Texas Cities Pay for the State Legislature’s Political Statement
In recent years, lawmakers in Texas have been sending a clear message to the financial industry: banks that take contrary political stances need not apply.
Since 2017, the Texas legislature has passed 3 separate laws prohibiting municipalities and state agencies from contracting with banks and investment firms that have enacted ESG guidelines. The term ESG refers to environmental, social, and governance factors that many of the world’s largest financial institutions (including Goldman Sachs, Citigroup, and JP Morgan Chase) have increasingly embraced in their investment decisions – publicly emphasizing investments toward fossil fuel alternatives. The Texas legislature sees such practices as a threat to the State’s major industries (including oil & gas and firearms) and is taking action to curb this movement.
First, the Legislature passed H.B. 89 which prevented governmental entities from doing business with any company that fails to provide written verification that it does not boycott Israel and will not boycott Israel during the term of the contract. Then, in 2021, the State passed 2 more laws, S.B. 13 and S.B. 19, barring any Texas municipality from contracting with banks that restrict funding to oil & gas (S.B. 13) or firearms (S.B. 19) companies.
State laws aimed at banning contracts between wayward banking institutions and municipalities are not exactly new. Since the deregulation of interstate banking, state legislatures in the U.S. have few weapons with which to punish financial institutions and shape their behavior. As a result, such battles are often carried out in the municipal space.
However, this latest round of anti-ESG banking laws were enacted on a much larger (and broader) scale with Texas’ cities standing on the front lines of the fight. The impacts are likely to have far-reaching implications in the municipal bond market, which may end up costing cities as much as $500 million in additional interest.
Indeed, such effects are already being seen. When H.B. 13 and H.B. 19 were passed in September of 2021, 5 of the State’s largest municipal bond underwriters (JP Morgan Chase, Goldman Sachs, Citigroup, Bank of America, and Fidelity) abruptly left the state. This exit left a huge hole in the bond market, as according to Daniel Garrett of the Wharton School of Business, Texas cities used these 5 banks to underwrite approximately 35% of the municipal debt in the State. Then, on August 24, 2022, per the requirements of H.B. 13, Comptroller, Glenn Hegar, issued a list of 10 banks and investment firms now banned from doing business with Texas municipalities and state agencies until they can prove to Mr. Hegar that they have changed their “boycotting” practices. Such firms include New York-based BlackRock and Swiss-based UBS Group AG. Ironically, as a result of their inclusion on the list, UBS Group was ousted from an underwriting syndicate handling a $3.4 billion bond aimed at bailing out natural gas utilities in Texas devastated by the winter storm of February 2021.
Cities often form long-lasting relationships with their underwriters, working with the same banks for years on multiple bond issuances under friendly (and more predictable) terms and rates. As a direct result of the State’s anti-ESG laws, many of these relationships have been severed, forcing Cities to shop for new underwriters in a much smaller market.
With less competition, remaining financial institutions now have all the leverage when negotiating with municipalities on borrowing terms. According to a recent study published by the Wharton School of Business, borrowing costs have increased by about 40 basis points for Cities that previously relied on the blacklisted underwriters for a majority of their bond issues. Daniel Garrett estimates that reduced competition resulting from the State’s laws will end up costing Texas taxpayers an extra $300 to $500 million from increased interest payments in 2023 alone.
Thus far, it would appear that the ousted banks have no plans to abandon their ESG policies. As a result, Texas Cities will continue to foot the bill for the Legislature’s message.
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