As an ESG investment revolution gathers pace, trustees are increasingly being asked by settlors and beneficiaries to take into account factors such as climate change or to exclude certain industries when investing trust assets. What challenges does this present for trustees of private family trusts?
Under English law, trustees have a duty to preserve and safeguard trust assets as well as broader statutory obligations relating to the exercise of their investment powers. However, these duties can be restricted or excluded by the terms of the relevant trust deed.
Bart Peerless, senior partner, Charles Russell Speechlys
Trustees can avoid certain sectors or asset classes, such as tobacco or munitions, or invest in riskier asset classes where the trust deed permits them to do so. Therefore, in the case of new trusts, flexibility can be factored into the trustees’ investment powers at the design stage. For example, the trust deed could include an express power to make ESG investments with provisions defining what will qualify as an ESG investment and setting out any limitations on such investments.
That said, generally, trustees must seek to obtain maximum financial return from their investments, by way of income or capital growth, putting aside their own views on ESG issues. ESG investment can therefore leave a trustee vulnerable to claims from disgruntled beneficiaries, who are not aligned to an ESG investment philosophy. For example, such beneficiaries might suggest that investments which disregard ESG considerations would have produced better returns and so the trustees should be liable for the difference.
Matthew Radcliffe, senior associate, Charles Russell Speechlys
In the case of new trusts, or where it is possible to vary the terms of an existing trust, such concerns can be addressed by the trust deed providing that trustees shall have no liability for loss due to the acquisition and retention of ESG investments corresponding to a particular description.
Existing trusts are less straightforward, particularly where there is no power to vary their terms; certain types of investments, such as speculative or non-income producing investments, (in some cases, a feature of ESG investments) may be expressly prohibited under the terms of the trust.
Even where ESG investment is not expressly permitted, trustees can still make “ethical” investments with good long-term investment prospects. Indeed, a recent proliferation of investment funds badged as ‘sustainable’ or ESG-focused presents trustees and their investment managers with a range of ESG investment options, satisfying a broad spectrum of risk and return appetites.
Taking the beneficiaries' views into account
Trustees should not invest merely to accommodate the wishes of beneficiaries but it is thought that if one or more beneficiaries object on ethical grounds to a certain investment, this can be taken into account, provided the trustees are astute to avoid significant financial detriment. However, trustees must remember they are answerable not only to current adult beneficiaries but also to minors and unborns and they must take care to balance those interests.
In practice, beneficiaries may not agree on which investments are acceptable from an ESG perspective. For example, a beneficiary may consider shareholder activism aimed at changing environmental standards of particular industries a more effective way to decarbonise that industry, in comparison to an investment-exclusion approach; or a beneficiary may disapprove of particular companies in which an ESG-focused investment fund has equity holdings.
Offshore structures: purpose trusts and reserved power trusts
Where new trusts are being established, families and trustees might consider the flexibility and protection afforded by mechanisms and structures in certain non-English law jurisdictions such as a Cayman Islands law “STAR trust”, which can be set up with the specific purpose of making ESG investments and have no beneficiaries. Guernsey and Jersey offer non-charitable purpose trust solutions.
In fact, England may follow suit. The English Law Commission is currently initiating a project reviewing the law of trusts” and it is possible that recommendations will be made to allow non-charitable purpose trusts under English law.
Alternatively, some jurisdictions allow for powers to be reserved to a third party (such as an investment committee) to direct the trustees as to its investment decisions, relieving the trustees of liability associated with following such directions.
Moral well-being
Although trustees are able to take into account beneficiaries’ moral wellbeing when considering whether a distribution is for the “benefit” of that beneficiary, it is not clear that a similar analysis could be applied to investments so that, for example, a diminished investment return can be justified by a societal benefit. However, this could be an area for challenge in the future.
A way forward
Trustees will have to keep evolving their approach to ESG investment and co-operate and communicate with families about the issues impacting trustees and family stakeholders alike. As so often when it comes to trustee investing, how trustees should pursue an ESG policy will ultimately be a question of balance and degree.