09 January 2018
The green muni bond market in the US is still in its infancy and could be set for major growth as pricing benefits are no longer a distant reality, Patrick Brett, Citi's Head of Municipal Debt Capital Markets, explains.
EF: What is driving the US muni market? Where are you seeing the biggest opportunities for growth?
Patrick Brett: Issuers coming to market now are very much pioneers in creating the market. They are willing to invest time and resources to develop a market they feel is going to help them get credit for what they're doing from an environmental and sustainability perspective. Also, if the market becomes more liquid these issuers with large green capital programmes can see this benefit in the long term. So it makes sense for them to help jump start the market. But we are still early in formation of this market. We're expecting continued growth in the green muni bond market and are seeing continued interest from issuers and investors.
In terms of sectors, I think mass transportation and water will continue to grow. We are really just scratching the surface. There was around $80bn of green bond issuance last year, and US issuance was a little less than 10% of that. But if all relatively easily eligible uses of proceeds were actually labelled as green this figure would be higher. Municipals are a very natural source and user of green capital and the US green muni market has the potential to rival the global green bond market in size.
EF: So what is preventing the market from growing at a faster pace?
Patrick Brett: The only major limitation we're seeing has been convincing issuers that there's a pricing benefit in issuing a green bond. Right now it's hard to convince municipalities to pay the additional expenses that come with issuing a green bond if they're not getting pricing benefits. They're buying into the environmental and social benefits of the product, but in terms of getting them to spend money on things like third-party verification it has been a bit more difficult.
EF: Are we on track to seeing more pricing benefits?
Patrick Brett: We're starting to see capital forming around the green bond theme which I think is really key to market growth. Some capital pools are being raised just to invest in green muni bonds. This is a watershed moment for the market. We're talking to multiple firms looking at managed accounts and major asset managers working on green bond funds. When this kind of capital is raised specifically for green we're going to start seeing pricing benefits. When we see pricing benefits we're also likely to see a very natural evolution in terms of more prescriptive and harmonised rules and standards in the market.
EF: For the issuers already in the market, what are their main challenges?
Patrick Brett: Any new ongoing disclosure has been a concern. Few issuers have committed to this and there is a concern that someone buys a bond assuming it's green and then a few years from now some entity says it's not green because it doesn't comply with a certain standard, and then the bond's value drops. Issuers are worried about future legal liabilities. But by and large the main concern is the same as for potential new issuers - if it's worth issuing without the pricing benefit. But clearly an increasing number of players are willing to invest in the growth of the market.
EF: And what are the biggest challenges for investors eyeing the US green muni market?
Patrick Brett: The fact that 90% of US munis are tax-exempt is a barrier to entry for global green bond investors or frankly US-based investors like pension funds and endowments as they are already tax-exempt. If you don't pay US taxes you have no use for tax-exempt income so you wouldn't invest in 90% of the US market. We do sometimes see investors cross over from one market to another, with some pension funds buying US muni green bonds and accepting a lower yield. But to the extent there is a taxable bond they'd pick that.
EF: What about policy Ð how is the current political climate impacting the US green muni market?
Patrick Brett: The new tax bill should be helpful in the sense that corporate taxes are going down, which means individual investors are going to become even more important. And individuals are driving most of the capital formation around green muni bond themes, both directly and via green SMAs and green funds. Individual investors in higher tax states will face higher tax bills and will want to allocate more to tax-exempt bonds. We're already seeing an increasing number of individual investors leaning into the green bond market and might see a growth in separately managed accounts raised under a green mandate as a result of the tax bill.