Building a sustainable investment strategy

The move to adopt more sustainable treasury practices is gaining momentum across Asia Pacific. From regulation forcing greater transparency on ESG factors, to shifting social expectations, to the funding implications of pricing ESG risks, numerous forces are at play. Collectively, they are driving an irreversible trend.

For corporates, in particular, investor pressure is pushing ESG disclosure from a “good to have” to a “must have” meaning all areas of corporate activity are under scrutiny. The near 4,500 engagements that HSBC AM had with corporates over the past 12 months to the end of April is just one example of this ever-sharper focus.

This presents treasurers with a challenge, as ESG risks get priced into funding rates, not paying enough attention to ESG scores is no longer something that companies can afford to do. “Investors and consumers have the ability to vote with their feet and can shun companies not perceived to be adequately addressing ESG risks,” said Martin McNamara, EMEA liquidity investment specialist at HSBC AM.

Yet for finance functions, the task of aligning treasury strategy with corporate sustainability objectives is a steep learning curve with a relatively limited support framework. Where virtually all other areas of treasury management are defined within narrow parameters, market standards and definitions are lacking on sustainability.

Seeking sustainable benefits

A potential reduction in funding cost is just one of several benefits for companies with well-defined and comprehensively integrated sustainability objectives, including within treasury objectives and policies on both the funding and investment side of the balance sheet.

“An appropriately aligned sustainable treasury policy can support wider corporate sustainability goals,” explained McNamara.

“It also contributes to corporate ESG disclosures, supporting shareholder and stakeholder relations and may enhance the credibility of corporate sustainability projects,” he added

Other positive knock-on effects have gradually become clear. Broadly, as treasury practitioners move towards sustainable finance and investment solutions, they become scaled. In turn, this directs funding to more sustainable companies and increases engagement on issues relating to sustainability.

Finding the right ESG balance

In line with the growing awareness and support for sustainability within investment policies, corporate treasurers may adopt one or a combination of methodologies to mitigate ESG risks and improve the overall sustainability of their investment activity.

Further, the various methodologies may be applied according to the instruments being employed, ranging from ‘green’ bank deposits, money market funds (MMFs), short or low-duration bonds or direct investments. One or a combination of methodologies can be selected to reflect unique considerations, such as the investible universe, alignment with investment policy or simply the availability of data on which the methodology is based.

Methodologies commonly used to apply a sustainability focus to an investment strategy

Yet while there are multiple options available, each with their own considerations and potential restrictions, treasury needs to consider where considerations of ESG risk mitigation and sustainability sit alongside traditional treasury objectives of capital preservation and liquidity.

“Selecting a singular sustainable investment approach that is too restrictive could tilt the strategy in a way that is incompatible with credit diversification and liquidity objectives,” said McNamara.

Striking a balance between sustainability and investment objectives

To balance these objectives, treasurers can piece together the most suitable strategy by considering the practical implications on their own investment process. For example, they can assess the alignment with investment policy and data available, and the materiality of ESG risk mitigation.

When considering a mandate or fund solution, meanwhile, concerns around green washing are valid given the potential exposure to reputational risk if due diligence at both a manager and fund level is not robust.

Ultimately, investors need to ensure the credibility of the solution. “They need to ask whether the strategy is materially different to a non-ESG alternative and whether or not it is aligned with their sustainability objectives both at a corporate and treasury level,” added McNamara.

Despite these concerns, a well-designed ESG MMF investment strategy represents an opportunity for treasurers to utilise a more sustainable cash investment solutions with lower exposure to ESG risk, whilst maintaining the many other benefits associated with MMFs including credit diversification and liquidity.

In addition, by purchasing an ESG MMF, a treasurer is effectively outsourcing that part of the cash management function to an institution with the depth and breadth of credit resources, as well as ESG know-how, which does not exist in-house, added McNamara.

Distribution of ESG scores in the investible universe

The left-hand chart shows the E, S, G and ESG score distribution across the A1/P1/F1 investable universe. The right-hand chart shows the change in ESG score distribution as a result of the ESG screens that are integral to our investment process.

Future-focused treasuries

Adapting to the reality and dynamics of the investible ESG universe is essential given that the move to adopt more sustainable practices is directional; corporates and the corporate treasury teams at the core of a smooth business operation are being given no choice.

“The C-suite is increasingly engaged on the topic of sustainability across all areas of business activity, so treasury teams need to understand the solutions available and apply appropriate due diligence,” explained McNamara.

Recognising the growing importance of sustainability to treasurers, HSBC have developed the first short-term MMF¹ to follow a best-in-class strategy to ESG investing, designed to identify the issuers that demonstrate they are better at addressing ESG risks to which they apply their 20+ years of responsible investment expertise to create a more sustainable list of high-quality issuers from which to construct their portfolios.

“The downside risks are high, and treasurers cannot rely on labels,” he explained. “With the right strategy and access to data from a range of specialist third party vendors, the worst performing issuers from an ESG perspective can be removed from an investment universe.”

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Source
1 - As defined by EU Money Market Fund Regulation


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