Factoring environmental, social and governance factors into investment decisions is raising questions among industry professionals about the differences between assessing ESG risk factor disclosures on one hand and ESG qualifications for labeled bonds on the other.
And while regulators have acknowledged that the concepts differ, municipal advocacy groups have expressed concern about whether future guidance would inappropriately conflate ESG risk factors and ESG-labeled bonds.
“A key concern is that guidance intended to apply to both ESG risk factors and ESG-labeled bonds could lead to disclosure that is simultaneously irrelevant and inadequate,” said Jennifer Brooks, a public finance attorney with Ballard Spahr.
As an example, Brooks, who does bond, disclosure, and underwriter’s counsel work, said that “encouraging municipal issuers to include specific ESG metrics, which might be appropriate for certain green-labeled projects, could in a climate change-related risk factor, be burdensome for issuers and ultimately not material to investors.”
On the other hand, Brooks added, “if the guidance is vague as to the disclosure expectations for ESG-labeled bonds to make it more broadly applicable to ESG risk factors, then issuers might omit material information regarding the projects to be financed.”
Generally speaking, ESG risk factor disclosures relate to broad, systemic risks. Brooks points out that these risks may be present regardless of the project that is being financed.
ESG-labeled bonds, on the other hand–which typically finance green or socially impactful projects and are labeled as green, sustainable, environmental impact, or social, for example–are more tailored to specific project metrics. Those bonds are expected to garner a greater share of the municipal market according to S&P Global Ratings projections.
With both concepts, disclosure is important. “Assessing the adequacy of disclosure for both ESG risk factors and ESG qualifications for labeled bonds may be based upon similar principles of materiality,” Brooks said.
Notably, questions surrounding what will be deemed required or material for purposes of disclosure were somewhat heightened after the Municipal Securities Rulemaking Board issued a request in December for information on ESG factors.
In its RFI, the MSRB noted the lack of uniform standards for ESG disclosures and ESG labeled bonds, saying that ESG trends “implicate important questions regarding issuer protection, investor protection, and the overall fairness and efficiency of the municipal securities market.”
Additionally, last fall, MSRB CEO Mark Kim expressed that the concept of materiality may be evolving as a result of ESG trends.
“The MSRB appreciates that there is a difference between ESG-related disclosures … and the labeling and marketing of bond deals,” Kim said, adding that both topics are of interest to the MSRB and “ESG means different things to different people.”
For its part, the National Association of Bond Lawyers argued in a 2021 comment letter to the Securities and Exchange Commission, that “disclosure in offering documents for labeled bonds can be easily distinguished from ESG risk factors and disclosure more generally.”
NABL added that “issuers should be able to decide whether to label or market their bonds to environmentally or socially-driven investors, but should not be required to otherwise meet climate change labeling requirements, barring materiality concerns.”
With regard to the RFI, Leslie Norwood of the Securities Industry and Financial Markets Association has indicated that the scope might be too broad.
“There are some initial concerns about MSRB’s request for comment, particularly with regard to materiality of disclosures and some thinking among different groups that materiality of disclosures is really in the SEC’s purview,” Norwood explained during a Government Finance Officers Association meeting last month.
Susan Gaffney of the National Association of Municipal Advisors echoed some of NABL’s and SIFMA’s concerns.
“We agree with other industry groups that [ESG risk factors and labeled bonds] need to be separately addressed and considered, not combined under one “ESG” umbrella,” Gaffney said.
From a disclosure standpoint, Brooks said that “all municipal issuers should determine with their financing team whether it is appropriate to include ESG risk factor disclosures.” Although, the specific risks to be disclosed will “vary from issuer to issuer depending on the applicable facts and circumstances.”
Meanwhile, Brooks noted that not all municipal issuers will issue ESG-labeled bonds. As a result, she said, disclosures related to ESG qualification and impacts should be tailored to the specific ESG projects and metrics to be achieved.
Brooks explained that this should be done in a way that provides investors with meaningful information regarding why a bond is labeled. However, a number of industry professionals say that can be complicated by the lack of universal language governing for example, what makes a bond “green.”
Meanwhile, initial comments filed in response to the MSRB’s RFI highlight some of the challenges regulators face in responding to the growth in ESG investing.
For example, the City of Detroit’s response favors voluntary disclosures for the municipal market because “standardized ESG disclosures would be overly burdensome, costly, and potentially inhibiting for municipal issuers.”
Ultimately though, Brooks thinks that it is unlikely that the MSRB will unnecessarily conflate ESG risk disclosure guidance with guidance regarding labeled bonds.
“Regulators might choose to provide principles based guidance intended to apply to ESG risk factors and ESG-labeled bonds given a common standard of materiality for both,” Brooks explains.
But she adds, “it’s anticipated that the MSRB will consider these two issues separately in any guidance or rulemaking.”