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Does ESG Matter in Public Finance? It Depends ...

Culture wars over environmental, social and governance factors used by pension fiduciaries are in the spotlight, but it’s the municipal bond arena where long-term analysis must trump short-term symbolic politics. Sustainability actually matters to investors.

A North Dakota oil well
An oil well in North Dakota. The culture war over pension funds’ involvement in environmental, social and governance-informed investment has primarily been driven by petroleum economics. (Shutterstock)
In case you’ve tuned it out, there’s a battle underway between proponents of “sustainability” analysis of corporate business practices and those who favor “drill, baby, drill” and “anti-woke” free market profitability metrics and political slogans. The debate worked its way up to Capitol Hill, where Congress passed and President Biden vetoed a bill to stifle retirement account fiduciaries’ consideration of environmental, social and governance (ESG) factors in their funds’ investments.

At the state level, meanwhile, a number of oil-rich states have put corporate proponents of ESG-informed investing in a penalty box by blackballing them from plum municipal bond underwriting business. On the political front, it’s another chapter in the ongoing battle over symbolic politics.

For pension funds, the argument for ESG investing has always been that it provides a long-term lens through which the future profitability and even sustainability of companies can be viewed, so that short-term financial performance and profits are not assumed to be perpetual. If you believe that fossil fuel industries will eventually be curtailed or replaced by green energy sources, then it’s a reasonable concern that the residual value of an oil company might be impaired and thus less investment-worthy. But that doesn’t sit well with political leaders in states where fossil fuel industries produce jobs, royalty income and a lot of tax revenues. So the primary focus has generally been driven by petroleum economics, with mostly symbolic focus on social and governance ideology.

Some public pension fund officials are now punching back at what they consider “performative” legislative proposals to rein in ESG, pointing to the same kind of over-reaching language that those bills’ own sponsors denounce. Pension officials’ legislative testimonies assert that the proposed anti-ESG laws will impair pension funds’ returns and increase costs to taxpayers. It’s an issue that cries out for sensible, fact-based policy analysis and implementation — not symbolic politics.

Meanwhile, the Securities and Exchange Commission (SEC) has taken a more aggressive and comprehensive posture toward companies that mislead investors on climate and ESG risks, bringing a number of enforcement actions. There’s also an international body that oversees industry-specific Sustainability Accounting Board Standards deemed to be “financially material, industry-based, decision-useful, cost-effective, evidence-based and market-informed.” When some of the most extreme anti-ESG laws go to court, which they will, you can count on judges and juries seeing citations of these SEC cases and SASB standards.

So what about the municipal bond market and the financial statements that states and localities provide to investors? Will the national debate over ESG factors creep into those governments’ annual financial reports — especially the accompanying “notes,” which provide supplemental information used by bond analysts and investors? Which disclosures are relevant and appropriate, and which are irrelevant fluff? And is there an inherent difference in the role of such factors in the ways companies and governmental entities operate and how investors evaluate their activities?

What Muni Bond Investors Need to Know

First, let’s not forget that most municipal bonds are tax-exempt, which means they typically are not good candidates for investment by tax-advantaged pension funds, 401(k)s and IRA accounts. So the debate over ESG-related retirement fiduciary risk factors is not realistically a concern here.

Add to that the reality that states and municipal governments are not profit-seeking entities that rely on investment capital from the sale of stock shares. They raise money from the capital markets by borrowing — by issuing bonds. So the primary interest of their investors is not future profit margins but rather the ability of the bond issuer to repay its obligations decades down the road. In that context, sustainability is an obvious consideration.

To address these issues, last year the Governmental Accounting Standards Board (GASB) issued a report on this very issue, and it’s well worth reading. GASB laid out 25 different topics, ranging from climate change to labor management to internal controls and transparency, where ESG “intersects” with financial disclosures often included in the financial statement notes. Each of these is then discussed briefly in a pragmatic and insightful table that shows how such disclosures are not an obtuse intellectual fixation but rather provide decision-useful information for a bond-rating agency or a big-shot muni bond portfolio manager.

It's impossible to read the GASB report and not come away with an appreciation that there really is “a there, there” from the standpoint of the full disclosures that the investment community needs to see. That’s not to say that clear-cut professional guidelines and examples for practitioner finance officers won’t help provide crisper clarity and relevance to the note disclosures. So some common sense can go a long way in providing investors with the most relevant, decision-useful information they deserve when evaluating a municipal bond issuer.

The Impossibility of Identifying Every Risk

Of course, some topics simply cannot be laundry-listed by either GASB or the fans of ESG. Sometimes the bond-rating agencies and investors need to do their own homework and cannot rely on just the financial statements and the notes. Who, for example, would ever imagine a CFO brave and foolhardy enough to insert this “governance” gem in the notes, even if it’s sadly the kind of occasional truth that prudent investors should know about: “Our local governing body is completely dysfunctional and incapable of thinking long term.” My point is that financial statement readers cannot expect the annual financial statement, with its phone book-sized appendices and customary disclosures, to identify all risks. It’s both impossible and unrealistic.

It should not be lost on readers here that all the kerfuffle about extensible business reporting languages and the Financial Data Transparency Act has almost nothing to do with this issue. There is no way on this earth that the meaningful financial insights discussed above will soon leap magically into a federal database. Actionable, reliable data systems and artificial intelligence may be coming, but don’t hold your breath for those dots to connect soon.

Although the oil and gas lobby may prevail in some skirmishes in the culture wars, pragmatic ESG disclosures are here to stay where they belong in the analytical dimensions of public finance.

Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.
Girard Miller is the finance columnist for Governing. He can be reached at
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