ESG (environmental, social and governance) investment has been a hot topic for some time, and even more so in the last year. The pandemic has highlighted for many people the extent of global inequalities, the importance of a more cohesive society, and the challenges posed by climate change. In the private client sphere, both charitable and non-charitable trustees have shown increased interest in taking an ESG approach to investing. However, many have been concerned about the compatibility of ESG investing and their fiduciary duties to their beneficiaries.
As we discuss below, we believe that ESG principles and fiduciary duties do not have to be in conflict, and that, with proper advice, an appropriate balance can be struck. Trustees are used to balancing a number of different and sometimes competing interests. Whilst each case will be client specific; it is clear that one of the most effective ways of assisting trustees is to incorporate the concept of ESG investment into the drafting of the trust documentation.
Why is ESG relevant to trustees?
The ‘traditional’ view was that trustees’ fiduciary duties restricted them from favouring ESG investments over conventional investments. However, this position has all but become redundant in recent years.
Whilst it remains the case that trustees’ primary duties are to act in their beneficiaries’ best interests (essentially being their best financial interests in the case of investment), there is now very strong evidence that many ESG factors have a material financial impact on investments. Due to the apparent favourability of such investments, in many cases trustees may find that ESG investing and their fiduciary duties are neatly aligned, and it would in fact be contrary to their duties to not incorporate ESG principles into their investment decisions. These decisions include the appointment of investment managers, choosing investment objectives and asset allocation, and in relation to businesses owned by the trust.
One of the main reasons that trends are moving so rapidly towards ESG investing is due to a generational shift in attitudes. Younger investors, in particular millennials who are quickly becoming the owners of more assets than any other generation, are much more likely to make sustainable investing a priority than the average investor. Many trustees are seeing an increased involvement from younger beneficiaries, who are keen to understand the structure and not just benefit the family for future generations, but also achieve a greater positive societal impact. It is therefore no surprise that the professional trustees we work with increasingly find that ESG is a topic their clients are keen to discuss.
Developments in legislation and case law
For pension and charitable trustees, there is strong legislative support for ESG investing. For example, under the Occupational Pension Schemes (Investment) Regulations 2005 (as amended in 2018 and 2019), trustees of relevant schemes are required to publish a statement of investment principles (SIP) that includes showing that they have considered ESG principles in making investment decisions. These trustees are now also required to publicly report on how they have followed their SIP, thus ensuring continued accountability.
The Supreme Court decision of R (on the application of Palestine Solidarity Campaign Limited and another) v Secretary of State for Housing, Communities and Local Government [2020] can be interpreted to provide comfort to trustees looking to strengthen their approach towards ESG focused investments. Here the court found that it was unlawful for government guidance to prohibit an administering authority in the Local Government Pension Scheme from making non-financial investment decisions which were contrary to UK defence and foreign policy. Whilst quite limited to its facts, on a wider application, this judgment supports the Law Commission’s position that it is open for trustees to take non-financial considerations into account when making pension scheme investment decisions, provided they are satisfied that such considerations do not pose a significant risk of financial detriment to the scheme and there is good reason to think that members would support that decision. Some commentators have also taken the view that the decision provides important guidance for trustees generally (and not just pension trustees).
In the case of charitable trusts, the Charity Commission recently hosted a consultation on revised draft guidance about ethical and responsible investing for charity funds, the submissions of which are still under review. The revision of guidance was triggered by a widely held perception from trustees that they have an overriding legal duty to maximise the financial returns above all else, and that there was insufficient assurance that trustees can decide to take a responsible approach to investment; these represent sentiments commonly shared by trustees of non-charitable discretionary trusts too.
The revised draft guidance makes it clear that rather than just focusing on financial returns alone, trustees can take an investment approach which considers the charity’s purposes and values. This is still qualified by the need to base decisions on what is best for the charity. The Commission states that it is unlikely to have concerns about a charity’s investment approach if the trustees can show that they have considered the relevant issues; taken advice where appropriate; and followed a set of “decision making principles”.
ESG investing for trustees of discretionary trusts
Whilst trustees of pension trusts and charitable trusts have the recent and express backing of statute, case law and guidance, we consider that trustees of discretionary non-charitable trusts can also be reassured in taking an ESG approach to investing. As mentioned, a trustee’s primary duty is to act in the best interests of the beneficiaries and to exercise a duty of prudence when investing. As the important case of Re Whiteley (1886) held:
“the duty of a trustee is not to take such care only as a prudent man would take if he had only himself to consider; the duty rather is to take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide.”
Under the Trustees Act 2000, a trustee has the statutory power to “make any kind of investment that they could have made if he were absolutely entitled to the assets of the trust”, yet this is qualified by the duty to have regard to the “standard investment criteria”, which includes considering 1) the suitability of the investments to the trust; and 2) the need to diversify investments, so far as is appropriate to the circumstances of the trust.
These criteria under the Trustees Act clearly show that the circumstances of the particular client and trust are central, and thus (where appropriate) provides the opportunity for an ESG approach to investments to be drafted into the trust documents or otherwise added by amendment. For many families, ESG considerations will be of paramount importance, and a trustee who takes those concerns into consideration (even if it were to lead to comparatively lower financial returns) is nonetheless acting in the best interests of the beneficiaries in a broader sense and is not breaching their statutory duty of care. Trustees should be careful however not to breach their fiduciary duty by substituting their own ethical considerations against the best interests of the beneficiaries.
We can advise on and draft ESG principles into trust documentation, to provide trustees with both the protection and flexibility needed to successfully navigate the current investment landscape.