Environmental Impact Bonds on Leading Edge of ESG Bond Market Evolution
Enter the Environmental Impact Bond (EIB)—a tool for municipalities seeking to better serve citizens, build community resilience, attract new sources of capital, and secure the best possible rate for their bond.
Featuring rigorous prediction, measurement, and reporting of actual project impact, EIBs are on the leading edge of the movement toward enhanced data, transparency, and accountability in the ESG bond market.
This movement presents an emerging opportunity for municipalities nationwide that need to innovate to address increasingly complex infrastructure challenges. Budgets and typical sources of funding remain strained. In its 2021 Report Card for America’s Infrastructure, the American Society of Civil Engineers estimated there is a $2.59 trillion gap between the cumulative investment needed in public infrastructure during the next decade and what is already funded.
As investors increasingly seek to allocate capital to initiatives that produce sustainable and ethical outcomes, an opportunity has arisen for municipalities to tap into innovative financing structures to address a myriad of infrastructure issues and deliver social and environmental benefits.
Environmental Impact Bonds Offer Flexibility
One of the most valuable aspects of working with Quantified Ventures on an EIB is that there is no one-size-fits-all approach. The problems facing us right now are sizable, complicated, and distinct. Shouldn’t our solutions rise to meet that?
Unlike a typical municipal bond, or even a green bond, an EIB requires a quantitative prediction, evaluation, and disclosure of ESG outcomes achieved by funded projects. Quantified Ventures works closely with municipalities to identify initiatives to be funded and to tailor the outcome metrics to the locality and the specific projects. EIB issuers may also choose to link the bond’s financial terms to project outcomes, adding another level of accountability on top of the market-leading transparency.
A look at several recent EIBs indicates how these issuances can take different forms depending on a municipality’s needs and opportunities.
In Hampton, Va., we worked alongside the city and the Chesapeake Bay Foundation to design an EIB with an ESG disclosure approach that appeals to the widest possible investor base. The Hampton EIB had a quantitative prediction of the added gallons of stormwater storage capacity produced by funded projects and outlined protocols the city would use to evaluate and disclose actual outcomes after implementation. Water equity in the city will be enhanced as low- to moderate-income communities that have suffered the most from chronic flooding will see improved conditions after the implementation of the nature-based solutions to help slow, store, filter, and redirect stormwater.
In Hampton, financial terms of the bond did not vary based on outcomes. The straightforward focus on disclosure is a “plug and play” approach to the EIB that many municipalities could take and run with if they’re looking for an EIB design that can go to market quickly and efficiently.
For municipalities more interested in a more customized solution that connects financing to outcome achievement, EIBs provide the opportunity to tailor funding and project elements to the situation at hand.
In the first-ever EIB, we worked with DC Water to reduce stormwater runoff into Rock Creek, which ultimately improved water quality throughout the district. After five years of rigorous measurement and evaluation, the project was recently deemed a success, with a stormwater runoff reduction of nearly 20%.
This private placement with Goldman Sachs Urban Investment Group and Calvert Impact Capital allowed DC Water to share the cost and risk burden of this complex implementation while pioneering innovative green infrastructure initiatives and creating new green jobs.
DC Water proved to be a jumping off point. Subsequent deals retained the core attributes of the EIB — a focus on rigorous prediction, measurement, and reporting of environmental and social outcomes — but produced several novel features.
In Atlanta, Ga., we worked with the Department of Watershed Management on the first public offering of an EIB, further evolving this financing method to open investment to the broader bond market. To do this, we created a new two-tier performance structure that ensured investors a guaranteed floor for returns with the possibility of a further upside. Through the installation of green infrastructure in economically distressed neighborhoods, Atlanta is able to absorb an additional 55 million gallons of stormwater annually, protect hundreds of homes from future flooding, create dozens of local sustainable jobs, and increase access to green space.
Our most recent EIB in Buffalo, N.Y., also is the largest-to-date, dedicating $54 million to the financing of green infrastructure. It is the first municipal bond issuance in the country to link financial incentives for the issuer to a positive performance incentive with the inclusion of an option for refinancing or retirement at the seven-year mark based on timely achievement of outcomes.
The Buffalo Sewer Authority will use the bond proceeds to design and implement green infrastructure to capture stormwater, reduce combined sewer overflows, and enhance community benefits. It is estimated the effort will lead to approximately 700 jobs in the community. The areas targeted for green infrastructure installation were selected based on social and economic equity considerations in addition to stormwater management needs.
We worked alongside each of these municipalities to create a bond and develop outcome metrics that best fit their city’s individual needs and goals. The beauty of the EIB model is that it can flex to accommodate a wide array of innovative approaches — all of them tied to quantifiable outcomes.
Environmental Impact Bonds Generate Tri-Fold Benefits
Quantified Ventures has worked with multiple municipalities on EIBs since the first-ever EIB was issued in 2016. Using an EIB brings issuers three categories of benefits.
Governance
EIBs can greatly strengthen transparency, accountability, and communication about the benefits produced by investments in municipal infrastructure. This model naturally encourages collaboration, engaging and aligning stakeholders around the process and the desired results.
Additionally, it results in tangible performance data related to key project goals. These can be employed to drive smarter decision-making in future capital spending, as DC Water showed with their hybrid approach to green and gray infrastructure that emerged from its EIB.
Lastly, an EIB positively engages the community. It provides elevated transparency and accountability in reporting how public dollars are being spent and the results those funds deliver.
Financial
Issuing an EIB widely expands the bond’s investor base, attracting the quickly growing ESG fixed-income investor community alongside the municipality’s usual investors, putting downward pressure on borrowing rates.
This also provides the municipality an opportunity to forge relationships with new like-minded investors who seek quantifiable environmental and social results alongside financial returns. These new partners may then become an integral part of future bond issuances.
Ultimately, the continued use of EIBs is also financially beneficial in that it will reduce the issuer’s perceived ESG risk by investors and credit agencies, because of the issuer’s diligence in quantifying ESG impacts and improved data-driven decision-making.
Reputational
Because of the relative freshness of this approach, deploying an EIB to address infrastructure problems is bound to attract attention. The focus on specific environmental and social outcomes and ongoing measurement present significant opportunities to share the story with the media and generate industry attention in the wake of a successful project.
It’s also likely that peers and regional partners will take notice of such projects, helping a municipality to establish thought leadership in the infrastructure space. Other municipalities will look to them for guidance on their major projects.
Finally, an EIB that successfully addresses a significant challenge while generating and measuring economic, environmental, and social benefits will build trust with taxpayers.
Environmental Impact Bonds Are The Future
It’s encouraging to see this financing model gaining traction in the marketplace, and what’s on the horizon for EIBs looks even more exciting.
We are currently working with the city of Memphis, Tenn., to develop a disclosure-focused EIB that will quantify stormwater management outcomes from funded green projects, while also measuring community health and equity impacts. Citizens and municipalities are increasingly recognizing the intersection of environmental, social, and governance factors and the need for true sustainability for people and the planet.
It’s become a widely accepted truth that social determinants of heath play a significant role in feeding the massive health inequality that exists in the United States. The more major players understand that improved environmental outcomes can be directly tied to improved health outcomes, the more we’re able to prioritize projects that provide benefit to traditionally underserved populations and enhance equity.
If you are curious about how an Environmental Impact Bond could work to address a challenge your municipality is facing, we’d love to talk with you. As more and more market participants begin to prioritize ESG factors, EIBs are are a great way to bring new investors in to the fold to tackle big problems while producing results that prioritize sustainability, increase equity, and enhance efficiency.