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Money market funds step up focus on governance

Environmental, societal and governance (ESG) investment considerations have become more integrated into money market funds (MMF) in both Europe and the US, reports Fitch Ratings.

The credit ratings agency (CRA) adds that governance considerations have an important influence on the exclusion of potential investable assets. However, MMFs’ core investment objectives of liquidity and preservation of capital have resulted in high-quality, low-risk investment profiles already very much aligned with ESG core investment objectives.

Recent launches of ESG-focused funds and existing fund conversions have driven assets under management (AUM) growth. They include BlackRock’s environmentally focused MMF – the BlackRock Liquid Environmentally Aware Fund – in April this year and, most recently, this month’s launch of State Street Global Advisors ESG Liquid Reserve Fund, the first MMF offering only investments that meet ESG criteria at the time of purchase.

While ESG MMF assets under management remain low in aggregate at US$57.2 billion at the end of last year, AUM increased 16% in the first half of 2019.

Restrictions on fund managers

Fitch reports that depending on the jurisdiction, ESG fund managers face a reduction of their eligible investable universe, additional costs of tracking and incorporating ESG metrics, as well as heightened regulatory and reporting requirements relative to traditional non-ESG-focused MMFs. Managers may also have to adjust allocations to account for evolving ESG considerations, which could result in increased asset sales and potential portfolio volatility.

ESG implementation may vary across managers, with the exclusion of investments by screening for ESG weakness the primary approach. Exclusions of investible assets reported by managers to Fitch vary, reaching as high as 20%. ESG strategies can meaningfully alter the investible universe for MMFs, especially if widely held entities are excluded.

However, managers may modify allocations relatively quickly due to the short maturity profile of MMF securities, as seen in response to the headline risk for Denmark’s Danske Bank AS linked to allegations around money laundering. Last September, a report found that around €200 billion of suspicious transactions from Russian and Azerbaijani sources passed through the bank’s Estonia branch between 2007 and 2015.

While Danske Bank’s short-term credit rating remains stable at ‘F1’, MMFs nonetheless chose to reduce exposure despite not having explicit ESG strategies.

Fitch estimates approximately 60% of ESG MMF managers conduct internal research, with the rest using third-party sources to incorporate ESG ratings into portfolio considerations. Challenges include screening for ESG weakness in complex instruments such as asset-backed commercial paper, which is typically backed by banks, but also used for activities such as funding finance receivables.

Although limited, governance issues are typically the main ESG consideration for financials, which account for the majority of MMF investments. Given the regulatory constraints on capital and the fact that the majority of business models have a financial asset and customer service orientation, environmental – aside from insurance – and societal risks are relatively low.

Of the 19 MMFs that have investment objectives with specific reference to ESG factors, six are domiciled in France and hold 88% of global ESG assets; seven are domiciled in Norway, three in the US and one each in Switzerland, Luxembourg and Sweden.

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