How money market funds can meet ESG requirements

Money market funds (MMFs) have capital stability and liquidity as their primary objectives. They pursue these goals by investing in high credit quality short-term, sovereign, agency and predominately financial issuance.

Historically, environmental, social and governance (ESG) considerations were largely limited to governance risk and associated rating downgrades, wider spreads and lower secondary market liquidity. 

However, this is changing. In this blog we consider how MMFs are increasingly incorporating environmental and social considerations, and why we believe they have an important role to play.

Beyond governance

As ESG continues to evolve and disclosures improve, increased attention is being paid to environmental and social characteristics. There is a greater focus on the importance of financing within the context of the policy and economic challenges of a transition to a low-carbon economy, as well as the social responsibility of financial institutions.

First, let’s list the ways in which MMFs can incorporate ESG considerations:

• Exclusions: Many MMFs will exclude issuers based on criteria such as percentage of revenue generated from fossil fuels, controversial weapons or tobacco, or those in violation of the UN Global Compact¹ Some MMFs also apply a proprietary ESG scoring methodology and exclude issuers that do not meet a minimum threshold.
• Integration: MMFs can integrate ESG considerations into their investment or credit process. This is where ESG risks are assessed on a company-by-company basis by a credit analyst with in-depth knowledge of the industry or sector.  This aims to capture the materiality of an ESG risk and any mitigants the company may have put in place. 
• Engagement: MMF providers can engage with issuers, set expectations and monitor progress over time, whether it’s in reducing their carbon footprint, increasing diversity and inclusion at their board, management or company levels, or improving disclosure of important ESG related metrics such as scope 3 emissions.
• Disclosures: Regulatory disclosure requirements such as the Sustainable Finance Disclosure Regulation (SFDR) are helpful in providing a consistent framework for the classification and communication of sustainability objectives or approaches for investors and supporting more detailed reporting over time on key ESG metrics such as carbon footprint, carbon intensity and ESG scores.

How MMFs can drive progress

To be consistent with the objectives of capital stability and liquidity, MMFs will often be restricted to investing only in the most liquid and higher credit quality issuance, ruling out much of the corporate issuer universe you might find in a fixed income fund. It’s worth highlighting, however, that MMFs are not the same as deposits. The amount invested may fluctuate, and the investor bears the risk of any losses. Money market funds are not protected by any national deposit protection schemes.

Green or sustainable-linked bond supply continues to grow. However, the maturity of this issuance would not be suitable for a short-term money market fund, and while some issuers have launched ESG commercial paper programmes, approaches vary, and this issuance is a very small portion of the investable universe.

That said, MMF providers have an important role regarding the management of ESG risk and sustainable investing.

While the individual investments that a MMF will make are short dated, they are an important source of funding over the longer term.

The identification of ESG risk and engagement with issuers are therefore important components to support the future resilience of the investment universe.

 

1. https://www.unglobalcompact.org/what-is-gc/mission/principles