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Sustainable Finance Insights

June 2022

The U.S. municipal bond market does not price in physical climate risk … Yet

Why does climate risk matter and what can key stakeholders do about it?

As concern about climate risk disclosure grows, an analysis of ~800,000 U.S. municipal bonds representing over $2.5T in outstanding debt shows no evidence it is being systematically priced in. Yet event-based climate risk is correlated with discounts in both property value appreciation and population growth over the past decade -- the pillars of municipal market tax revenue and stability.

The below reasons might partially explain why the market has not priced in climate risk – yet.

  • “Muni bonds rarely default.” The municipal bond market is thought of as low risk. Some of this is rooted in rules or conditions that protect lenders; e.g., many are state-backed. Much of this is just rooted in data -- compared to other asset classes, municipal bonds have historically been less risky. Because of this, systemic risk in general (climate and otherwise) has not been nearly as central a concern to municipal bonds as it has to insurance or mortgage-backed security markets.

  • “Climate hasn’t historically caused defaults.Climate risk is now increasingly bankrupting small towns in the US. Since investors set the tone and ultimately drive yield expectations, if climate is expected to be a true credit risk, then yield spread should ultimately follow.
  • There is more demand for municipal bonds than supply. Today, there is more capital for lenders to put into play than supply of municipal bond issuance. It is well known that this dynamic compresses yield spread in the market. While a large number of bond buyers are now factoring climate risk into decisions, the Miamis of the country haven't taken a hit on credit spread yet.
  • Issuers are not clearly incentivized or equipped to disclose climate risk on their own. Buy side participants relying on issuers’ official statements will often lack critical information. While more bond buyers are operating with objective climate risk data, several are still in this situation. Much is made of the need for issuers to disclose their climate risk -- but many lack the resources to do so, especially in a standardized objective manner.
  • Ratings agencies don’t bake climate risk explicitly into credit profiles of issuers … yet. But of course, in light of (for example) Moody’s recent acquisitions of 427 and RMS, this is likely just a matter of time.

All data and charts used in this report are based on data obtained by ICE Data Services and available via its product offerings, unless otherwise cited.

So why does climate risk matter and what can key stakeholders do about it? Read more