Anti-ESG laws have pushed up cost of borrowing for Texas municipalities, study finds

Study estimates that US state will pay additional $303m-$532m in interest on municipal bonds issued since legislation was introduced in September.

Anti-ESG laws in Texas are harming the pricing of the state’s municipal bonds, according to a new paper co-authored by one of the US Federal Reserve’s economists. 

Gas, Guns, and Governments: Financial Costs of Anti-ESG Policies, published this month, explores the impact of two bills that came into effect in Texas in September, excluding banks from government contracts if they have restrictions in place around fossil fuels or the firearms industry.  

The authors of the paper are Ivan Ivanov, principal economist at the Fed’s systemic financial institutions and markets section (research and statistics), and Daniel Garrett, assistant professor of finance at the Wharton University of Pennsylvania.  

Their study compares bond offerings of public issuers in Texas previously reliant on banned banks with those that were less dependent on them for underwriting. It found that, following the introduction of the legislation, yields increased by 19.3 basis points for issuers that had at least 10 percent of their previous underwriting business with the targeted banks. That rose to around 23bps and 39bps for issuers reliant on the banned banks for more than 20 percent and 50 percent of their underwriting, respectively. 

Texas’s anti-ESG legislation resulted in the “abrupt exit” of five of the largest bond underwriters from the state, identified in the paper as Citigroup, JPMorgan Chase, Goldman Sachs, Bank of America and Fidelity Capital Markets. 

From September 2021, when the legislation was passed, to April 2022, the authors estimated that municipalities in the state issued $31.7 billion in bonds. 

The average offering yield in that period was found to be 1.83 percentage points, meaning that issuers with more than 50 percent previous reliance on the targeted banks saw borrowing costs jump by around 20 percent. 

The study estimated that barring banks on the grounds of their ESG policies led to “15.4bps… higher yields on the average dollar of borrowing”. 

If these post-legislation bonds are outstanding to maturity, the additional cost to taxpayers was put at $532 million. If they are called on the first call date – on average 6.2 years – the additional cost would be $303 million. The authors added that, if the anti-ESG policies remain in place, taxpayers could be on the hook for an additional $445 million per year in interest payments. 

“In the case of Texas, we document that these efforts to curb ESG activities result in significant adverse impact on the capital raising of affected municipalities,” the authors stated. 

Diminished competition and lack of access to the “national bond placement networks” of the excluded major banks are highlighted as the two drivers of the negative impact on bond pricing.  

When asked if the shock of the bills might diminish over time, Garrett told Responsible Investor that there was potential for other banks to enter the market, which could mean the damage to competition would be short-lived – “but unless the new entrants have very large distribution networks like exiting banks it will be very unlikely for borrowing costs to return to what they were before the laws”.

The findings of the study are consistent with prior research on banking relationships in the municipal market, according to the authors, namely, the “loss of banking relationships has large adverse effects for borrowers”. 

The research was based on a sample of 234,849 bond offerings by 37,516 unique issuers since 2007. 

Additional tests were also undertaken to compare the borrowing costs of Texas and non-Texas issuers reliant on the exiting banks. These also found a similar increase in borrowing costs for Texas issuers (relative to similar non-Texas issuers) after the introduction of the bills. 

The paper, which has not yet been peer reviewed, will be presented at the Brookings Municipal Finance Conference in July. 

Concluding their paper, the authors wrote: “if economies around the world that are heavily reliant on fossil fuels attempt to undo ESG policies by imposing restrictions on the financial sector, local borrowers are likely to face significant adverse consequences such as decreased credit access and poor financial markets outcomes.”