ESG & The New Alternatives

Investors Look To Direct Capital Toward Long-Term Sustainability

Addressing the materiality of climate risk through issuer engagement

A new report from Breckinridge Capital Advisors’ municipal bond research team identifies five key climate change topics across large sectors of the municipal market. Excerpts are provided below. Access the full report here.

Breckinridge’s 2021 Issuer Engagement program focused on climate change risk as a unifying theme. We view climate change as a risk multiplier for corporate, municipal, and securitized bonds. It is an integral factor in our approach to environmental, social and governance (ESG) risk assessment.

During the first eight months of 2021, our research team members held nearly 60 direct engagement discussions with issuers and subject matter experts (SMEs). These meetings were in addition to the numerous interactions the analysts had routinely with issuers and SMEs as they conducted new security research and ongoing surveillance of the bonds in our investment portfolios.

UN Report Starkly Illustrates the Challenge

This year, the United Nations (UN) confirmed that climate change risks are permanent and intensifying. On August 7, 2021, the UN International Panel on Climate Change (IPCC) assessment report stated that climate change is unequivocally driven by greenhouse gas (GHG) emissions caused by human activity.

Climate change and its consequences—extreme weather including hurricanes, typhoons, cyclones, and tornadoes; rising seas; melting ice caps; wildfires; deadly urban heat; coastal flooding; persistent droughts—are constant threats to human life and commerce. The more than 200 scientists convened by the UN to develop the report concluded that nations can no longer stop global warming from intensifying over the next 30 years.

While the science says that there is still a short window to prevent a disastrous future, the authors warned that, even if nations started sharply cutting emissions today, total global warming is likely to rise to around 1.5 degrees Celsius within the next two decades.

Designing the Engagement Program on Climate Change Risk

During our 2021 issuer engagements, our analysts, issuers, and SMEs explored material physical risks of climate change. They also examined transition risks facing corporate and municipal issuers as they adapt to a low- or no-carbon economy. Our engagement discussions also highlighted the dimensionality of climate change. Climate change is a pervasive risk across corporate and municipal sectors. This dimensionality of material climate change risks can complicate the task of transitioning to a low- or no-carbon economy, but it also may provide potentially powerful opportunities for collaborations that can accelerate progress.

For example, representatives of city and state governments spoke of effective partnerships forged with regional groups addressing risks associated with water/sewer services. Corporate issuers discussed with us their work with SMEs to develop climate risk mitigation, adaptation, and measurement strategies.

Two of Many Investment Insights from Issuer Engagement Meetings

While the science says that there is still a short window to prevent a disastrous future, the authors warned that, even if nations started sharply cutting emissions today, total global warming is likely to rise to around 1.5 degrees Celsius within the next two decades...

Two conclusions from our engagement discussions on climate change are inescapable:

  • By and large, issuers recognize the threat of climate change to their current operating models and are seeking to mitigate the risks, but remain in the early stages of doing so; although there are pioneers.
  • Investors must be discerning as they decide where to direct their investment capital for long-term sustainable performance in the markets and society

Corporations at Various Stages of Addressing Climate Risks

Among corporate bond issuers, we learned that companies in the banking sector are increasing lending that targets sustainability projects, specifically climate change. The banking industry is also a leader in reducing GHG emissions in operations. In the energy and transportation sectors, we believe that carbon is a financially material ESG consideration.

Municipal Bond Issuers Confront Multiple Challenges, Often Locally Defined

In the municipal market, we spoke with management teams at the state and city level, at municipal utilities, and at housing finance authorities. States often commented on the need for greater direction and funding from the federal level. As noted, cities are collaborating with state and regional teams that focus on local climate concerns. For example, our engagement with cities highlighted concerns associated with heat island effects in urban centers, and the inclusion of social and environmental justice considerations in mitigation and adaptation.

Mortgage-Backed Securities and Climate Change

We also discussed integrating climate change risk in analysis of mortgage-backed securities (MBS) with one of the nation’s largest government-sponsored enterprises (GSE) that issues mortgage bonds. The agency is in the early stages of including climate change in its considerations. We had the opportunity to advocate for more robust risk disclosure.

Disclosure Must Be Improved to Better Serve Investors, Increase Climate Change Understanding

Another current vulnerability that was mentioned frequently during our engagement discussions was disclosure on climate risk. We discussed with issuers reasons that investors cannot access relevant information on climate risks. Some organizations may not have integrated comprehensive climate risk disclosures in their reporting practices. Regulatory requirements may not be up to date with the rapidly changing information required for robust climate risk reporting.

Finally, and this rings true in our experience with issuers of municipal bonds, sufficient resources—financial and human—are not available to provide investors with comprehensive climate risk data.

Access the full report here.