Evaluating an ESG Approach to Short-term Cash Management

Corporate cash management strategies have long focused on attributes like yield, stability, and liquidity, but today forward-looking treasury departments are adding another criterion: social responsibility. An environmental, social, and governance (ESG) approach to treasury management applies socially-responsible investing strategies to money market and other short-term cash investments.

These strategies enable companies to invest for positive impact. At the same time, treasury teams can avoid the risks that can come from holding securities issued by companies with poor ESG practices, including: regulatory issues, fines, lawsuits, boycotts, negative publicity, and loss of customer trust.

The rise of ESG investing practices

Over the last several decades, increasing numbers of institutional and individual investors have sought to align their portfolios with their values. In 1995, the Foundation for Sustainable and Responsible Investment (US:SIF) reported just $639 billion in U.S.-domiciled ESG assets; by 2018, these assets had grown 18-fold to more than $12 trillion.

ESG-focused asset managers invest in companies that protect the environment, foster a diverse and inclusive workforce, respect human rights, and practice strong governance policies.

Up to now, asset managers mostly applied ESG to longer-term investments, such as stocks and bonds in pension portfolios. In recent years, however, institutional investors—at first in Northern Europe and now increasingly in the U.S.—have begun to extend ESG analysis to their short-term cash portfolios, too.

Fitch Ratings found that ESG-screened money market assets grew by 15% to $52 billion in the first half of 2019 after increasing by just 1% throughout all of 2018. Even with this accelerating growth, ESG-focused short-term investments still make up a small portion of the $6 trillion in global money market investments.

ESG analysis of short-term securities has been difficult historically. Managers of money market funds and other short-term investments operate in a market with relatively few issuers, compared to stock and bond markets. A focus on liquidity, quality, and yield further constrains the pool of available investments.

Screening for ESG characteristics can have an outsized impact because there are simply not as many alternatives as there are in other markets. In addition, data on the ESG characteristics of short-term debt issuers has been scarce, but this is starting to change.

The Sustainability Accounting Standards Boards’ Materiality Map identifies key ESG issues in each industry, which gives investors an easy way to analyze exposure to specific sustainability risks and opportunities. Similarly, the U.N. Sustainable Development Goals now highlight 17 areas where companies, governments, and other organizations can have a positive ESG impact. Many corporations are now linking their ESG reporting and objectives to these development goals.

A number of third-party data and analytics companies, including vendors like Sustainalytics, have also emerged to provide data on the ESG risks of specific short-term debt issuers. Fitch Rating recently launched a scoring system that shows how ESG impacts individual credit rating decisions. Similarly, S&P Global Ratings published its first ESG-focused credit rating in the summer of 2019.

All these new tools will make integrating ESG analysis into short-term investments easier and more effective as interest in these strategies grows.

The business case for ESG

ESG appeals to investors because of its potential for social good, but it is also a way of analyzing and reducing risk.

In particular, this type of research helps investors understand three types of exposure:

  • Environmental risk: Companies with strong environmental practices are less likely to experience costly accidents. For instance, the Elk River chemical spill in 2014 leaked toxic chemicals into nine counties in West Virginia and eventually caused the bankruptcy of Freedom Industries, the company responsible for storing the chemicals.
  • Social: Organizations that protect human rights and provide a safe, equitable working environment are less vulnerable to boycotts and lawsuits. Examples include the class action lawsuit against Goldman Sachs for equal pay or the $10 billion settlement against Purdue Pharma for its role in creating the opioid crisis.
  • Governance: Strong governance practices, like establishing an independent, diverse board, can help companies avoid taking on inappropriate risks. Poor governance was a factor in the Enron accounting scandal of 2001, which triggered the largest bankruptcy in U.S. history.

Companies that score high in ESG screening have attractive investment characteristics.

One global aggregation study by Oxford Partners and BNP Paribas analyzed 200 different academic papers on ESG and investment performance. It found that 88% of the studies it reviewed linked robust sustainability practices with better operational performance and stronger cash flows, while 80% demonstrated that prudent sustainability practices had a positive influence on investment performance.

ESG analysis in short-term securities is still evolving, but a variety of ESG-screened money market products are starting to emerge for the treasury marketplace.

In 2018, Federated Investors purchased a majority stake of ESG specialist Hermes Fund Managers. This was partly to add ESG capabilities to its market-leading family of money market funds. Blackrock, DWS, and State Street all launched ESG-screened cash products in 2019, significantly adding to the capacity for what had previously been a niche market area.

How companies are applying ESG to the treasury management function

Adding ESG to the investment management function may seem complex, but often it builds on existing socially responsible practices.

Many companies already have mission-aligned investment guidelines that determine how they allocate cash investments to minority-, women-, or veteran-owned asset managers.

Companies also already perform extensive research to reduce risk in their cash investment portfolios. It may add clarity to think of ESG investigation as another form of risk management—akin to credit or duration analysis.

There are a variety of tools available to analyze ESG risks, from non-governmental entities like the UN, ratings agencies, and third-party research providers. Treasury departments don’t have to develop this expertise on their own.

Even so, integrating ESG into treasury management is a collaborative, customized process, requiring an understanding of a treasury organization’s unique set of goals, constraints, and values.  Finding the right ESG solutions requires a broad, comprehensive view of market providers, granular research into portfolio holdings, and an unbiased approach dedicated solely to meeting investor goals.