ESG regulatory focus presents risks for global money market funds
Uniformity and transparency of global environmental, social and governance (ESG) disclosures for money market funds (MMFs) have become increasingly important, with mounting regulatory scrutiny driven by the outsized growth of ESG-related assets under management (AUM), Fitch Ratings says. Large ESG reporting disparities exist between the EU and the U.S. and between individual funds, amid growing investor demand for ESG investing.
To the extent regulation provides investors with consistent, comparable information about fund ESG strategies and investments, this could be supportive of longer term growth in AUM. However, increased investor and regulatory focus on ESG also presents outflow risks for ESG-related MMFs which fall short of standards or expectations.
Traditional investment managers’ (IMs) sustainability focus has intensified, becoming a differentiating factor for AUM growth. European ESG MMF assets increased by approximately 200% in 2021 to EUR350 bil., mostly driven by funds aligning their names and objectives with ESG principles. European MMF assets, excluding government funds, rose by 4% in 2021, per Lipper data. Fitch classified the universe of European ESG MMF based on relevant indicators in their funds names and/or investment objectives.
Expanded ESG disclosures can serve to reduce greenwashing, or overstating the magnitude of ESG-related investments. European regulatory scrutiny is likely to grow, given the European Securities and Markets Authority’s (ESMA) Sustainable Finance roadmap published in February 2022, which prioritized combating greenwashing.
Unlike the EU, the U.S. and the UK do not mandate specific ESG disclosures by funds or advisers. These jurisdictions may also adopt more prescriptive regulatory approaches similar to the EU’s Sustainable Finance Disclosure Regulation (SFDR), albeit with some differences likely to remain.
Misinterpretation or misstatement of ESG data has led to punitive regulatory actions, with reports that the SEC is investigating Goldman Sachs’ asset management unit over its ESG mutual funds, the recent USD1.5 mil. SEC fine against Bank NY Mellon and the resignation of the head of German asset manager DWS Group amid police investigations into claims of greenwashing.
Recent SEC proposals have focused on improved transparency regarding ESG factors in certain investment products and ESG-marketed funds, establishing a framework to differentiate ESG-related investments of registered funds, private funds and investment advisers.
EU-registered funds must disclose SFDR classifications under Articles 6, 8 or 9, indicating the scope of sustainability investing. As of mid-June 2022, out of the 60 European non-government funds rated under Fitch’s MMF criteria, 58% were classified as article 6 funds, indicating they disclose how sustainability risks are incorporated into investment decisions or are otherwise deemed as not relevant.
Another 33% of Fitch-rated funds were classified as article 8 funds, indicating they promote environmental and/or social factors. The remaining 8% of funds were not EU-domiciled, and were not required to report SFDR classifications.
Fitch does not expect MMFs to classify under Article 9, as the ESG objective (relating to more bespoke, and likely less liquid, sustainable investment products) differs from MMFs’ primary objective to provide investors with liquidity. While a fund’s classification under SFDR is not directly relevant to ratings, misclassification or regulatory sanction could affect ratings if these events lead to material outflows affecting fund liquidity.
The classification of MMFs under SFDR may benefit investor inflows and support near-term fund growth, with several planned fund conversions to Article 8 categorization. AUM in Article 8 classified funds was EUR643 bil. at YE21, or 42% of European MMF AUM as of June 2022, according to Lipper.
Regulators and investors will likely face difficulties in evaluating ESG fund investments, given data limitations and cost constraints. These issues have been further challenged by increased geopolitical conflict, especially pertaining to governance, energy and fossil fuel investing.
