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ESG Perspective published on May 1, 2019

Municipal Engagement Yields Additional Insights

Engagement is an integral part of our municipal investment process, as it allows us to better evaluate environmental, social and governance (ESG) factors for issuers. We believe that prudent credit analysis requires an evaluation of both traditional credit measures and ESG factors, rather than relying on public ratings.

Breckinridge invests in a wide variety of municipal bond issuers on behalf of our clients. Given our large coverage universe, we engage with a subset of our holdings to learn about broader trends in the municipal market that may be applicable for issuers across a municipal sector.

By having direct conversations with municipal leadership, we can ask questions that have emerged from our research efforts and gain a below-the-surface understanding of borrowers. Engagement is one of our most valuable tools for getting an authentic view of a borrower’s ESG performance (see Expanding Impact through Engagement).

2018 Engagement Calls: In-Depth Discussions on City Sustainability Initiatives

In 2018, we engaged with 27 cities to learn more about their sustainability initiatives and the importance of their initiatives. Cities selected for engagement were on our research team’s coverage list and fulfilled at least one of the following objectives:

  • Applicability to Other Cities: We considered whether the city is known for best practices in managing sustainability issues. Findings about practices in cities with strong sustainability reputations can be applied to our ESG research for other cities. Specifically, the calls allow us to benchmark the strength of our investment universe relative to issuers demonstrating strong thought leadership in the ESG space.
  • ESG Issue at Hand: In some cases, we targeted a specific municipal issuer to get a better understanding of an ESG issue affecting it, and to explore ways the city is managing the issue – regardless of whether we invest in its bonds.

In this piece, we expand on key themes from our 2018 municipal engagement calls, which were originally highlighted in last year’s ESG newsletter article Muni Engagement Can Give Credit Analysis a Richer Texture. We note that our engagements were limited to those municipalities that were willing to have discussions with us. As most of the cities that engaged with us in 2018 (our “engagement pool”) had a sustainability program in place, the conclusions presented in this paper may not represent a broad-based perspective on municipal ESG performance.

Figure 1 illustrates some of the major characteristics of the cities we engaged with:

Definition of Sustainable Development
An often-cited definition of sustainability is one that was coined in 1987 by the Brundtland Commission: “Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.”1 

Putting a Name and a Structure to Sustainability Efforts

The cities in our engagement pool varied in their approaches to sustainability, the intensity of their sustainability efforts, the points of focus within their efforts and the organization of the team responsible for implementation. However, the calls revealed a recurring theme: Municipalities are putting more structure around their sustainability strategies. In some cases, this means repackaging existing sustainability efforts. Municipalities have long managed programs that can now fall under a sustainability strategy, but were not in the past marketed as such. For example, many cities have affordable housing programs that are now captured as part of their sustainability strategies.

We note that most cities in our engagement pool already have a formal, structured sustainability action plan, and 14 of those plans have been updated within the past two years. These plans cover a wide range of issues, including climate change policies, environmental conservation initiatives, affordable housing, inequality, healthy foods, land use and transportation. However, most of the cities are still in the early stages of putting structure around a sustainability department and packaging their efforts appropriately under a sustainability umbrella. Through our calls, we drew several conclusions about the structure of sustainability programs and the challenges that municipals are facing as they implement sustainability initiatives, as follows:

Most cities in our engagement pool have a dedicated sustainability officer, but only half of the cities have a stand-alone sustainability department.

Lines of business, rather than the chief executive, are typically responsible for sustainability in cities.

City sustainability departments are usually housed within an existing line department, such as the planning department or the public works department. According to research from Rachel M. Krause, Richard C. Feiock and Christopher V. Hawkins,6 about 60 percent of sustainability departments are either embedded into an existing line department or created as a specialized unit that’s added to an existing department. Only 14 percent of cities have a standalone sustainability department (Figure 4).

In our view, a siloed sustainability office may be less effective than having the sustainability team embedded into an existing department. Embedded sustainability team members may have a greater influence on decisions made in those broader areas. Regardless of the reporting lines, nearly all of the cities in our engagement pool said the sustainability departments make a concerted effort to work across various city units toward a shared goal.

Most of the sustainability departments in our engagement pool were established by the lead administrator of the city. However, the executive branch typically does not own the responsibility of sustainability, per the Krause, Feiock and Hawkins research. Instead, in most cities, the line department not only houses the sustainability department but is ultimately responsible for sustainability in the city (Figure 5).We think it’s also important to consider whether a city has an overall sustainable culture, rather than focusing on the influence of a few sustainable team members in a city. 

The choice of a city’s sustainability officer could impact the ability to make progress on sustainable initiatives.

We believe that a sustainability program manager who is already overseeing traditional city functions may be better able to make valuable change. “A key finding of a lot of our research is that having a sustainability champion or a designated lead is important to keep the issue from falling by the wayside or being overwhelmed by other priorities,” stated Rachel Krause, associate professor at the University of Kansas School of Public Affairs & Administration and a top mind in the field of sustainable communities. Sustainability officers who have pre-existing knowledge of the operations of a particular city may be more successful in driving action from stakeholders, as they may have greater credibility in the city. In addition, those employees whose “traditional” role is also integral to moving projects forward or getting them funded will be better positioned to champion sustainability projects.

For example, Hoboken, New Jersey, has a two-person sustainability team consisting of a chief sustainability officer (CSO) and a chief resiliency officer (CRO). The CSO and CRO come from city planning backgrounds and have served in Hoboken government for several years, in various roles. The CSO and CRO are well known to key city decision-makers, increasing the likelihood of obtaining buy-in for sustainability initiatives.

Furthermore, Hoboken’s sustainability team is responsible for management of the city’s capital planning process. This entails collaboration on project prioritization with all city departments and with the administration and/or mayor. This blending of the sustainability and capital planning roles, which is rare in local government, ensures that ESG considerations are deeply embedded into decisions on capital projects, budgeting and finance. That said, we should note that this type of cross-departmental structure is more likely to be feasible in smaller and mid-size cities like Hoboken. In larger cities, the sheer size of government operations places more constraints on day-to-day employee interaction.

Funding poses big challenges for cities.

As cities seek to shape their sustainability programs, city leaders must determine the optimal way to fund the initiatives. Our conversations determined that funding for sustainability departments comes from a variety of sources including the operating budget, grants from both the state and federal government or nonprofit institutions, utility revenues, or a combination of all three. Of our engagement pool, 13 cities were funded from both the general operating budget and grants. Figure 6 shows that grants are a significant component of funding. Therefore, when possible, it is important for cities to collaborate with partners that could help supply research and funding to support sustainability initiatives. Some common collaborations include the Bloomberg Philanthropies’ “What Works Cities” initiative, 100 Resilient Cities7 and STAR Communities.

In terms of securing funding from existing operating budgets, it is important for municipalities to garner both public and government support for sustainable initiatives. It can be difficult for public officials to get buy-in for broader, longer-term sustainability goals that do not have immediately apparent, quantifiable benefits. However, many cities are becoming more adept at connecting sustainable efforts with fiscal health, which we will discuss later in the piece. Additionally, some cities pointed to natural disasters as catalysts for public support of large investments in climate resiliency and adaptation projects. Others cited preservation of critical natural resources as a tool to galvanize community interest. For example, Milwaukee strives to become a global leader in sustainable water management in part due to its desire to protect its access to valuable fresh water from Lake Michigan.

Looking Forward: Emerging Issues in Sustainability for Municipals

Currently, municipal sustainability programs do not follow a formula and cannot be defined uniformly. Environmental goals such as climate change mitigation remain the most common focus for sustainability efforts in U.S. cities. However, our calls highlighted the fact that sustainability efforts increasingly include social issues. Specifically, we found a growing emphasis on social and racial equity and housing affordability. In addition, we noted that more cities are drawing a link between sustainability and fiscal health. Finally, our conversations revealed that transparency of sustainability efforts is becoming more important and that while green bond issuance is increasing, hurdles remain.

Pittsburgh’s definition of equity: Equity exists when everyone has the resources and opportunities they need to enjoy full, healthy lives. Equity aims to promote fairness and justice, which means that different groups may require different resources or opportunities to succeed.
- Pittsburgh Equity Indicators, Annual Report 2017, page 12

Some cities have set measurable goals for social and racial equity.

Through our calls, we found that social and racial equity is taking a more prominent role in the sustainability strategies of cities. As examples, we are highlighting the efforts of Pittsburgh and Providence, Rhode Island.

Pittsburgh’s sustainability strategy, or OnePGH, is described as “a strategy for Pittsburgh to thrive in the 21st century as a city of engaged, empowered and coordinated neighbors.” OnePGH identified “social, racial and economic inequities” as persistent and significant challenges for the city.8 To help counteract challenges stemming from inequities that include less access to community services and worse educational outcomes, Pittsburgh in 2017 created the Pittsburgh Equity Indicators project. With support from the City University of New York and 100 Resilient Cities, the Equity Indicators provides a scoring system for the city to measure its progress on equity in four main areas: health, education, transportation and civic engagement. The city’s score in 2017 was 55 out of 100, denoting widespread inequalities by race, gender and income.9

Racial equity and its application to sustainability is also a major initiative for Providence. In 2016, the city established Equity in Sustainability, using a grant from Partners for Places. In 2017, Partners for Places followed with a second donation.10 The goal of the city’s racial equity initiative is to directly integrate the voices of people of color into the city sustainability and resiliency planning processes.

One key element of Providence’s program was the creation of a Racial and Environmental Justice Committee (REJC) made up of community members and city officials. REJC engages with communities of color to identify environmental sustainability concerns and to make connections to the city’s office of sustainability. The REJC engagement process enabled city residents to more effectively amplify issues such as the industrial health hazards in their neighborhoods and the lack of youth after-school programs.11

Rising housing costs have brought about sustainable initiatives for affordable housing.

Soaring housing costs in Silicon Valley and other “hot” markets across the U.S. have been well-documented. Due to the slow and steady economic recovery and the persistent strength in labor markets, demand for housing has pushed up prices and outstripped supply in other cities. We heard firsthand from officials in Reno, Nevada, and Denver about their challenges related to the lack of affordable housing and what they are doing to counteract them.

In Reno, after a multiyear decline in rents that bottomed out in 2012, car manufacturer Tesla Motors announced in 2014 that its lithium-ion battery “Gigafactory” would be built nearby.12 Over the next six years, many other companies in industries such as advanced manufacturing and data management brought thousands of jobs to the region. The boom led to a significant rise in rental costs and pushed the rental vacancy rate and available supply of affordable homes to historic lows (Figure 7). Officials are exploring nine programs to increase affordable housing options for residents, including inclusionary zoning, where new residential construction projects would include affordable units, and infill development. The city hopes to use the infills to create residential “hubs” that are connected to public transportation.

The availability of affordable housing is also a concern for Denver officials and residents. Denver’s chief sustainability officer noted how housing and mobility are two of the biggest problems facing the city. Rising home prices have their benefits, such as increasing equity for homeowners and community gentrification, but it is leading to displacement of residents who cannot afford the higher home prices and rents. As a result, people are being pushed to live farther from their jobs and are being forced into cars, which is causing other issues , such as increased congestion. The city has targeted housing as one of its 2020 Sustainability Community and Government Operations Goals (Figures 8 and 9). Denver wants to ensure that 80 percent of neighborhoods are rated as affordable. For government operations, it intends to help develop 3,000 units that cost 80 percent of area median income (AMI) within a half mile of a light rail station or a quarter mile of a bus corridor. Denver is making progress on both objectives:

Communities are drawing connections between fiscal health and sustainability – but the connections are typically tangential.

We believe municipalities that are proactive on sustainability issues are likely to maintain more-stable financial performance over the long term. In our engagement calls, we sought to determine whether our engagement pool viewed sustainability with the same perspective.

While most cities in our engagement pool identified at least some connection between their sustainability initiatives and the long-term fiscal health of their cities, we perceived these connections to be tangential in the most cases. To varying degrees, sustainability staff interacts with city budget officials and has input on sustainability-related capital projects. However, only five of the municipalities that we spoke with indicated that sustainability staff had extensive involvement with that city’s financial and capital planning decision-making. Only six cities’ sustainability departments believed they were highly integrated with the overall budgeting process.

Several cities cited annual operating budget savings as the primary fiscal benefit of their sustainability programs. Because sustainability is often perceived to be outside the core functions of local government, many sustainability officials feel it is important to demonstrate to city management and political leaders that sustainability programs can provide value by reducing costs. In this respect, investments in energy efficiency projects that can lower a city’s electric bill are particularly popular. In contrast, projects addressing long-term threats, such as climate change, have uncertain costs and the benefits may not materialize for many years, if not decades.

In our view, strong governance is a key aspect of fiscal stability. Some cities make direct links between their sustainability programs and strong governance practices. For example, Grand Rapids, Michigan, includes “governmental accountability” as one of the key pillars of its sustainability program and emphasizes fiscal transparency and efficient delivery of city services. Oklahoma City’s sustainability planning efforts build, in part, on prior work the city has done to promote higher-density development as a key mechanism to reduce the cost of delivering public services.

The city of Grand Rapids has a unique term to describe its sustainability strategy: the Quadruple Bottom Line (QBL). Its QBL framework consists of four sustainability pillars: Environmental Quality, Social Responsibility, Economic Prosperity and Governmental Accountability.

The sustainable-financial connection is being amplified partly due to a growing rating agency focus on ESG. Several cities in our engagement pool noted that rating agencies are asking more questions on ESG issues, particularly on climate resiliency efforts. In addition, there is rising awareness of ESG from business leaders. The business community has become more aware of sustainability issues. For example, Las Vegas mentioned that companies considering relocation to the area frequently inquire about the long-term water supply. This suggests that cities in the western U.S. that fail to take proactive steps to address water scarcity concerns may have difficulty expanding or retaining a strong local employment base.

Cities are becoming more transparent about their ESG efforts.

In line with the broader municipal market, cities are increasingly seeking to inform investors about their ESG programs and projects and their efforts to track progress on these ESG initiatives. More than half of the municipalities in our engagement pool had sustainability plans that were published within the past two years, which mirrors the broader market. According to a Moody’s survey, 57 percent of survey respondents had climate action plans in place, and of those without a plan half indicated they would have one by the end of 2019.13

The results of our 2018 municipal engagement efforts highlighted the heterogeneous nature of sustainability plans. The scope of challenges and risks varied considerably, with many coastal communities focusing on environmental issues such as sea level rise and severe weather while other cities focused more on social issues such as homelessness and housing affordability. Among the cities that published a sustainability plan, there was considerable variability in the frequency, depth and type of reporting on the progress or follow-up steps. Challenges to sustained ESG reporting included personnel changes in the city administration and funding requirements for generating additional reports.

About one-fifth of our engagement pool used an established sustainability reporting platform, STAR Communities, to report on their sustainability metrics and plans. STAR Communities is a nonprofit that works to “evaluate, improve and certify sustainable communities.” We spoke with the following five communities that worked with STAR: Baltimore; Louisville, Kentucky; Birmingham, Alabama; Reno, Nevada; and Indianapolis. Those communities generally found it useful to determine progress, collect information and report on sustainability issues within a defined framework. However, some cities noted that the STAR reporting requirements were time-consuming and resource-intensive.

STAR Communities is a nonprofit that publishes and supports a tool called the STAR Community Rating System. To date, 74 cities, towns and counties have used the system to evaluate their sustainability initiatives based on STAR’s framework of seven goal areas and 44 objectives.14

These 74 Certified STAR Communities received a 3-STAR, 4-STAR, or 5-STAR rating based on their performance on the STAR rating framework. In 2018, STAR Communities merged with the U.S. Green Building Council (USGBC). The combined organization is now in the process of consolidating USGBC’s LEED for Cities sustainability metrics with STAR’s rating system.

Cities are increasingly collaborating.

The increasing collaboration between cities and various stakeholders can facilitate knowledge and funding for cities. Our engagement effort revealed that cities view collaboration with external entities (such as sustainability organizations and municipal peers) as an important tool in addressing challenging sustainability issues. Most cities and towns showed a strong willingness to partner with other organizations, with Providence characterizing these alliances as necessary. Cities in our engagement pool partnered with a variety of entities such as nonprofits, colleges and universities, regional councils, business, and other sectors of government, including county leadership. The benefits to towns and cities included:

  • Increased funding for projects or positions
  • Access to subject-matter experts
  • Raised awareness of pressing ESG issues

The cities also generally sought high levels of interaction with their citizens in formulating sustainability initiatives – especially those involving social issues or requiring voter approval to move the project forward.

For example, four of the cities in our engagement pool partnered with the Rockefeller Foundation’s 100 Resilient Cities. This initiative has successfully partnered with municipalities across the U.S. to address climate and related sustainability issues. The partnership not only seeks to build resilience against flooding and other natural disasters, but also seeks to combat challenges “that pressure a city on a daily or reoccurring basis, such as chronic food and water shortages, an overtaxed transportation system, endemic violence or high unemployment.”15 The initiative also provides cities with funding for a chief resiliency officer and access to private sector entities and other non-governmental organizations that can provide guidance on the development of a resiliency strategy. Four of the 27 cities in our engagement pool partnered with the foundation: Los Angeles, San Francisco, Miami Beach, and Louisville.

We found the level of collaboration between Florida and external entities to be noteworthy. Most of the Florida cities in our engagement pool had multiple alliances in place to help the cities create strategies to address climate challenges. Miami and Fort Lauderdale, Florida, work closely with the Southeast Florida Regional Climate Change Compact, which was formed to “coordinate mitigation and adaption strategies across county lines.”16 Among other accomplishments, the compact has been instrumental in addressing and coordinating a regional response to sea level rise.

In our discussions, we learned that formal networks, such as national and regional sustainability directors’ networks, were some of the most valuable and productive collaborations. Seven cities in our engagement pool (Miami Beach; Fort Lauderdale; Peoria, Arizona; Indianapolis; Birmingham and Louisville) highlighted the importance of these networks for sharing sustainability strategies with peers who are dealing with similar challenges. For example, the Southeast Sustainability Directors Network provided a forum for regional directors to gain knowledge and build networks. Similarly, an Indianapolis sustainability official said the Urban Sustainability Directors Network was useful for understanding information and best practices in the sector, and said the network led to significant peer-to-peer learning.

Several cities cited other relationships that helped further their sustainability goals, including business relationships. For example, Birmingham believes that property developers in the city could help their city reduce its water bills by two-thirds. Chapel Hill, North Carolina, mentioned its work with property developers to increase affordable housing. Other cities said their partnerships with local colleges and universities helped to increase intellectual capital on certain subject matters.

In addition, most cities sought to actively collaborate with their own citizens on various sustainability issues through public meetings or outreach initiatives. The cities recognized that citizen input is critical to ensure that projects have maximum impact and meet the needs of the community, while furthering greater sustainability goals.

Green bonds are on issuers’ radar, but hurdles remain.

Municipal bonds, in general, typically back projects that benefit the public welfare (see Looking Beyond Use of Proceeds). As we highlighted in Look Before You Leap into Green Bonds, we believe that green bond issuance should be approached with care; however, we think that overall growth in green bond issuance over the past few years indicates enthusiasm in sustainable fixed income investing. For further thoughts on our approach to investing in municipal green bonds, see our case study for the Principles of Responsible Investment.

In our engagement pool, three cities (Los Angeles, San Francisco and Tampa, Florida) issued green bonds in 2018. These communities are large and highly rated by the rating agencies, characteristics that are typical of the broader subset of cities that have issued municipal green bonds to date. Notably, several of the municipalities in our engagement pool did not see compelling value in pursuing green bond financings. These communities cited a variety of hurdles to green bond issuance, including the increased reporting burden and a lack of differential in pricing between traditional and green bonds. Other cities in our engagement pool conveyed their belief that placing a green label on their bonds was unnecessary, as the proceeds were clearly funding “green” projects.

Conclusion

Our 2018 engagement calls illustrated that the sustainability focus, planning, funding availability and administrative structure varies widely across U.S. cities. However, some key themes were uncovered, such as the rising evidence that sustainability is linked to fiscal health, the benefits of collaboration and the growing importance of transparency. While municipalities are generally tasked with sustainable goals such as the health, safety and education of their citizens, we believe many communities are at a point of transformation, with efforts being structured and “marketed” as sustainable. Even though many municipalities continue to focus largely on the “E” in ESG, we were pleased to see that most of the cities in our engagement pool have a sustainability plan in place and are focused on making progress across a variety of initiatives in the coming years. We are encouraged to see an expansion of focus beyond the “E” and toward a more inclusive and broad-based approach to sustainability. We believe that the integration of all three factors (environmental, social and governance) is instrumental to the long-term success of a city.

 

[1] The Brundtland Commission was a working group formed by the United Nations in 1983 to encourage countries to pursue and coordinate sustainable development initiatives. The commission work culminated in a 1987 report called Our Common Future. The definition of sustainable development appears on page 16.

[2] As a result of limited data on the sustainability profession, we reached out to experts in the field to gain a better understanding of broader trends. We would like to thank the following individuals for sharing their time and insights with us: Rachel Krause, associate professor/MPA program director, School of Public Affairs and Administration, University of Kansas; Nils Moe, managing director, Urban Sustainability Directors Network (USDN); Hilari Varnadore, director, LEED for Cities and Communities, U.S. Green Building Council.

[3] The Kyoto Protocol to the United Nations Framework Convention on Climate Change committed signatory countries to greenhouse gas reductions. The United States decided against signing the agreement, which was ultimately replaced by the Paris Agreement in 2015.

[4] The Urban Sustainability Directors Network (USDN) is a member-led organization with a mission to develop, adopt, and share practices to create equitable and prosperous communities and a healthy environment.

[5] The percentage of sustainability professionals was obtained from the 2015 Local Government Sustainability Practices Survey. The survey is a joint project of ICMA, the Sustainable Communities and Small Town and Rural Planning Divisions of the American Planning Association, Binghamton University, Cornell University and the U.S. Department of Agriculture. The survey was sent to 8,562 local governments and achieved a response rate of 22.2 percent, with 1,899 local governments responding. Available here: https://icma.org/documents/icma-survey-research-2015-local-government-sustainability-practices-survey-report

[6] Rachel M. Krause, Richard C. Feiock and Christopher V. Hawkins, “The Administrative Organization of Sustainability Within Local Government,” Journal of Public Administration Research and Theory published August 18, 2014, Volume 26, Issue 1, January 2016, Pages 113-127, https://doi.org/10.1093/jopart/muu032.

[7] At the time of this writing, the Rockefeller Foundation has decided to wind down 100 Resilient Cities by July 31, 2019, citing how the initiative met its goals. More information is available here: https://www.bloomberg.com/news/articles/2019-04-01/rockefeller-announces-end-of-major-climate-resilience-initiative.

[8] OnePGH: Resilient Pittsburgh, Pittsburgh Resilience Strategy, 2017, pages 11, 31.

[9] Pittsburgh Equity Indicators, Annual Report 2017, pages 5, 6.

[10] Partners for Places is a program of the Funders’ Network for Smart Growth and Livable Communities, an organization of 160 North American grant-makers focused on supporting “fair, prosperous and sustainable communities.” Members include community and family foundations and other philanthropic institutions.

[11] Information on REJC available here: http://www.providenceri.gov/sustainability/equity/. References to the specific issues such as hazardous health hazards and lack of after-school programs were made during a discussion with the City of Providence Director of Sustainability.

[12] Jason Hidalgo, “Reno renters buckle from record-high apartment rent, ‘near-zero’ vacancy,” Reno Gazette Journal, August, 16, 2017. Available here: https://www.rgj.com/story/money/business/2017/08/16/reno-renters-record-high-apartment-rent-zero-vacancy/104635272/

[13] Moody’s Investors Service, “Cities’ Heightened Focus on Mitigating Climate Risk is Credit Positive,” January 17, 2019.

[14] As of April 23, 2019. Data gathered from http://www.starcommunities.org/certification/certified-star-communities/.

[15] See http://www.100resilientcities.org/faq/.

[16] See http://southeastfloridaclimatecompact.org/about-us/what-is-the-compact/.

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