Investing in Resilience: How Municipal Bonds Can Fund Climate Adaptation

Get used to the phrase “climate adaptation” – you’ll be seeing it a lot very soon. And as so often is the case with societal changes, the municipal bond market is the canary in the adaptation coal mine.

Climate adaptation refers to tangible steps taken – usually at the state and local level, usually involving infrastructure upgrades – to withstand “extreme weather events.” Extreme weather events are defined as weather and climate disasters where overall damages and costs reached or exceeded $1 billion. The number of extreme weather events increased from six in 2002 to 18 in 2022 to a record 28 in 2023.

 1980-2023 US billion-dollar disaster year-to-date event count graph
Since 1980, the U.S. has averaged 8.5 extreme weather events per year. Over the last five years, that number has jumped to over 20. Source: National Oceanic and Atmospheric Administration.

Note that “adaptation” is distinct from “mitigation,” which refers to strategies to reduce industrial emissions like carbon and methane. According to a 2020 study by Boston Consulting Group and the Global Financial Markets Association, the aggregate mitigation investment required to keep global temperatures from rising more than 2 degrees centigrade is $100 trillion – $150 trillion. By contrast, “adaptation” refers to infrastructure improvements to mitigate the damage severe weather events can do. Think building up sea walls, elevating buildings, raising roads and sidewalks, restoring vegetation as a buffer against rising sea levels, upgrading storm sewer systems, reinforcing water treatment facilities and investing in electric grids so they don’t fail in extreme cold or heat spells – not to mention updating zoning regulations that govern building in flood zones.

Conversations about adaptation are more likely to take place in city halls, town meetings and state legislatures than in international climate conferences, and they don’t garner the same attention that mitigation efforts do. Nevertheless, while the numbers for adaptation are smaller than for mitigation (hundreds of billions rather than trillions), they are still daunting. Climate adaptation plans for the Florida Keys alone cost out at $1.8 billion.*

That’s where municipal bonds come in.

Munis have long been the principal financing vehicle for local community infrastructure improvements, providing more than 75% of the capital for infrastructure-related projects in the United States each year. It’s not a stretch to see how municipal bonds could be used to spearhead efforts to finance climate adaptation. Importantly, though, the capacity of the muni market is limited: State and local governments have raised an average of $400 billion annually for various purposes – adaptation needs could push that to over $600 billion.

If municipal bonds are to be effective in helping communities protect themselves against extreme weather events, supplemental sources of capital will be needed – from the federal government, from not-for-profit entities, possibly even from corporations looking to preserve quality of life in the communities where their employees, clients and customers live and work.

Additional tax revenues will also be needed to service the debt on adaptation bonds – which is tricky, because the communities most exposed to extreme weather risk are those where commercial and residential property tax valuations – a key to local revenues – are under pressure. This is especially true in markets like Florida, where property and casualty insurance companies are cutting back or pulling out entirely. As Tom Doe, president and founder of muni bond research firm Municipal Market Analytics, recently told the Senate Budget Committee, “Climate-related disasters … have the potential to cause a sustained, non-reversible erosion of the tax base or devastate it immediately.”

Given those risks, investors can expect to see more disclosure by state and local governments about the risks of extreme weather and the measures being taking to address them. Consider the language the state of Hawaii used in the “Risk and Vulnerability from Climate Change and Natural Disaster” section of the official statement for their $740,000,000 2022 General Obligation bond issue:

“The foreseeable impacts of rising sea levels and other climate change challenges are priorities for Hawaii due to its geographic isolation, costal-focused society, and observable present-day impacts from coastal erosion and flooding.”

Access to municipal bond investor capital is critical for local communities looking to protect their long-term vitality and ways of life. As Municipal Market Analytics senior fellow Chris Hamel told me, “We are headed into a changed set of circumstances. The world is going to miss our carbon reduction targets. What we need to do now is plan and fund resilience and adaptation projects.” It’s clear that whatever the climate adaptation solution looks like, the financial industry has a role to play.

P.S. If you haven’t heard of Chris Hamel, do yourself a favor and follow him on LinkedIn. Chris is the single most prolific poster I know of materials on the intersection of climate, municipal finance and infrastructure policy. His LinkedIn site offers daily scrolling commentary on the critical role financial services firms (notably property and casualty insurers) and the municipal bond market will need to play to help the world adapt to increasingly extreme weather events – an undertaking that will require innovation and new forms of public–private partnerships.

*Source: https://www.miamiherald.com/news/local/environment/article255155012.html