18 January 2023, London: The Principles of Responsible Investment (PRI) has released its second report on ESG investment approaches in the US$4trn US municipal (muni) bond market. This report, The thematic ESG approach in US municipal bonds, frames key issues when investors use muni bonds to finance projects tied to specific environmental or social outcomes.

Muni bonds fund much of the US’s public services and infrastructure through providing capital to an issuer base that includes cities, counties, school districts, utilities, universities, and hospitals. The clear environmental and social implications of these projects mean that muni bonds are well-positioned for investors pursuing a thematic ESG approach.

“US municipal bonds are useful for fixed income investors seeking to contribute to sustainability outcomes, since issuers of these bonds are crucial for the wellbeing of most Americans and also the transition to a low carbon economy,” said Jasper Cox, Investment Practices Analyst, Fixed Income, at the PRI. “This report will help market participants understand the potential of muni bonds for a thematic ESG approach, but also how investors still need to perform appropriate due diligence on both labelled and unlabelled bonds.”

Momentum is building for thematic ESG investing in US muni bonds due to increasing investor interest in environmental and social themes, and growing opportunities to fund climate-related projects, among other factors. Indeed, some PRI signatories are using muni bonds to align investment objectives with the UN Sustainable Development Goals, or, alternatively, exclude bonds linked to revenue from certain sectors, such as tobacco, according to data from the PRI’s Reporting Framework.

Investors can contribute to positive outcomes or reduce negative outcomes through investing in both labelled and unlabelled muni bonds. The labelled muni bond market has grown rapidly, most of all through issuance of use-of-proceeds bonds, such as green, social and sustainability bonds. While less common, labelled bonds that link financial terms to project outcomes and sustainability targets have also been issued by some municipal entities.

Labelled bonds can help investors assess and report on the environmental and social outcomes of their investments, but the label does not exempt them from conducting due diligence on the bonds’ structure and framework. The report contains examples of various types of labelled bond. Adequate disclosure from issuers both before and after issuance is also essential for the credibility of this market.

This paper follows the release of an earlier PRI report, ESG integration in sub-sovereign debt: The US municipal bond market, concentrated on the ESG integration approach, where ESG factors are considered from the perspective of optimising risk-adjusted returns. As the largest liquid sub-sovereign debt market in the world, the US muni bond market merits consideration by ESG-minded fixed income investors. As a next step, the PRI intends to facilitate investor-issuer discussions to improve issuance practices, as well as further exploring sub-sovereign debt markets outside the US.