A framework for responsible cash management

Read this article to understand:

• How the concept of responsibility in cash management has broadened to include sustainability considerations
• The options for liquidity funds to apply responsible investment criteria to their investments
• Why investors should look beyond SFDR fund classifications to assess the responsible investment credentials of MMF managers

Responsibility has always been a core tenet of cash management. The responsibility of the treasurer is to ensure the business has the cash it needs on time, at all times. To do so, treasurers invest cash responsibly, seeking to preserve principal and ensure timely availability of liquidity on demand.

While this understanding of responsibility has never changed, the meaning of “responsibility” has expanded over time. The “responsibility” we want to focus on is the broadening of the classical concept to the modern concept: The responsible part of sustainable and responsible investment.

Funding

Sustainable and responsible activity has expanded dramatically in recent years – witness the growth of the green, and more recently, social bond markets.

The ability to issue green, social or other sustainable bonds has provided a useful tool for treasurers to raise cash responsibly. Over time, the availability of responsible instruments has increased from bonds to other securities, including short-term or money-market instruments.

As treasurers can increasingly access responsible funding, the question then arises as to the responsible cash investment opportunities available.

Investing

Recent developments have allowed treasurers to apply a responsible investment framework to their cash investments. An important recent development was the introduction of Europe’s Sustainable Finance Disclosure Regulation (SFDR). Under SFDR, financial products, such as money market funds (MMFs) used by treasurers for cash investment purposes, have to classify based on their responsible investment approach and to provide additional disclosures to investors. Aviva Investors’ non-government MMFs classify as Article 8 under SFDR.

Article 8 MMFs can serve as a useful tool for treasurers to invest cash responsibly. The largest investors may also be able to invest directly in ESG money market instruments, such as CP.

Responsibly invested MMFs

It is important to understand what a MMF can and cannot do when it comes to responsible investment. MMFs primarily provide short-term funding to financial institutions. They do not provide long-term funding to finance wind farm development, flood defences or retro-fitting clean-tech to “brown” industries. But that is not to say MMFs cannot play a role. Environmental or social projects do, after all, have periodic short-term funding requirements; however, other sources, notably the green bond market, are the primary providers.

MMFs are, however, long-term stewards of capital. While MMFs only buy short-dated instruments, they typically roll those investments, meaning they may have long-term exposure to a given issuer via sequential exposure to short-term instruments. MMFs are sizeable investors, whose investment choices can have long-term consequences for an issuer’s funding mix.

MMFs primarily invest in bank securities. This structural exposure means the most important tools currently available to MMFs relate to governance considerations and engagement. MMFs can also apply environmental or social filters. While these provide a rigorous baseline, they tend to be more meaningful for corporate issuers that either do not issue securities regularly in money markets or do not meet the strict credit quality and liquidity minimum thresholds demanded by MMFs.

Good governance considerations are a universal good, supporting the quality of MMF portfolios. We would also argue we can put more faith in better governed companies executing on their own environmental and social objectives. Engagement is a critical component of our responsible investment framework. Through the engagement programme in which our MMFs participate, we can push existing and prospective issuers to make tangible progress on broader environmental or social commitments.

Over time, we expect more information to become available on financial institutions, allowing us to potentially differentiate them based on their lending activities.

Selecting responsible MMFs

Most of the Low Volatility Net Asset Value (LVNAV) MMFs in Europe were Article 8 at the end of December 2022. While it is a positive many MMFs invest responsibly, the wide spread of SFDR Article 8 status diminishes its usefulness in differentiating MMFs. It is also important to re-iterate SFDR is a disclosure regulation – unclassified funds (also known as Article 6 funds) must also disclose their approach to responsible investment; they simply do not promote environment or social characteristics.

We suggest investors look beyond SFDR in selecting responsible MMFs, using four simple and tangible tests based on the history and position of the fund manager:

1. Length of commitment to responsible investment practices

Investment managers who have demonstrably focused on responsible investment for longer have had more time to develop and refine their frameworks. An objective measure of this comes from the Principles for Responsible Investment (PRI), a United Nations body seeking to understand the investment implications of ESG factors and support signatories in incorporating ESG factors into their investment frameworks. The PRI was founded in 2006. The initial signatories included 17 investment managers of which five are major MMF providers. We were a founding signatory.

2. Third-party indicators

Recognition of ESG capabilities by third parties is a good – and independent – indicator of an investment manager’s ESG capabilities. Two of the most reputable bodies are the UN PRI and ShareAction, an entity involved in defining responsible investment standards. As part of their commitment to the UN PRI, all signatories must report annually. The PRI assesses the reporting and provides ratings. The higher the rating, the better the quality of reporting. Our 2021 UN PRI rating was A+.² ShareAction’s 2023 review awarded a rating of ‘A’, putting Aviva Investors fourth in the global responsible investment rankings.³

3. Breadth and depth of commitments

The number and quality of responsible-investment related organisations to which an investment manager belongs and initiatives to which it is a signatory provides a good indication of the importance it attaches to responsible investment. We are a founder member of 18 responsible investment initiatives, a member of 37 relevant organisations such as the International Corporate Governance Network and signatory to a further 32 major initiatives, such as the Women in Finance Charter – a total of 70 relevant organisations.⁴

4. Contribution to the responsible investment debate

A final test, requiring more subjectivity, is to assess the contribution managers make to responsible investment. Statements from senior management and activities supporting current issues are good indicators.

Figure 3: Going beyond SFDR Article 8

We believe investors can use a series of simple, objective tests to go beyond a liquidity fund’s SFDR Article category to identify managers with stronger responsible investment credentials.

Source: Aviva Investors, June 2023

Market reform

One of our differentiators is in the field of market reform. For example, at COP27 we called for a Bretton Woods 2.0, proposing a redesign of the international financial architecture to ensure all market participants consider climate change within their mandates. Our hope is to influence how central banks, standard setters and regulators factor climate risks into the financial system.

For short-term markets, climate stress testing could become increasingly meaningful to the banks in which our liquidity funds invest. In terms of sovereigns, one of our engagement priorities (with the finance ministries) is to ask for increased issuance of credible sovereign green bonds (potentially including short-term debt), and, through their role as shareholders of government-related entities to “engage on the greening of state-owned or regulated entities, while greening public procurement”.

Every January, we send a letter to the chairs of companies we invest in (and some we don’t, but still want to influence) to set out our stewardship priorities for the year. See Our annual letter to company chairpersons to read our 2023 letter.⁵

Having established the manager of the MMF has robust responsible investment credentials, it is important to dive deeper. While this will involve some work, the process need not be overly complex. We suggest three guiding principles in assessing a MMF’s responsible investment process:

• “Hard” commitments: Anything the fund manager has written in the MMF’s governing documentation is a hard commitment. Failure to deliver on any element of the governing documentation would be a regulatory failing. Therefore, investment managers will only include processes and language to which they can commit. A good indicator then is the extent to which the responsible investment process is presented in the MMF’s governing documentation. More depth, all else being equal, means more confidence in the process. We have a well-documented responsible investment framework.
• Clear process articulation: Clear articulation of the responsible investment process is a good indication of the ability to execute the process. It’s a measure of the ability the investment team has in executing on the stated procedural requirements. You can find out more about our responsible investment process in our SFDR pre-contractual disclosures.⁶
• Examples, examples, examples: A well-documented and clearly articulated process is all well and good, but as the old saying goes, the proof is in the pudding. Examples of applying the responsible investment process are key to determining its efficacy. We have recently published an insight highlighting one of our recent liquidity-specific engagements, Do what you say: Investing responsibly in liquidity.⁷ You can find out more about our broader engagement activities in our annual responsible investment reports.⁸ For example, in liquid markets (encompassing our fixed income, equities and multi-asset activities), in 2022 we undertook 3,328 company and 41 country engagements.

With these simple considerations in mind, liquidity investors can step beyond SFDR and get a robust view of a MMF’s responsible investment framework.

Future state

MMFs will be able to increase the role of environmental and social factors in their investment processes in future. However, at present, there are material impediments to doing so, with two main areas for development:

1. Data: Better information on the environmental and social characteristics of bank lending could be a game changer for MMFs’ responsible investment frameworks. Bank lending practices vary. With granular information on environmental and social characteristics of banks’ lending books, MMFs would be able to actively tilt their portfolios towards better performers, and away from worse performers. To some extent, we can do this already, using ESG ratings (in our case from MSCI) as an input. However, the power and accuracy of this approach should improve as more and more consistent data becomes available.
2. Labelled instruments: Some funds invest only in labelled green or social bonds (e.g., green bond funds). In principle, we think it possible a MMF could be constructed entirely from labelled ESG money market securities (e.g., green CP) at some point. At present, this would not be possible for diversification and credit quality reasons:
   1. There are not enough issuers: NatWest counted 28 issuers of ESG CP at end-December 2022. Compare this with the 200-250 issuers in the broader money market and it becomes clear there would not be enough diversification to make a viable fund (not to mention the vagaries of issuance timing and the ability to diversify decreases further). That’s not to stop our funds buying some green (or other ESG) CP now, should we find the credit quality, liquidity and pricing suitable, but it would preclude a MMF invested only in ESG money market instruments for now.
   2. Issuer credit quality limits the universe: MMFs invest only in high credit quality issuers. Of the issuers of green CP to date, several fall below the minimum credit quality requirements. Excluding these issuers would reduce the eligible universe further, compromising diversification.

We will look to incorporate new information and tools into our responsible investment process. We will consider eligible ESG CP for inclusion in our funds, although a final investment decision will be security dependent.

Key takeaways

• Responsible cash management is now possible in the broadest sense.
• Treasurers can use responsible investment or ESG-integrated vehicles to raise cash on the liability side of the balance sheet and deploy that cash responsibly on the asset side in responsibly invested MMFs.
• Investing cash responsibly calls for looking beyond SFDR fund classifications to dig into the responsible investment characteristics of different MMFs. The additional analysis need not be burdensome and can add significant value as part of a broader responsible investment approach.