By Brian Reilly and Bruce Kimmel
Our financial landscape is liberally dotted with acronyms that seek to simplify complex concepts, but often end up confusing people. Fortunately, one has emerged in the last few years that speaks directly to the public sector, especially cities. It’s easy to understand and uses just three letters: ESG — which stands for Environmental, Social, and Governance.
What does it mean?
ESG was primarily born out of Socially Responsible Investing (SRI). SRI mandates seek to leverage capital resources to influence outcomes, with ESG used as a risk framework when deploying that capital.
While the initial focus of ESG was on corporate interests, it has since expanded to governmental entities. Cities clearly stand at the epicenter of the core principles and functions embedded in ESG.
The role of ESG as a risk measurement tool has since evolved into a mosaic of opportunities to harmonize the policy of “doing good” with financial pragmatism that leads to “doing well.” Let’s break down the meaning of each word.
Environmental. Cities are preeminent stewards of our environment. They strive to preserve important water resources and green space, engage in best management practices related to stormwater, and collect and treat wastewater.
As owners of facilities and equipment, cities have an interest in leveraging energy-saving measures and using sustainable and resilient construction practices.
Social. Cities are also essential components of our social fabric. They use various policy tools, like zoning and ordinances, to promote social welfare, health, and equity.
Cities provide programs and buildings to promote good social outcomes and enhance residents’ lives. Think libraries, community centers, and parks. Many cities also operate housing, redevelopment, and other agencies that finance and manage property designed to deliver social benefits.
Governance. This is one of the paramount functions of any municipality. This aspect of ESG encompasses more than purely legislative matters. More specifically, the focus is on the structures underpinning your city’s decision-making, delegation of authority, and financial management practices.
City finances and ESG
There are times when elected officials’ policy directives may conflict with the limiting factors administrative staff operate under. The desire to “do good” can sometimes be constrained by financial realities. However, this doesn’t always have to be the case.
Take, for instance, evaluating “green” projects like energy conservation improvements or other sustainability initiatives. These projects typically require an up-front capital investment that will provide cost savings over time.
Achieving policy objectives under ESG principles and rigorously analyzing capital projects are not mutually exclusive. Governance can and should support policies associated with positive environmental and sustainability outcomes.
Your city’s capacity for capital financing should be treated as a valuable and limited resource — just like water, energy, and raw materials. Proper implementation of green projects will do more to build resiliency over time than any single project in isolation.
ESG and issuing debt
Cities should also consider ESG factors relative to their role as debt issuers, as rating agencies have incorporated ESG criteria into their rating methodologies. While governance factors were already embedded in broader financial management assessments, environmental considerations are made in the context of potential climate risks to the issuer.
For example, Minnesota has plenty of rivers subject to flooding events that are becoming more severe and frequent. Rating analysts and committees will consider an issuers’ risk mitigation efforts related to such events, and implications for finances, the local (and regional) economy, and demographic profile.
Growing interest in green bonds
As debt issuers, cities should also note growing interest in “green bonds.” This has become more common as SRI has become one of the fastest growing investment sectors.
You may be wondering how your city can issue green bonds. First, the projects being financed should meet the Green Bond Principles of the International Capital Markets Association.
There are two ways to achieve the “Green Bond” label. One path is to engage a qualified verifier to review your project and prepare a report certifying compliance. Portions of the report are then included in the issuer’s official statement for the bonds.
The second, less formal route is for your city to self-label its bonds as green without second-party verification. In both cases, you should provide a detailed description of the use of proceeds in the official statement to allow qualification in SRI-focused portfolios.
The lack of harmony between ESG policy initiatives and viable financing strategies has waned significantly in the last few years. That trend is likely to continue, further aligning the mutually beneficial interests of doing well financially and doing good for constituents.
Brian Reilly is a senior municipal advisor/principal and Bruce Kimmel is a senior municipal advisor with Ehlers (www.ehlers-inc.com). Ehlers is a member of the League’s Business Leadership Council (www.lmc.org/sponsors).