Getting over the ESG integration hurdle in U.S. public finance

The tax-exempt market has been relatively slow to jump on the environmental, social and governance (ESG) bandwagon as market participants continue to search for a standard analytical approach. 

So far, the institutional buy-side has been leading the charge into sustainable investing, leaving bond underwriters and issuers scratching their heads as to how to best respond.

The lack of industry consensus has also opened the door to accusations the ESG rating process is inherently biased against conservative values. Herein, we argue that successful integration of ESG factors into the municipal market critically depends on the clear distinction between “risk” and “impact” factors, and on a clear understanding of the fragmented, bespoke nature of our market.

We believe issuers and public finance professionals should focus primarily on risk factors, especially environmental risk and governance risk, arguably the least controversial (read: non-politicized) components of ESG, and leave “impact” considerations to the buy-side.

Further, the risk assessment framework should be tailored to each sector of the market and to the various types of issuers that have access to tax-exempt financing.

Distinguish between ‘risk’ and ‘impact’ factors
The problem with an umbrella term like ESG is that it means different things to different people and thus lends itself to misinterpretation and outright distortion. For one reason or another, politicians from conservative states have seized upon the…