If we look for guidance on how trustees should manage their fiduciary duty a useful reference source can be found in the United Nation’s principles of responsible investment (PRI). This is a recognised global framework within the wealth investment space for responsible investment. The United Nations PRI published an index study in 2019 with the title “Fiduciary Duty in the 21 century”. In this report it states that “ESG issues are a financially material factor which have become a core characteristic of a prudent investment process.” The report argues that ESG standards should be incorporated into regulatory conceptions of fiduciary duty. It even goes a step further and states “investors who fail to incorporate ESG issues are failing their fiduciary duties and are increasingly likely to be subject to legal challenges.”
The investment community now commonly regard ESG as a risk-based tool in line with these PRI requirements. It is hard to argue why trustees should not consider investing in the same way. In fact, trustees will have to face up to the real financial risk of not incorporating strategies to protect trust funds from ESG failings, be they in the underlying assets or in the managers appointed to do so. The transparency coming from the financial reporting will give beneficiaries visibility on such aspects and thereby arm them to challenge trustees. As carbon pricing becomes more standardised, those investment portfolios which hold high carbon industries could face valuation issues or risk becoming wasting assets.
Some trustees and investment managers have begun to steer away from classifying their portfolios as ESG mandates. The term “ESG” has faced some headwinds and is now even considered “old news” in some quarters. The reasons for this include:
- With greater transparency from corporate reporting, arguably an unintended consequence of the term “ESG” is that a fossil fuel company can have a better ESG score than a manufacturing meat free company with lesser emissions. For example, in a scenario where despite the latter business being clearly better for the environment, it fails to keep up to the high scoring of the “S” and “G” attributes.
- Reporting transparency has also led to the identification of investment firms who have been “greenwashing”. The selection of such a firm is complicated not least due to the lack of appropriate benchmarks. This poses a risk to trustees who have not done their due diligence to understand the difference between an authentic ESG manager and one who is not.
- The oil and gas crisis arising from Russia’s invasion of Ukraine led to a shift back to fossil fuel investments as these increased in value under the supply/demand economics. The net result was that for a short period ESG investment performance suffered. Investment managers naturally veered away from this. This underperformance has now reversed but the sentiment remains.
- In the US, the ESG debate has become a political hot potato and unfortunately that has polarised opinions.
- The adoption of ESG as a risk screen has become so widespread amongst the investment community it could be argued that it has become normalised into their operations.
With this in mind, private capital has started to gravitate towards impact investments. Investors want better visibility on how their capital can directly address some of the global climate crisis challenges. Many also recognise the potential for financial upside in these investments. Often this deployment of capital is in the form of Private Equity/Venture capital. The focus is on repairing the damage to the world and preventing further damage from happening. They aim to generate specific beneficial social or environmental effects. Impact and financial return are not mutually exclusive and there is a growing likelihood of impact investments bringing above market returns.
On the back of the United Nations Climate Summit meeting (known as COP) government funding is being re-directed towards such investments, and we are starting to see this with private wealth too. Some investors are now asking their trustees to make such investments.
This presents an opportunity to yield significant financial (and other) returns by investing now in businesses that solve some of these global challenges. This is evidenced in the growing willingness from family offices to invest capital in philanthropic and climate crisis driven initiatives. It is estimated that wealth between $30-$40 trillion is set to transfer to Gen X and millennial generations over the coming decades. The reality is that it is the next generation that will have to live with the environmental and climate consequences caused by the current and prior generations. Unsurprisingly they will want to see their family capital being deployed to improve their lives and their “best interests” will extend beyond wealth to also encompass living on a habitable and stable planet.
Some trustees prefer not to hold such investments and would rather make a distribution to the beneficiaries to enable them to make the investment in their own names. The “distribution route” still leaves the question as to whether such a decision taken by a trustee is “in the best interest of the beneficiaries” – there is a high likelihood of tax consequences or asset protection issues coming into play by doing this – potentially leading to a net financial loss for such beneficiaries.
The position becomes further complicated where, within some families, some members of the founder generation are not in favour of ESG/Sustainable or Impact investments and where there is a divergent view on such investments within a family the trustee dilemma is heightened. Some members may also not appreciate the trustees making decisions based on what could be perceived as a moral position of another beneficiary.
So, what do high-net-worth families and individuals looking for both future wealth planning and sustainable investing at the same time do? Do they consider two trusts? One being a purpose trust and another discretionary trust, but the latter does not carry out pure impact investing. It is fair to say high-net-worth families and individuals have been disappointed by the lack of flexibility.
Another issue with impact/sustainable investments is that trustees struggle to monitor them without adequate benchmarking metrics. This risk will wane with better regulation and reporting, both of which are now coming through thick and fast. That transparency has shaken up the ESG market and is being effective. It is worth noting that some beneficiaries are not overly concerned by this lack of industry standardisation as they can often have direct visibility on the impact their family wealth is having on the underlying project.
The wave of international regulation, reporting and best practices that will inevitably come to trust law jurisdictions should provide clarity but considering these anticipated changes, trustees need to have their businesses ready for this and have the knowledge and the reporting tools to do so for the assets under their care.
Here are some ideas trustees can implement to prepare themselves for the sustainability revolution:
- Documenting the clients’ wishes and views relating to sustainability and impact as much as possible in a letter of wishes, a carefully crafted investment policy statement or a family mission statement.
- Reviewing standard trust instruments carefully to include sustainability and ESG wording, to exclude the trustees’ duty to preserve and enhance the trust fund.
- Similarly devolving trustees’ duties and powers on specialist investment managers in the Trust Deed will give trustees more comfort.
- To delegate certain of the trustees’ powers to sustainable finance specialists.
- Including Anti Bartless clauses in the Trust Deed can also help with this.
- The letter of wishes can also set out the intention of the settlor/s to fulfil a purpose.
- A carefully crafted investment policy statement.
- Use of foundations, charitable or non-charitable purpose trust.
As always, if trustees thoroughly document their decision making, adopt a broad and holistic view as to what benefit encompasses and adopt prudence in the appointment of investment managers, or indeed in deploying capital, the perceived risks around impact/sustainable investing diminish. The time to embrace this is now. If not, we risk being assessed on today’s decisions in the years to come and it will be hard to argue against the challenge when the consequences of non-sustainable investments being included in portfolios are already well known – the current climate risks are well reported.
Sources:
Bronwyn Clare (2021). Insurance industry must align to Paris Agreement, starting now. Cambridge Institute for Sustainability Leadership (CISL).
Mark Poynting (2024). World’s first year-long breach of key 1.5C warming limit. BBC News.
Grant Thornton (2023). ISSB sustainability symposium – what happened? Grant Thornton Insights.
Jersey Finance (2021). Virtuous Circles: Sustainable Family Governance Models in an Evolving Environment. Jersey Finance Research Report.