Climate Change Is Coming to Your Hometown Bonds
Climate Change Is Coming to Your Hometown Bonds
In some corners of finance, climate-change risks are only starting to appear on investors’ radars. By contrast, in the $3.8 trillion US municipal-bond market, natural disasters have been a nagging concern for decades.
In the wake of Hurricane Katrina in 2005, Moody’s Investors Service slashed New Orleans’s credit rating by three levels to junk. It didn’t win back its investment grade until May 2007. Joplin, Missouri, suffered the deadliest US tornado in almost six decades in May 2011. Two years later, almost half of its 7,500 students were still in temporary classrooms, but construction progressed on new schools thanks in part to voters approving the largest bond sale in city history. In August 2014, the strongest earthquake in 25 years hit Napa County, California, and traders exchanged a record amount of its debt in the following days amid concern that it could halt payments because of the damage. The list goes on.
Yet for all the examples, pinning down the risk has always been elusive for the muni market, which is known for its dispersion. The US has more than 90,000 “local government units,” according to the most recent Census data, and although not all of them issue bonds, those that do tend to borrow across a range of maturities and with varying revenue streams. While many deal documents now include some language about climate change, and investment banks and legal counsels are more thoroughly conducting due diligence around the issue, ultimately there’s little evidence that the risks are baked into bond prices.
Enter Boston-based startup risQ Inc. Pronounced like “risk,” the company has made moves recently that make it a contender as the go-to source for municipal-bond buyers as they assess the likelihood that climate change and natural disasters will disrupt any potential local government, school district, hospital or utility system.
At the core of risQ is a blend of climate science, catastrophe modeling and geospatial machine-learning technology. It categorizes climate risk based on the probabilities of a given type of hazard — wildfire, flood and hurricane — and also “climate conditioning,” which takes into account changes to variables that would increase the odds of a natural disaster. It breaks down the US into a grid of 100-meter-square cells and spells out two specific variables: Risk to property value and impairment of gross domestic product. And the grid is flexible enough for risQ to compile climate risks across boundaries large and small.
Now, risQ isn’t the only provider of geospacial data. As Bloomberg News’s Amanda Albright and Mallika Mitra reported earlier this month, more investment firms say they’re starting to focus on information from sources like Google Earth as a way to assess climate risks. S&P Global Ratings analyzed US water utilities with data from National Aeronautics and Space Administration satellite missions. “Largely, finance lives in columns and rows in Excel spreadsheets — climate change is not a row and column exercise,” said Chris Goolgasian, director of climate research at Wellington Management.
Chris Harsthorn, chief commercial officer at risQ, isn’t so sure about that.
The company last month announced a partnership with Intercontinental Exchange, in which risQ will provide its climate data and ICE will connect it to specific bonds so investors can analyze and compare distinct securities or even full portfolios. In other words: Working in Excel spreadsheets.
“We’re linking to CUSIPs, which was almost a binary for a lot of the additional folks we’ve been talking to,” Harsthorn said in a phone interview, referring to the nine-character identifier assigned to a given bond. “These are real numbers that can immediately be interpolated into the same sorts of metrics that the analysts are already using.”
The climate product went live Feb. 3. It went through beta testing in the final three months of 2019 with about 10 different entities and 140 users, Harsthorn said.
All the while, risQ had an advocate within the market in Tom Doe, president and founder of Municipal Market Analytics. MMA for a time was itself something of a startup in the state and local government debt market. Now it’s arguably the most well-known independent research firm in the space.
Doe said in an interview that he was captivated by the book “The Uninhabitable Earth” and concluded that “climate will be a disruptive element in the municipal market.” He closely watched how Hurricane Florence flooded North Carolina in 2018. “Wouldn’t it be disruptive if you had a wide swath of IG credits become junk because of some circumstance? Could climate be that?” The answer, he decided, was yes.
Doe was among those who told risQ leadership that its climate data probably needed to be attached to specific bonds for investment managers — and, in fact, himself — to buy in. Harsthorn and others were on board with that direction, and Doe helped make introductions to the right people at ICE.
With the product launched, the obvious question is at what point any of it will matter for bond prices. As I wrote earlier this month, munis are in the middle of a relentless rally, with benchmark 10-year tax-exempt yields close to record lows and cash streaming into mutual funds week after week. Money managers as a whole don’t have the luxury of being choosy with their bonds, even if it’s a coastal Florida city vulnerable to hurricanes or a locality in California susceptible to wildfires. Likely, any penalty for those risks will just be viewed as a better buying opportunity.
As with many things involving climate, that view might be too short term. Doe sees risQ as a way to put information into the market, if not for the bond buyers of today then for those two years, five years or 10 years from now. “While people may disregard it at this point, there will be a clear track record that this data was there,” Doe said. “We can utilize the data and be voices for it in order to create awareness, even though the end investor may not yet be engaged.”
There’s no guarantee that risQ will become the muni market’s defining climate-risk tool. In July, Moody’s Corp. acquired a majority stake in Four Twenty Seven Inc., which also provides climate data and analysis. The announcement uses similar buzzwords and phrases, like “quantifying climate-related exposures and producing actionable risk metrics.”
Those who expect climate risks to intensify in the coming years should welcome the competition. As for risQ, it seems to have committed partners, and, perhaps most crucially, is willing to listen to what investors and analysts truly want.
A little flattery doesn’t hurt, either.
“Each individual user will have their own strategies and their own opinions and their own scenarios — we don’t want to take the ball out of hands of the smart people on the user side,” Harsthorn said. “We want to give them the tools to allow them to make their own decisions and factor in climate in a way they think is sensible.”