary Market Disclosure related to E-environmental risks:
- Identify primary risks
- Discussion of environmental risks identified in State, regional or local government studies or analyses undertaken, if any, outlining primary risk factors.
- Quantify, if possible, or provide examples of recent experiences with primary risks identified, including natural disasters or other extreme weather events.
- Discussion of how these studies or analyses are tracked and updated over time.
- Describe processes and systems in place for responding to and mitigating your identified risks, including the level of government and/or departments responsible for those processes and systems.
- Identify policy actions taken
- Discussion of State, regional and local government policies adopted addressing environmental factors impacting your Government.
- Quantify climate policy goals established impacting your Government and progress towards meeting those goals, including implementation efforts.
- Discussion of how these policies and goals are tracking and updated over time.
- Summarize information for an investor to gain a general understanding of your response efforts. Only link to reports available for more detailed information, if needed, to convey relevant and meaningful information for disclosure purposes. In many cases, it is more meaningful to summarize salient points from voluminous reports rather than simply linking to or referencing detailed assessments or technical materials.
- Include appropriate disclaimers or cautionary language to properly frame the discussion of environmental risks, which are inherently unpredictable with projected impacts that are equally unpredictable and, at times, unknowable. As noted by the Securities and Exchange Commission, good faith attempts to provide appropriately framed forward-looking information were not expected to be second guessed by the SEC. Disclaimers should also be considered for any links to websites that are not under the direct control of your government.
- Ensure that the disclosure is reviewed with each bond offering to keep the information up to date and disclose any new events that have occurred as well as the response and impacts.
General Considerations for Additional Voluntary Disclosure
- Governments may also choose to provide periodic voluntary environmental information of identified E-environmental risk factors and policies adopted to address those risk factors to investors. It is important to note that governments should contemporaneously disseminate any voluntary financial information to the market as a whole. Governments should also be aware that while communicating this information increases transparency of the government to investors, any information determined to be “communicating to the market” could be subject to regulatory scrutiny.
- GFOA is the lead organization for an industry-wide workgroup addressing concerns on municipal disclosure that have been raised by investors, analysts, and the Securities Exchange Commission. In August 2020, this Disclosure Industry Workgroup release a paper entitled “General Continuing Disclosure Considerations for Municipal Securities Issuers” that, while focused on COVID-19 matters, addressed the need for relevant timely disclosure including voluntary disclosures. Although the paper was developed in order to address COVID-19 pandemic related disclosures, the principles developed can be easily applied to environmental voluntary disclosures.
- GFOA Best Practice: Maintaining an Investor Relations Program
- GFOA Best Practice: Primary Market Disclosure
- Disclosure Industry Workgroup: General Continuing Disclosure Considerations for Municipal Securities Issuers
- SEC Statement: General Continuing Disclosure Considerations for Municipal Securities Issuers
- Board approval date: Monday, March 8, 2021