A Texas law requiring firms that do business with state entities—including state agencies, counties, municipalities, and school districts—to certify they do not discriminate against the firearm or ammunition industries came into effect on September 1, 2021. Senate Bill 19 (SB 19), which was passed in mid-April and signed into law in June by Republican Governor Greg Abbot, comes on the heels of Texas SB 13, which prevents state investments in companies that restrict business activities with the oil and gas industry. Reaction to SB 19 included three of the state’s top municipal bond underwriters—J.P. Morgan Chase, Citigroup, and Bank of America (BofA)—electing to pull back from competing for new issue business in the state on grounds they could not or would not certify compliance with the law. As the second largest municipal debt market after California, Texas had over $58 billion in bond issuance in 2020. J.P. Morgan, Citigroup, and BofA are among the top five underwriters in the state, accounting for $6.4 billion of issuance in the first half of 2021.
Kroll Bond Rating Agency’s (KBRA) environmental, social, and governance (ESG) Management approach highlighted the critical role that stakeholder preferences can play and the effect they can have on financial outcomes. Texas SB 19 represents the latest in a series of high-profile episodes across the country where conflicting stakeholder preferences on issues related to ESG have real-world financial implications. Competing stakeholder preferences, particularly on social issues, also highlights why KBRA does not offer subjective ESG scores but instead focuses on the tangible credit impact of stakeholder preferences on an issuer’s operating plans and financial performance.
Key Takeaways
Texas SB 19 exemplifies the complexities of competing stakeholder preferences.
Stakeholder preferences on ESG issues and the related reputational risk is a growing concern for debt issuers. As such, stakeholder preferences have been a key component of KBRA’s analysis of ESG-related credit issues.
KBRA’s ESG analysis remains objective and focused on an issuer or transaction’s risk of default. KBRA does not assign value-based judgments around the subjectivity of stakeholder ESG preferences but instead focuses on the relevance of these preferences to credit risk.
KBRA’s Focus on the Growing Importance of Stakeholder Preferences
KBRA has long recognized that each issuer, regardless of industry or sector, may face pressures from their stakeholders’ own ESG preferences. The core of KBRA’s ESG analysis of social issues focuses on stakeholder preferences as public opinion on ESG issues is evolving rapidly and can affect an issuer’s revenue, costs, and growth strategies. ESG stakeholder preferences are complex as there are often competing interests at work that may represent risks or opportunities for issuers now or in the future.
Across the broad landscape of corporate, financial institution, and government (CFG) issuers, these stakeholders can include voters, investors, customers, employees, and regulators, among others. KBRA believes it is critical for issuers to demonstrate awareness of the ESG preferences of their key stakeholder groups and how these preferences may impact issuers’ operating, capital, and financial strategies. The effects of stakeholder preferences on ESG issues can affect the demand for an issuer’s product and services, the strength of its global reputation and branding, its relationship with regulators and lawmakers, and, importantly, its cost of and access to capital. As KBRA analysts interact with management teams, one guiding question often used to initiate inquiry into an issuer’s management of stakeholder preferences and related reputational risk is: Do your investors, customers, employees, regulators, voters, or other key stakeholders have ESG goals or policy preferences that present risks and/or opportunities to your enterprise? When evaluating stakeholder preferences, it is important to underscore that KBRA does not make subjective, value-based judgments but instead objectively evaluates how stakeholder interests can affect an issuer’s current or emerging risk of default.
The Often-Competing Interests of ESG Stakeholder Preferences
Increasingly, ESG integrated investing and ESG-related mandates, such as exclusionary screening, have become mainstream for global investors and have amplified the voices of a broader array of stakeholders than historically has been the case. However, as Texas SB 19 highlights, stakeholder preferences can often be competing and can vary greatly by geographic location. From the viewpoint of Texas politicians and regulators, they are protecting an industry critical to the state and its voters, while Citigroup, J.P. Morgan, and BofA have said they are integrating their customers’ and stakeholders’ ESG preferences by restricting funding to certain controversial industries such as firearms, oil and gas, and tobacco.
There have been many recent examples of competing stakeholder interests on regulatory matters. A similar situation occurred in Louisiana in 2018, where the state’s Bond Commission voted to exclude Citigroup and BofA on a deal due to their restrictive policies on firearms. The North Carolina “Bathroom Bill” is frequently cited as an example of a discrepancy between voter and regulatory interests and the business community. The bill required people in North Carolina to use the bathroom of their gender assignment at birth and was criticized as discriminatory against the LGBTQ+ community. The bill faced widespread backlash from businesses operating in the state and parts of the bill were later repealed. More recently, in spring 2021, Barclays faced backlash when it started underwriting bonds for new prisons in Alabama after committing to ending its financing of for-profit prisons. It later backed out of the deals.
While it is too early to know what the ramifications of Texas SB 19 will be for the state municipal market and financial institutions, it is important to note that deals in the state have not slowed since the law’s passage—118 bond sales have been issuedout of Texas totaling $3.52 billion since September 1.
Conclusion
Texas SB 19 highlights the importance of KBRA’s approach to ESG-related credit issues around stakeholder preferences. KBRA believes it is not the role of a credit rating agency to make value-based judgments and instead focus on the way ESG factors can impact credit default risk. Stakeholder preferences can be important to credit risk but only when they affect financial outcomes and impact the risk of default. KBRA’s view is that subjective beliefs on ESG-related issues are left up to the stakeholder, not to rating agencies.
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Contacts:
Van Hesser, Chief Strategist
+1 (646) 731-2305
van.hesser@kbra.com
William Cox, SMD, Global Head of Corporate, Financial and Government Ratings
+1 (646) 731-2472
william.cox@kbra.com
Pat Welch, Chief ESG and Ratings Policy Officer
+1 (646) 731-2481
patrick.welch@kbra.com
Emilie Nadler, Associate Director, ESG
+1 (646) 731-3386
emilie.nadler@kbra.com
