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Since municipalities and provinces fund public services and infrastructure with clear environmental and social benefits, as well as having substantial power to shape policies in their jurisdictions, municipal and provincial bonds are useful tools for institutional investors pursuing a thematic environmental, social and governance approach, according to a new report by the United Nations’ principles for responsible investment.

The PRI report explores the relevance of ESG factors for risk-adjusted returns, as well as how investors can use this market to work towards positive sustainability outcomes. 

Bond investors provide an important source of funding for Canada’s sub-sovereign entities, noted the report, and they’re often international, with more than $230 billion of foreign investment in provincial and municipal bonds and provincial money market instruments.  

Read: Considerations for integrating ESG into fixed income

As well, Canada’s provinces and municipalities are on the frontlines of many sustainability challenges, including extreme weather events, the transition to a low-carbon economy and demographic change. 

While the report was written before Canada’s recent devastating wildfires, these latest events further demonstrate the environmental risks that the country faces, according to a press release, and may prompt provincial and municipal bondholders to go further in considering climate change in their investments. 

The report also noted some borrowers have started issuing green and other labelled bonds, which can help bondholders signal participation in projects that are environmentally or socially positive. However, it cautioned that investors always need to conduct appropriate due diligence on the bond and the issuer before buying.  

“Environmental and social themes are very tangible in the Canadian provincial and municipal bond market — for example, with many provinces hosting substantial fossil fuel, agriculture or mining industries,” said Jasper Cox, guidance analyst for fixed income at the PRI, in the release. “There are many opportunities for responsible investors to drive progress, too. This report aims to help bondholders start to incorporate ESG considerations in their investment processes for this market.” 

Read: 2022 IIC coverage: Navigating the complexities of ESG in fixed income