Et Tu, MSRB?

Defining ESG Disclosure in the Muni Market

The U.S. Securities and Exchange Commission (SEC) took up all the oxygen in the proverbial financial regulatory room two weeks ago with its proposal to mandate climate disclosure for publicly reporting companies. (I will have more to say about that in a future blog.) But what went almost unnoticed was a parallel foray into climate disclosure by another financial regulator, the Municipal Securities Rulemaking Board (MSRB), which earlier this year issued a request for information on environmental, social and governance (ESG) practices in the municipal bond market.

The Securities Industry and Financial Markets Association (SIFMA) and the American Securities Association (ASA), in both of which Baird is a member, filed comments letters with the MSRB that capture fairly comprehensively the issues raised by potential ESG disclosure regulation in the muni market. (SIFMA letter; ASA letter.)

Both the SEC's proposal and the MSRB's request raise the same critical and fundamental policy issue: What is the proper role of financial regulators when it comes to ESG disclosures? Do they have the legal authority to mandate ESG disclosures without explicit authority to do so delegated to them by Congress (which none of them have)?

In the muni market, the issue of prescriptive ESG disclosure is further complicated by a couple of additional factors. 

First, it would be enormously difficult to implement in an effective manner. That's because there are an approximately 50,000 state and local government entities, not including many not-for-profit or other obligors, that raise capital by issuing municipal bonds (as opposed to about 4,000 public companies) and a staggering one million bonds outstanding. There are widely varying risks and exposure considerations between different types of governmental units and geographies. As the Government Finance Officers Association wrote in a letter to the SEC, "the notion of developing a uniform set of metrics to evaluate risks is so impractical as to be virtually impossible."

Then, consistent with our country's foundational principle of federalism, there's the historical reluctance of Congress to regulate the activities of states and their political subdivisions. As officials from 23 states contended in a comment letter to the MSRB, the request for information "thwarts Congress's decision to leave states free from bureaucratic securities supervision." "The MSRB needs to stay out of this area," Utah State Treasurer Marlo Oaks told The Bond Buyer

The irony in this situation is that municipal bonds are the original socially responsible, green, ESG-focused securities. U.S. Treasury and IRS rules have long required tax-exempt municipal bonds to be issued for a public purpose. Municipal bonds finance parks and greenways, energy efficient improvements to schools and hospitals, mass transit development and water management systems, the environmental and social impacts of which are fairly obvious. 

Clear, factual disclosures by state and local government borrowers as to how bond proceeds are going to be used and the impact they are going to have on real people living in real communities in the real world, are far more important to investors than adding ESG labels without clarity or consistency as to what they mean.