By John Filar Atwood
Municipal securities industry best practices on environmental, social and governance (ESG) issues are still emerging, and the Municipal Securities Rulemaking Board (MSRB) should wait before imposing uniform standards that may limit meaningful ESG risk disclosures. This is among the messages received by the MSRB from commenters on its December 2021 request for information on ESG practices, which the Board summarized in a new report.
The MSRB issued the request for information in order to better understand how ESG practices are being integrated in the municipal securities market. In addition to inviting general feedback on trends in ESG practices, the MSRB specifically asked stakeholders to comment on the disclosure of information regarding ESG-related risk factors and ESG-related practices, and the labeling and marketing of municipal securities with ESG designations.
The MSRB received 52 comments on the request for information. The MSRB said that commenters generally discussed the evolving nature of ESG practices, challenges associated with ESG integration, and opportunities for improving transparency through the MSRB’s electronic municipal market (EMMA) website.
Regulation would be premature. According to the report, the MSRB found wide consensus that ESG practices in the municipal securities market are still evolving, and that premature regulatory action could inhibit further development of best practices. Several commenters pointed out that market-based solutions are being developed, with one association citing its recent release of ESG risk disclosure best practices which it intended as a framework for issuers to how each ESG factor could potentially affect creditworthiness or its ability to repay its debt.
One commenter said that a market-based approach to good municipal disclosure will generate better results than any standardized requirement. Similarly, an industry association representing dealers told the MSRB that its preferred approach would be to let issuers tailor disclosures in a way that discusses risks that are material, including ESG factors.
The MSRB noted that a number of respondents cautioned against premature regulatory action by the MSRB with respect to ESG. The opinions were captured by an industry association representing municipal analysts which stated that at this juncture regulatory actions would not be optimal “as such directives tend to be inflexible, set bare-minimum standards instead of best practices, and introduce unnecessary compliance costs throughout the system.”
ESG integration challenges. The MSRB found that many commenters are concerned about the difficulties surrounding ESG integration including the lack of uniform practices and standards, and possible regulatory compliance challenges for municipal dealers and advisers. One commenter noted that some investors care primarily about what ESG factors say about a company’s risks, but others want to know what impact ESG measures are having. The same set of data and reporting does not necessarily allow for both risk analysis and impact measurement, the group stated.
Labeling is also a concern, according to commenters, since some municipal bonds are labeled as green, sustainable, or ESG based on frameworks that do not include environmental performance standards grounded in climate science or environmental justice performance standards. One association noted the confusion regarding ESG information for labeled bonds and ESG issuer disclosures. Individual investors are likely to assume that “green” or “social” labels are being assigned based on a uniform set of principles since there is not adequate information available to them, said an institutional investor.
The MSRB noted an association’s concern that certification services, standard-setters, and credit rating agencies use different criteria to determine what a municipality’s ESG score may be or how ESG topics factor into a municipality’s credit rating. The proliferation of inconsistent approaches can lead to systemic risks that threaten market structure, potentially creating disruptions that impact bond pricing in the secondary and primary market, one commenter stated.
Disagreement over solutions. While the MSRB found widespread agreement that there is a lack of ESG standards and uniform practices, commenters were divided on what to do about it. Some commenters said that uniform ESG disclosure standards or metrics will not improve investor protections or increase meaningful information for investors. However, one company said that clearer standards as to what constitutes “green” or other ESG-labeled bonds could provide more clarity to issuers, improve investor acceptance, and perhaps lead to a pricing advantage for the bonds.
The report states that commenters also disagreed on the potential benefits to market efficiency. On one hand, a commenter said that standardized ESG disclosures would promote a more efficient municipal market, while on the other a municipal issuer stated that the threat of mandatory ESG disclosure standards could impair the efficient operation of the municipal market. Some commenters worried that requiring additional disclosures would raise the per-dollar cost of funding for small offerings, thereby penalizing small communities.
Enhancements to EMMA. One area where the MSRB found widespread agreement among commenters was on the need for enhancements to the MSRB’s EMMA system. Commenters felt that improvements are needed to make the system easily accessible for the submission and retrieval of disclosure information, including voluntary ESG information. A group representing dealers went a step further by suggesting that improvements to the EMMA website could include clarifying any issuer self-designations, adding in specifics regarding any external review, removing confusing labels, and focusing on objective and standardized ESG labels.