Mary Tchamkina, Manager (Email)
Tristen Townsend, Associate Consultant (Email)
ESG stands for environmental, social, and governance. The framework is a tool that provides practical input for planning and decision-making to mitigate risks associated with climate and environmental sustainability, social impacts, and good governance. A public agency might prioritize E strategies like building flood resilient facilities, S strategies by emphasizing community engagement in project planning, and G strategies by adopting policies that allow for transparency to the public. Strategies that come out of an ESG framework are sometimes said to support the “triple bottom line” of profit, people, and the planet.
This emerging framework may create new opportunities for the municipalities and utilities that choose to use it. Understanding how to incorporate ESG into organizational planning and leverage it through marketing, as well as the financial and other implications of the framework, are important ways to ensure they’re positioned to take advantage of it. However, the way that a public agency may incorporate ESG into its decision-making may vary based on the goals of the community it serves.
While the ESG framework isn’t yet commonly adopted by municipalities and public water utilities, its impact in the public sector is likely to increase over time if trends in the private sector are taken as a leading indicator. This is especially true for organizations facing an increased need to take on more debt by issuing general obligation or revenue bonds.
In recent years, reporting on how the ESG framework impacts an organization’s decisions has become more common in the private sector. In the water industry, investor-owned water utilities, including California Water Service and Washington Water, as well as private companies, such as Watts Water, apply the ESG framework and issue reports that reference ESG standards. To date, DC Water is the only municipal-owned utility in the US that has published an ESG report.
Investors, credit rating agencies, and insurance providers have begun considering environmental, social, and governance risks in their general evaluations of organizational risks and business practices. The table below outlines a few examples of specific factors that may be considered.
Environmental | Social | Governance |
Resource management | Rate/Tax base demographics | Institutional structure |
Carbon transition | Labor/Workforce relations | Regulatory compliance |
Waste and pollution | Worker health & safety | Reporting and transparency |
Climate resilience | Community engagement | Financial management |
Because ESG is still a new concept for most utilities and municipalities, adopting the framework as a decision-making tool may seem daunting. Nevertheless, ESG aligns with many known municipal and utility best practices and helps focus planning on areas that traditional planning approaches may not always prioritize. This type of focused assessment can make it easier for an organization to define and prioritize goals.
Collecting and reporting ESG information also enables utilities to clearly communicate additional benefits they provide to their customers. As interest in environmental sustainability and social and governance factors continues to grow, demonstrating achievements in these areas and being transparent about future opportunities can build community and stakeholder trust.
The recent passage of federal funding bills, such as the American Rescue Plan Act (ARPA), the Bipartisan Infrastructure Law, and the Inflation Reduction Act, increases funding available to water utilities and local governments while prioritizing impacts to disadvantaged communities.
The federal Justice 40 Initiative strives to distribute this infusion of funds guided by the principles of environmental justice, with 40% of overall benefits targeted to underserved and marginalized communities. Federal agencies and state subgrantees are tasked with coming up with policies and strategies to achieve this goal. Having a clear ESG strategy that drives project design toward social equity can help utilities and municipalities secure funding from these new federal sources.
Buffalo Sewer Authority’s (BSA) Rain Check 2.0 program is an example of project design that is driven by social equity and can therefore align with the ESG framework. The project uses green infrastructure to capture stormwater runoff and reduce the incidence of combined sewer overflows (CSOs). Early in the planning phase, BSA leadership recognized that green infrastructure is not just an engineering solution, it also has the potential to provide green space and ancillary benefits in the community.
In 2019, BSA developed an Opportunity Report that highlights equity as an explicit goal and prioritizes social benefits with environmental and economic benefits. Project planners intentionally used a social equity index as an input for selecting communities and CSO basins most in need of green infrastructure benefits, in addition to relying on engineering and environmental considerations, analyses of economic impacts, and development trends. BSA also engaged the community directly by getting input from the private sector, local government stakeholders, and the general public to inform site selection.
After wrapping up the planning, BSA sought funding for the project. In 2021, the Opportunity Report helped garner an innovative $54 million environmental impact bond, the proceeds from which will fund projects in priority CSO basins identified in the report. As of early 2023, BSA continues to use a similar “environmental plus social” lens to pursue ARPA and other federal funding for replacing old, combined sewer lines and lead service lines, installing permeable pavements and street trees, and other projects.
Components of ESG are additional risks that insurers consider in their underwriting. Insurers and re-insurers have seen unprecedented losses due to extreme weather events in recent years. Understanding and clearly communicating the environmental risks that an organization faces, as well as the mitigation strategies already employed, helps insurance providers make coverage available at a cost tailored to the utility. Proactively disclosing the policies that govern this type of risk mitigation provides transparency and, in turn, helps mitigate governance risk.
The recent 2023 Utility Management Conference in Sacramento, CA, held a 3-hour special session on ESG that was organized by the Water Environment Federation’s ESG Accelerator group. During that session, Paul Fuller of Allied Public Risk spoke about how climate change is the most pronounced exposure facing the insurance industry, impacting availability and applicability of insurance for water utilities. In his experience, utilities with high exposure to extreme events may find it increasingly difficult to obtain insurance at a cost that they can afford. Additionally, in some states, there may be a legal liability risk for utilities through the novel theory of “inverse condemnation,” which “links governing body decisions to the failure of public improvements to protect as intended.”
Insurance companies are increasingly interested in how their clients, especially those located in disaster-prone areas, are mitigating climate risks. Risks of interest include flooding, hurricanes, droughts, wildfires, extreme cold and heat, and sea level rise.
Credit rating agencies are beginning to be more transparent about how ESG risks factor into credit rating evaluations. Environmental, social, and governance risks make up a subset of the total risk that rating agencies consider. Reporting on ESG risks and strategies to mitigate them eliminates credit rating agencies’ risk assumptions. For example, a sustainability or ESG report with clear organizational policies, goals, strategies, and metrics demonstrates an organization’s consideration of ESG risks and could help earn a higher score.
The table below shares examples of mitigation strategies that may influence the rating agency’s evaluation of a utility’s ESG risk exposure.
Risk Type | Mitigation Example |
Environmental / Climate | Organization has/is preparing to harden assets against climate variability. |
Social | Considers affordability for its customer base, such as by establishing a customer assistance program. |
Governance | Strives for transparency and accountability through reporting. Practices long-term financial planning. |
Some utilities may be apprehensive about spelling out their ESG risks, especially if their mitigation strategies do not seem as far along as they could be. Helen Cregger, Moody’s Vice President, addressed this hesitation at the 2023 Utility Management Conference in Sacramento, explaining that at this point in time, rating agencies are expecting utility leaders to be aware of ESG risks. These risks contribute to an organization’s overall credit rating evaluation and often align with the types of disclosures that organizations would be expected to make when issuing bonds. Moody’s takes into consideration any mitigation plans that are in place and recognizes that most utilities will be somewhere on the spectrum between being unaware of ESG risks and having those risks wholly mitigated. Acknowledging these risks is a starting point for long-term planning as ESG considerations drive the public sector toward more holistic risk management.
Currently, ESG can be assessed using many different methodologies, frameworks, and standards that generally guide what information to include and how to structure a report. As of spring 2023, the Water Research Foundation is planning to develop ESG standards specifically for the water sector, which will help provide clearer guidance for those within the water industry seeking to engage in ESG reporting.
Recently, there has been increasing political polarization of ESG. Some states, like Texas and Florida, have passed anti-ESG laws, which in turn affect the municipal bond markets. There was even an attempt to pass anti-ESG legislation at the federal levels, which was vetoed in March 2023. In these cases, the label of “ESG” may be more polarizing than the actual risk assessment methodology that it signifies. Whether labeled as ESG, sustainability, or another name, risks related to environmental, social, and governance factors are increasingly recognized as important when evaluating overall organizational risk and conducting long-term planning.
