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ESG Adoption Increases Burden of Proof on Money Market Funds

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London – Increased adoption of Environmental, Social and Governance (ESG) language in money market fund (MMF) governing documentation and investment processes will increase the burden of proof on MMFs marketing themselves as ESG MMFs (“named ESG MMFs”), Fitch Ratings says. In the longer term, if ESG becomes common in traditional MMFs, demand for named ESG MMFs may decrease.

If investors in a named ESG fund conclude that the ESG investment process does not result in a materially different profile from traditional MMFs, they may decide to redeem their holdings, leading to outflows, reputational setbacks for managers, and possibly closures of named ESG MMFs. Conversely, named ESG MMFs that can clearly demonstrate the quality of their ESG processes on a sustained basis may see increased demand. However, we do not expect these dynamics to have rating implications in the near term given that MMF investor focus on ESG is still in its early stages.

In the longer term, if ESG processes and governing language become the norm in the MMF sector, named ESG MMFs may lose their competitive advantage, at least among ESG-oriented investors, particularly if investors conclude that traditional MMFs with some ESG elements would meet their needs. Fitch estimates that about two- thirds of Fitch-rated European short-term MMFs featured some ESG element in their governing documentation at end-2019. (See Global ESG Money Market Fund Dashboard: End-2019.)

BNP Paribas Asset Management is the latest fund group to increase its focus on ESG in its MMFs, saying in early March it had integrated ESG criteria into the investment processes of all of its MMFs. It will also update its MMF prospectuses to include ESG language as part of a wider effort to make all of its funds ESG-compliant. The BNP Paribas Asset Management MMFs, with combined assets under management (AUM) of about EUR50.6 billion at end-February 2020, will increase the share of European MMFs featuring ESG elements in their governing documentation.

The ESG language in governing documentation can differ materially among MMFs. Similarly, the incorporation of ESG into investment processes may differ between investment managers. BNP Paribas Asset Management’s approach, for example, is both exclusionary, avoiding investment in certain entities, and integrational, favouring issuers with higher ESG scores. A dedicated internal team is responsible for ESG analysis, informed by external data and research sources. The lack of standardisation among traditional MMFs with ESG elements may sustain demand for named ESG MMFs in the near term.

Fitch estimates that global AUM in named ESG-focused MMFs grew by 30% in 2019 to EUR70 billion, compared with 15% estimated growth in traditional MMFs. Several asset managers, such as BlackRock and DWS, have recently launched new European MMFs as named ESG MMFs, or converted existing funds. Others, such as Goldman Sachs Investment Management and JPMorgan Asset Management, have added ESG language and processes to their existing traditional MMFs, reflecting their respective strategies and demand from their investors.

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