USA - Climate Change and Municipal Finance
Climate change is an unprecedented global reality that will require reform in every aspect of the economy, including public finance. Federal regulations should require state and local issuers to provide investors with robust climate risk disclosures. Comprehensive disclosure of climate risk will help ensure that the municipal market continues to enjoy accurate risk-based pricing and a high degree of liquidity.
In the absence of aggressive and sustained reduction of greenhouse gas emissions, global temperatures will very likely hit and surpass 1.5 degrees Celsius by as early as 2030.2 Higher global average temperatures will cause more devastating storms, floods, and fires as well as rising sea levels.
For many years, climate economists have focused on how the effects of climate change will reduce gross domestic product as well as the earnings of firms directly tied to the production and heavy use of fossil fuels, including the oil, power, and chemical sectors. More recently, researchers have turned their attention to systemically important financial institutions and capital markets, which underpin every aspect of the economy.
Climate change has the potential to have a large impact on the normal functioning of the financial system. Financial markets rely on participants’ belief that the prices of debt and equity securities and other financial products more or less approximate the underlying real economy and its risks. When a natural disaster, pandemic, or other economic shock reveals a large gap between actual risk and asset prices, markets can experience severe volatility. When investors do not understand what is happening in a particular market, they withdraw their capital and look for safe havens. Stated differently, capital markets rely on steady investor demand to provide liquidity. Investor demand in turn relies on accurate pricing. Accurate pricing relies in turn on effective risk assessment. And effective risk assessment relies in turn on transparency and comprehensive disclosures.
Providing accurate and effective assessments of climate risk is critical for maintaining stable financial systems, but are state and local government municipal bond issuers providing potential investors with accurate and comprehensive climate risk disclosures?
While no comprehensive data exist, evidence suggests that climate disclosures in state and local government municipal bonds are a relatively new occurrence, with many issuers including minimal details about how climate could negatively affect an issuer’s ability to make bond payments over time.3 This issue brief uses a recent revenue bond issuance by the Miami-Dade Water and Sewer Department (WASD) to highlight the shortcomings of limited disclosures