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Municipal Markets
BY Laura Levenstein and Michael Stanton, Build America Mutual

Municipal Green Bonds: Poised for More Growth? - Build America Mutual

The issuance of green bond volume continues to grow in the municipal market, driven both by shifts in issuer capital planning programs and a growing awareness of investor preferences for bonds that finance projects that provide positive environmental outcomes. There’s also reason to believe that “success will breed success” and fuel even larger volumes in the future.
The first U.S. municipal green bond was sold in 2013 and issuance grew steadily through 2017, when volume reached $12 billion. At the time, however, the market was dominated by a relatively small number of large issuers, including a handful of city water systems and a few large public transit agencies like New York’s MTA or San Francisco’s BART. That concentration left it susceptible to large annual swings in activity, and the next two years illustrated that risk: Volume fell to less than $5 billion (just 1% of the new-issue market) in 2018 and $8.9 billion in 2019, before rebounding and setting new annual records in 2020 and 2021.
When Build America Mutual consulted with major institutional investors before launching the BAM GreenStar program in the midst of that 2018 issuance drought, we learned that the volatility in labelled bond supply was holding the market back. Buy-side firms were reluctant to commit to dedicating analytical resources to sourcing and analyzing green bonds if there was a risk of extreme scarcity.
Today, the discussion has pivoted. Last year’s record $20.4 billion of green bonds came from a significantly more diverse universe of more than 150 individual issuers, and the broader “ESG Labelled” bond market has also surged, with strong volume from the emerging social and sustainability-linked bond categories. Whether ESG labelled bonds deliver a consistent economic benefit to issuers remains a matter of debate, but in the relatively few transactions where comparable green and traditional bonds were sold side by side, underwriters report receiving more bids for the green series, which have translated to lower yields in some cases. Advocates believe the trend will continue as volume grows, and have organized voluntary initiatives like the Green Bond Pledge, which encourages issuers to embed sustainability into their capital planning, and to sell green bonds whenever they finance a qualifying underlying project in order to “support the rapid growth of a green bonds market.”


Ultimately, ESG labelling is intended to increase transparency by making it easier for investors to identify bonds that finance projects they want to support. That task is complicated by the fact that the investor community is diverse: ESG investment strategies can cover a wide range of interests, from buyers who want to explicitly (and exclusively) support projects that generate zero carbon emissions to those who want to support historically underserved communities. In addition, some investors focus solely on financing new projects, while others will also incorporate refundings for qualifying uses into their investment guidelines.
Given those diverse preferences, the buy-side recognizes that no single labelling standard will meet all investor needs. In its response to the Municipal Securities Rulemaking Board’s recent request for information about ESG issues, the Investment Company Institute (the leading trade association representing mutual fund managers) listed five distinct approaches buyers can take when incorporating ESG considerations into their investment process, and said that “given the diversity of the market and varied investment approaches by funds, there is no one answer to many of the questions raised in the request for information.”
The International Capital Market Association’s Sustainable Finance initiatives provide a starting point for underwriters and issuers considering whether a given bond issue should be labelled:
  • ICMA’s Green Bond Principles state that bonds financing projects in one of 14 categories can be eligible, but municipal market professionals only need to focus on a subset of that list: Most of the categories involve various commercial and industrial activities: US municipal green bonds generally finance projects focused on: Renewable energy, energy efficiency, green buildings, sustainable water and wastewater management, pollution control, or climate change adaptation.
  • The Social Bond Principles require looking at both the nature of the project financed (including affordable housing and other “basic infrastructure”), as well as the population served.
  • The Sustainability Bond Guidelines help issuers identify bonds that align with BOTH the Green Bond Principles and the Social Bond Principles.
Beyond the use of proceeds, all three ICMA standards include calls for issuers to develop a process for project selection, demonstrate that they have controls in place to make sure bond proceeds are spent as intended (existing policies and state-law restrictions can often satisfy this requirement), and provide post-issuance reporting to the market once the financing’s goal is achieved – letting investors know when the proceeds are fully spent and the qualifying project is completed. Issuers may also opt to align their labelled bond disclosures with two other standards: The Climate Bond Initiative’s Certified Climate Bonds program identifies debt that finances projects that are consistent with the 2015 Paris Accords, which set a goal of limiting global temperature increases to 1.5 degrees Celsius. Separately, the United Nations Sustainable Development Goals provide an additional taxonomy of projects that are generally supported by impact investors.


BAM’s experience developing the criteria for our BAM GreenStar assessment, then working with issuers to apply it to more than 300 bond series aggregating more than $4 billion over the past 3+ years has given us insight into some of the key obstacles hampering more widespread green bond issuance:
  • Questions about use of proceeds: The ICMA Green Bond Principles’ 14 eligible categories for the use of green bond proceeds leave gray areas, and some key terms (like “sustainable” in the Sustainable Water and Wastewater Management category) are not well-defined. The Climate Bonds Initiative helped clarify the issue when it published the methodology for its Green Bond Database [ADD LINK], which included a detailed taxonomy of the types of projects that fit into each of the ICMA categories. Third-party verifiers can also be helpful here, providing guidance about current market practices.
  • Questions about ongoing reporting: With memories of the SEC’s Municipal Continuing Disclosure Compliance (MCDC) program still fresh, many issuers and their counsel are understandably reluctant to take on additional continuing disclosure obligations. We’ve helped to address that by engaging BAM’s surveillance team, which was already updating our internal analysis of each insured bond annually, to request annual voluntary disclosures about project status from the issuer. In addition, in some cases, issuers have already agreed to provide adequate disclosure, sometimes as part of mandatory reporting in conjunction with state or Federal grants: Once our underwriters highlighted that, it was an easier hurdle to convince the issuer to share that information with bondholders.


Regardless of whether they decide to sell labelled bonds, issuers and underwriters should recognize that an ESG label does not necessarily provide any information about an investment’s exposure to ESG risks, which can include everything from the risk that climate change will drive more severe weather events and impact an issuer’s tax base to questions about governance and social justice practices. The Bond Dealers of America’s comment letter to the MSRB highlights the fact that ESG risk disclosures and ESG labelling information are distinct, while in a separate letter, the Milken Institute’s Center for Capital Markets expanded on that point, saying that “while sustainability, ESG risks, and positive community impact are often conflated … ESG is not an asset class.” The Institute’s letter suggested the MSRB encourage the market to stop using “ESG” to refer to labelled bonds at all – reverting to the more specific categories of green bonds, social bonds, or sustainability bonds. Impact-focused investor Breckenridge Capital Advisors went even further, focusing most of its letter to the MSRB on ESG risk disclosures and stating “disclosure issues relating to the emerging labelled bond market deserve less of the MSRB’s attention.” BAM’s own letter to the MSRB said, “ESG risk disclosures and analysis – particularly those related to the potential for physical and financial damage associated with severe weather events and other natural disasters – are becoming both more important and more common as the frequency and severity of flooding, wildfires, and other events have both increased in recent years.”


Missing in the discussion to this point is the most important question for many issuers, municipal advisors, bond counsel and dealers: Will selling green bonds allow an issuer to command a premium price? If the market demonstrates that the answer to that question is “yes,” the existing growth trends are likely to accelerate.
To date, the evidence is inconclusive. Issuers who sell green bonds and non-green bonds regularly report receiving additional orders for their green series. Many market participants expect that incremental demand to eventually translate into a consistent pricing advantage for green bonds, and there is a growing volume of anecdotal evidence that an economic preference is emerging: In one noteworthy case, the City of Boston reported receiving premium pricing on green bonds sold alongside non-green bonds on the same day in December 2021.
Beyond the potential emergence of a sustained economic advantage for green bond issuers, market participants will also be watching for potential regulatory action. The MSRB’s outreach for comments on ESG factors generated a large volume of input, and the Board’s reaction will be closely watched by the market.
Laura Levenstein is the Chief Risk Officer for Build America Mutual, and Michael Stanton is BAM’s Head of Corporate Strategy and Communications. BAM launched the BAM GreenStar program in 2018 to verify bonds sold by its issuer-members that align with the ICMA Green Bond Principles. BAM GreenStar bond issuance now totals more than $4 billion across 280 series.