Chicago will pursue ESG investors and city residents in next GO sale

BY SourceMedia | MUNICIPAL | 06/28/22 12:30 PM EDT By Yvette Shields

Chicago will debut its first ESG-related label on a portion of its next general obligation bond sale tied to funding for the $1.2 billion Chicago Recovery Plan as it looks to meet a market increasingly concerned about environmental, social and governance issues.

The label remains under construction as the city works with third party verifier Kestrel Verifiers on structuring and reporting to meet International Capital Market Association standards and investor interest, supported by the city?s self-imposed analytics for tracking outcomes tied to Recovery Plan initiatives.

Given the social equity goals of Mayor Lori Lightfoot's COVID-19 economic recovery plan ?we wanted to give investors an opportunity to be able to buy into that as well,? said Chief Financial Officer Jennie Huang Bennett.
Chicago Chief Financial Officer Jennie Bennett in her office on Sept. 16, 2019?We want to structure an ESG bond issuance that really truly fits the heart of ESG" as bond proceeds will go toward projects the city consider critical to social issues, Bennett said. ?What's important for us is to establish value for ESG bondholders.?

The city intends also to ?market to Chicago residents aggressively? the Chicago Recovery Plan bonds, Bennett said.

Most Illinois municipal bonds aren't exempt from state income tax on interest so there's no built in local retail demand, but Bennett sees the potential for interest from residents lured by the opportunity to invest in their community. The city is considering radio advertisements, public service announcements, and prioritizing orders from some zip codes.

The city will attach the ESG label to a series of between $100 million and $200 million that?s part of an up to $1 billion borrowing this fall. A portion is earmarked for the Chicago Recovery Plan and another for the Chicago Works capital program. UBS are RBC Capital Markets are leading the syndicate on the sale.

Bennett said the ESG label will be meaningful.

?I think some of what we've all experienced is a bit of green-washing where every bond you issue ends up becoming an ESG bond,? Bennett said. ?What we wanted to ensure is? that investors can see the impacts expected from the social aspects of the projects and how they fit into their own ?criteria for investments and market it as such.?

Amid questions about identifiable pricing benefits for social, green, or climate bonds, Chicago?s deal could provide new data given its offering alongside other series in the larger GO issue.

Even without a clear pricing benefit at first, Bennett said, it?s about building a market and expanding the city?s buyer base.

?Ultimately what you want to do is create value so it is a particular categorization that is not just about a label but is in fact creating value for issuers and that investors are willing to pay for because it is categorization in a way that creates value overall,? she said.

Disclosure
The upcoming GO deal will also offer further refinements to the city's expanded and consolidated seven-page ESG disclosure that debuted in the offering statement for its December GO sale under the heading ?City Environmental, Societal, and Governance Considerations.?

In formulating the December update, the city looked to disclosure by other issuers and best practices recommendations laid out last year by the Government Finance Officers Association. ?If an issue has significant nexus to credit then it's important to flesh out further,? Bennett said.

Issuers are navigating decisions on what is a material to investment decisions on ESG without clear-cut criteria as both the buy side and regulators consider the path forward.

?We are all evolving as an industry around this and we are going to continue to think about this as we have conversations with investors,? Bennett said.

If an investor is seeking some specific information or statistic, Bennett said the city will weigh how it can disclose that information to have the conversation. ESG discussions also will likely play prominently at the city?s annual investor conference in the works for later this summer, said deputy CFO Jack Brofman.

The December offering statement laid out the city?s climate action plan, which since has been updated, and risks tied to Lake Michigan shoreline preservation, a daunting $6 billion to $10 billion price tag to replace 400,000 lead service lines, police oversight, a federal consent decree compliance, and the ongoing price tag for judgments and settlements.

The city has paid out an average of $142 million annually over the last five years for judgments and settlements, with about 55% related to police conduct.

Bennett, who sits on the Municipal Securities Rulemaking Board, said the city is acting on its own on disclosure ahead of any regulatory prodding.

The Securities and Exchange Commission?s 2020 guidance on voluntary disclosures related to COVID-19 has received mostly positive marks from the market. The commission may be considering expanding some of the provisions on cautionary language going forward, but SEC muni chief Dave Sanchez said issuer fears that ESG regulation will lead to disclosure trouble are overblown.

The MSRB will be releasing a comprehensive summary in July of the comments it received as part of its request for information on environmental social and governance considerations in the muni market. The board received 52 comments in response to its request for information.

Recovery plan
The ESG series of between $100 million and $200 million would represent a portion of the overall $660 million of planned borrowing approved last year by the Chicago City Council to fund the $1.2 billion recovery plan.

The remainder will come from the city?s share of its $1.9 billion allotment of American Rescue Plan Act funding. Lightfoot has promoted the recovery plan as a once-in-a-generation opportunity to make transformative equity-based economic investments to lift up underserved communities in a long-lasting way.
?We felt like it was important since we were getting this infusion of federal money that would help with some of these investments that we also pair it with permanent infrastructure investments,? Bennett said. ?The pairing of that allows us to create this longer-term investment plan that we expect have a transformative rate of return for the city and we are tracking that."

The $1.2 billion of investments to be made over the next three to five years fall under two goals: ?Thriving & Safe Communities? represents city efforts to address the root causes of violence by investing in core social and community supports and ?Equitable Economic Recovery? provides targeted economic relief and neighborhood development support to businesses and communities hardest hit by the pandemic.

The Thriving & Safe Communities piece directs $776 million of funds for residents in targeted areas to access summer and after-school programs for youth, public health services including mental health, maternal health, increased educational opportunities for low-income youth and families, violence reduction strategies, support for victims of violence, and housing support to prevent homelessness.

The Equitable Economic Recovery piece puts $451 million toward investments in workforce support, place-based development, improvements to the city?s infrastructure and ability to deliver services to residents, and funding for arts and culture to drive economic growth and build wealth in historically underserved areas.

Many of the investments represent the largest allocations in civic spending on mental health, environmental justice, crime prevention, and climate.

The city will spend a record $40 million to plant 75,000 trees over five years to improve the tree canopy, which offers the benefit of reducing heat and air pollution, while $87 million will go to clean up the city?s 3,000 vacant lots.

In the lot cleanup program, the city looked to data from Philadelphia which conducted a smaller-scale cleanup that resulted in a 70% increase in neighborhood usage and 30% reduction in gun violence.

?Ultimately we expect that there are going to be a lot of really tremendous and transformative outcomes that will come from these investments,? Bennett said. A project management office will track outcomes.

While the investments are billed as one-time in nature so they won?t set back city efforts to reach structural balance next year, each investment was independently analyzed to identify the economic and financial benefits to help support debt service on the bonds.

?We have some estimates about what we think it will do for our tax base, driving population growth. Creating public safety also creates a more stable population base,? Bennett said.

Some outcomes are more easily tracked than others and so many of the social benefits the city expects, for example, from improving mental health aren?t factored into what?s needed to offset debt service.

Overall, about $400 million will go to projects and programs aimed at reducing violence and improving community safety, striking at the heart of a chronic problem for Chicago, which like many urban areas saw spikes in some forms of violent crimes during the pandemic. It?s a sore spot for investors who worry about the impact on both the residential and business tax base and city efforts to maintain and build both.

Chicago saw 794 murders in 2021 ? an average of more than two daily ? compared to 502 in pre-pandemic 2019, according to data published by the Chicago Sun-Times.

Headlines that follow an especially violent weekend, or involve mass shootings, or the killings of children caught in gang crossfire, exact a toll, as do big-name departures like that of billionaire Ken Griffin who announced last week that he was moving his investment firm Citadel?s headquarters to Florida.

Griffin had previously cited city violence as one reason he was considering a move.

Investments in particular that deal with the social safety net hit at the root causes of violence and ?are so critically important to how it we get past what are really some of our major challenges,? Bennett said.
Bennett sees the rise of ESG as having its roots in a combination of the civil unrest of recent years and the pandemic that ?laid bare certain inequities in our society and those inequities have also now manifested themselves in public safety challenges in a lot of the cities across the country.?

Rating agencies
Borrowers also face amplified scrutiny from some rating agencies on the ESG front as their views also evolve, but Bennett so far has no complaints.

S&P Global Ratings has drawn ire from some borrowers, including Idaho, which objected to its use of ESG scores and ?any attempts at subjective quantification beyond the conservative and careful management of a state?s finances, repayment of debt, and a state?s ongoing creditworthiness.?

Bennett said the city welcomed the positive comments it received from several rating agencies after reviewing the recovery plan.

"We believe this significant investment in social capital, both in terms of the nominal size and how the city prioritized a large-scale effort to address legacy social issues as a core component of its economic recovery plan,? S&P said in its November report ahead of the December bond sale. ?The extent to which the plan translates to lasting, long-term change remains to be seen, but we believe this initial installment is meaningful."

Kroll Bond Rating Agency lays out in detail the city?s efforts on each ESG front. ?The mayor has advocated and the city has adopted a reform agenda that includes economic and social policies targeted to population growth in historically underinvested communities,? Kroll said.

The deal marks the first public offering using such a label by the city. Chicago Public Schools entered into and the City Council signed off on a social impact bond financing for Chicago Public Schools in 2014 to expand an early education program. The lenders -- Goldman Sachs Social Impact Fund and Northern Trust (NTRS) in senior roles and the J.B. and M.K. Pritzker Family Foundation as a subordinate lender -- are only repaid if students realize positive academic results.

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

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