Integrating ESG money market funds into your treasury management strategy

Environmental, social and governance (ESG) issues have transitioned from trend to global cultural shift; the importance of a sustainable social infrastructure and protecting the environment for future generations has come further to the fore, in part driven by the Covid-19 pandemic.

According to the HSBC Sustainable Finance and Investment Survey 2020, over 90% of respondents (issuers and investors globally) regard environmental and social issues as important. This greater focus can also be observed in the rising numbers of public commitments to achieve net zero emissions targets.

Treasury functions have an increasingly important role supporting a company’s ESG ambitions and objectives, which in turn drives demand for new ESG strategies in cash and investment management.

Driving forces of ESG in treasury management

The increased adoption of sustainable treasury management solutions is a result of multiple external factors – with societal perceptions (client or employee) being cited as a primary driver by 43% of Corporates today, according to the HSBC survey.

Government action also plays a role; not only have influential countries such as China, South Korea, Japan, and Hong Kong announced their intentions of carbon neutrality, significant progress has also been made in sustainably linked government policy, evidenced by the UN PRI database which identifies 650 policies globally supporting Sustainable Development Goals. This suggests we may begin to see policies incentivising businesses, such as specific funding programmes and subsidies.

The increased transparency of ESG factors through regulatory developments is also important. Sustainability reporting instruments¹ are now in place across 64 jurisdictions, the majority of which (65%) have mandatory requirements, increasingly scrutinising business activity.

As mandatory disclosure requirements increase, so we expect the consideration of ESG risks to have a financial implication through refinance pricing. This is already evident in some Asia banks, which dedicate a percentage of their loan book to sustainably focused companies, creating a widening yield divergence between issuers less equipped to deal with ESG risk factors who may face an increased cost of capital.

As such, it is clear why treasury functions are increasingly aligning their treasury management practices with the company’s wider sustainability objectives, which has undoubtedly prompted the significant growth in ESG Money Market Funds (MMFs) of 50% over the last year – a trajectory we expect to continue.

However, to date the sustainable investment practices adopted by the majority of MMF managers do not result in a meaningfully different outcome versus non-ESG MMFs, raising questions around their credibility.

Application of sustainable investment principles in MMFs

The investable universe for MMFs typically includes only the highest rated short-term issuers (A1, P1, F1), consisting of financial institutions, government and agencies, and some corporate issuance.

These constraints present unique challenges when applying traditional sustainable investment approaches relative to other asset classes. A commonly applied approach is ESG Integration which evaluates how an issuer addresses ESG risks, together with financial data to generate a credit score reflecting the risks arising from ESG factors. Whilst ESG integration has significant value, this process alone will not result in a meaningfully different portfolio versus a non-ESG fund, and is inherently backward-looking.

Another common approach is the use of sector screens or exclusions, which removes issuers from the investible universe based on controversial activities or the sector they operate in.  However, given the limited range of industry sectors across an MMF’s investable universe, there are limited (and sometimes no) issuers excluded using this approach.

A new breed of ESG MMFs

With the credibility of some sustainable investment processes being questioned, MMF managers must go one step further in their approach to deliver a credible application of ESG that’s aligned to their clients’ overall sustainability objectives – an approach we haven’t yet seen applied by the majority of the industry today.

One such approach in approach in this ‘new breed’ of investment solutions is HSBC Asset Management’s ‘Best-in-Class’ ESG MMF strategy, an industry recognised approach to sustainable investing.

Building on the highly rated² ESG integration platform serving all HSBC MMFs, the ‘Best-in-Class’ investment strategy uses a multi-layer scoring and screening process – ensuring only the best performing issuers from an ESG perspective are considered, who are able to demonstrate better management of both ESG risks, as well as opportunities. The process can be summarised as follows:

ESG scoring is not, however, the sole focus of this strategy. Through our ESG liquidity governance process portfolio managers, credit analysts and responsible investment experts are able to challenge the inclusion or exclusion of an issuer based on any of the filters or screens above.

We also place a great importance on feeding back to issuers any shortcomings that we have identified through either ESG scoring or other ESG factors as part of our ‘Issuer Engagement’ initiative. In doing so, the investment process remains dynamic, providing issuers with the opportunity to improve on their management of ESG risks and ultimately help to preserve client interests.

In addition, investors can be confident that by investing in this strategy they are using their economic ‘clout’ to influence positive change among money market issuers to recognise and better manage ESG risks.

How do I identify a credible ESG strategy?

Although regulatory frameworks continue to increase transparency with standardised reporting requirements, such as the EU’s Sustainable Finance Disclosure Requirements, we still see room for improvement.

Much like MMF ratings, it is imperative investors still look under the bonnet to understand fully how a manager is meeting the stated objective of the fund. This is especially true for a MMF, where the application of sustainable investment principles is, as referenced, more nuanced.

Investors should focus their assessment of an ESG MMF on whether or not the manager is credibly applying sustainable investment principles – whereby the ESG process creates a material and quantifiably different outcome to a comparable non-ESG fund, as well as an assessment of the ability of the manager to demonstrate where that difference is being achieved in the investment process and outcome.

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Sources
1 - 2016 Study by Carrots and Sticks
2 - HSBC Global Asset Management achieved A+ in the 2018, 2019 AND 2020 PRI Assessment Report for Strategy and Governance and Fixed Income modules

Disclaimer
The views expressed above were held at the time of preparation and are subject to change without notice. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Asset Management accepts no liability for any failure to meet such forecast, projection or target.