'Woke Bond Rating’? The Muni Finance Fight Over ESG Scores

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Public Finance Update - May 17, 2022

Welcome back to another edition of Route Fifty's Public Finance Update! I’m Liz Farmer and this week, I’m looking at the latest squabble over ESG evaluation—assessing governments’ long-term environmental, social or governance risks. As always, send feedback and tips to: publicfinance@routefifty.com.

ESG evaluation has always been a somewhat contentious issue in the investment community because data on those metrics are not standardized. But a recent move by S&P Global to assess states’ ESG exposure is sparking new debate, and has conservative lawmakers and interest groups fighting back in one of the most concerted efforts yet to discredit the practice.

At issue are new “ESG credit indicators” S&P released in late March. Each state was given a report card on its environmental, social and governance factors and assigned a ranking of 1 (positive) to 5 (very negative) on each factor. States all generally scored twos and threes for each category. “ESG credit indicators,” said S&P in a recent FAQ, “provide additional transparency on what’s already incorporated into our credit rating analysis.”

Utah, for one, isn’t buying it. In a scathing op-ed in The Wall Street Journal this month, State Treasurer Marlo Oaks accused the agency of embracing “left-wing” beliefs and blurring the line between subjective judgments and objective financial assessments.

In an email to Route Fifty, Oaks said that categories such as how a state scores on “managing carbon” or “political unrest stemming from community and social issues” were open-ended and subject to the evaluator’s political beliefs. 

“In this iteration of S&P’s ESG indicators report card, Utah was dinged for drought,” he wrote. “A normal credit rating considers drought, as well as what the state is doing to mitigate the issue and how drought factors into our overall rating. The ESG report card isolates the issue and portrays Utah negatively because of it, painting a very different picture than Utah's overall AAA credit rating. That in and of itself is problematic.”

Pressure From the Right

Oaks’ protest followed earlier pressure from conservatives and fossil-fuel states against attempts to elevate ESG in financial disclosures. In April, Oaks, Utah Gov. Spencer Cox, and the state’s entire congressional delegation penned what essentially amounts to an informal cease and desist letter to S&P, demanding that it withdraw its “misleading, potentially damaging to the entities being rated, and possibly illegal” ESG indicators. Americans for Limited Government swiftly praised the officials’ opposition to what the group dubbed S&P’s “woke bond rating.”

S&P has emphasized that its ESG indicators are not ratings or scores (it does offer those types of services separately), and that the indicators do not change the agency’s credit rating criteria. It uses an alphanumeric system so that investors can easily compare issuers across different sectors, but an ESG indicator cannot cause a credit upgrade or downgrade.

Elsewhere, Texas and West Virginia pension systems are cutting ties with investment funds and managers, such as BlackRock Inc., that prioritize ESG investing. The moves follow model policy created by the conservative American Legislative Exchange Council aimed at “protect[ing] pensioners from politically driven investment strategies.” 

On Capitol Hill, some Republicans are showing interest in taking on ESG issues. U.S. Rep. Chris Stewart, of Utah, told Roll Call recently that if the GOP gained control of the House in the midterm elections, they would try to curb additional ESG regulations. It’s possible this push could target the Securities and Exchange Commission’s plans to regulate corporate climate disclosures. 

Investors Supportive of ESG Metrics

But the increased focus on ESG data didn’t begin with regulators—investors have been clamoring for it for years. The argument from governments has generally been for self-reporting. In the absence of standardized disclosures on things like carbon emissions or water conservation, private companies have stepped in to fill the gap and offer their own assessments.

“If issuers had gotten ahead of the disclosures demand and provided the narrative around that, they could control the discussion a little more,” said Lisa Washburn, managing director at  Municipal Market Analytics. “But they chose not to do that.”

Matt Fabian, a partner at MMA, said S&P’s ESG Indicators are part of a larger pattern of credit agencies attempting to lengthen the five- or six-year time frame they have typically taken in assessing issuer credit quality and ability to repay debt. A similar uproar occurred after the Great Recession when pensions took a beating and Moody’s Investors Service started using their own pension liability calculations in assessing governments.

“This is [S&P’s] attempt to look longer-term at where a state is going to be in 30 years,” said Fabian. “ESG will tell you the challenges they have now that might make it harder for them—in the long term—to pay their bonds.”

Divisions between rating agencies 

Credit rating agencies have for years been writing about ESG in their market reports, and all four offer independent ESG analyses. But when it comes to credit ratings, which fundamentally assess a bond issuer’s ability to repay, S&P (the largest rating agency for U.S. public finance) has arguably gone the furthest singling out ESG fundamentals in ratings reports.

Following the Utah flare-up, the upstart Kroll Bond Rating Agency appears to be making a move to distinguish itself when it comes to ESG evaluation. Kroll is the only rating agency that does not rate Utah’s general obligation bonds. But in a report issued last week the agency said that while ESG analysis is important, scoring issuers on ESG factors often lacks objectivity.

“We have judiciously avoided the inclusion of a distinct ESG scoring system into our credit rating methodologies and reports,” the Kroll report said. “In fact, we believe ESG scores are a disservice to market participants.”

That’s it for this week’s edition of Public Finance Update. We’ll be back next month with another issue. Thanks for reading!