Between the Biden administration’s ambitious plans—driven in large part by climate change concerns—to bolster the nation’s infrastructure, the looming specter of tax hikes, and the growing desire among many investors to “make a difference” with their investment dollars, it’s an ideal time to explore opportunities in the market for “green” municipal bonds. Good old-fashioned munis, after all, will be supplying much of the capital as communities build out their infrastructure and deal with the effects of climate change.
Not all credits or issuers should be viewed in the same light, though. Some issues marketed as green bonds, for example, may not achieve the environmental benefits investors had hoped for, whether due to inefficient use of proceeds, a lack of proper oversight, or because proceeds were deployed to insufficiently green projects.
Similarly, investors should bear in mind that green bonds may be issued for very different reasons, with some intended to drive proactive environmental benefits while others fund more “defensive” projects that bolster communities’ resilience to the negative impacts of climate change.
Investors should also be aware of the new and intensified areas of risk that many municipalities are experiencing as a result of the effects of climate change. While natural disaster-driven defaults do not happen and credit downgrades are rare, some weaker issuers may come under additional pressure in the event of severe hurricanes, flooding or other unforeseen catastrophes.
In all, how can investors identify suitable bond issues that address their own environmental priorities while keeping an eye out for potential risks? Here are some key tips:
• Watch out for “greenwashing.” Despite the growing popularity of green investing overall and the increased demand for eco-friendly bonds, the MSRB has not yet settled on a universally accepted market standard or definition of what a green bond is—meaning that, in some cases, a bond may only appear green in the eyes of its issuer.
The MSRB defines “greenwashing risk” as the risk that proceeds from an issue marketed as a green bond will not be applied to eligible projects. Greenwashing carries obvious reputational downside for both underwriters and issuers—along with risks to investors that their environmental priorities may fall by the wayside.
Additionally, even when proceeds are used as advertised, investors should be aware that there can be significant differences from one issuer to the next when it comes to project evaluation and selection; management of proceeds; reporting on the use of proceeds, project impact and benefits; and more.
Fortunately, ratings agencies and other third parties are working to bring transparency to the green muni segment. Moody’s and S&P have developed their own green bond assessment methodologies which, although they do not gauge credit quality, provide relative scores that account for governance oversight, administration, execution, monitoring, reporting and other key attributes that are critical to achieving a green bond’s advertised goals.
• Bear in mind the difference between “mitigation” and “adaptation” issues. As part of its green analytical framework, S&P has introduced a helpful distinction between the various types of projects green bonds are intended to address.
According to S&P, “mitigation” projects are intended to drive environmental benefits including reduced depletion of natural resources or biodiversity, controlling pollution or combatting climate change broadly.