The impact of ESG on private wealth structuring

Isabel Baxter, 20/12/2022

As conversations about the role of environmental, social and governance (ESG) become prominent within the private client industry, it is important to recognise its complexities, Jonathan Arr, a partner at UK law firm Macfarlanes, told eprivateclient. 

Mr Arr explained that ESG affects how private clients structure their wealth and how trustees, fiduciaries and investment managers administer those structures.

“ESG is now affecting the way all structuring is done,” Mr Arr said.

This is because trustees and family members have to consider ESG issues in terms of litigation risk and it is now a “default topic for everyone to have to think about”, Mr Arr added.

This is to the point where some may not realise that they are talking about ESG, Mr Arr explained.

There are certain aspects that now affect “thought patterns”, not just of the client, but of everyone involved.

Due to this, Mr Arr said certain questions arise for advisers. These include: “will they be sued for doing something or not doing something as a trustee? Are the family going to fall out over ESG issues? Is that going to cause a dispute?”

Alongside this, if a family does fall out over ESG issues, will it cause a dispute? Mr Arr noted, which then ultimately means a trustee has to step in or in some cases take the matter to court.

For fiduciaries, investment managers and trustees, there is a risk of reputational damage if they do not pay sufficient attention to ESG.

This is because an investment policy implemented with ESG not taken into account could impact on the interests of the beneficiaries in the long term if the trustee fails to make it sustainable.

This creates a “long tail” of risk for trustees, Mr Arr said.

He added that dismissing ESG issues can be “damaging to the interests of the beneficiaries in the long term and not enabling the investments that a trust makes to be sustainable might create loss in the future”.

However, Mr Arr noted there is still the perception that ESG investing can create low returns.

There are more immediate risks that these investments will not perform, Mr Arr believed, “especially in the current difficult equities market.”

Subsequently, individuals may “seize” on decisions by trustees to invest in particular ESG related investment, Mr Arr added.

“Some may want to maximise returns and pay less attention to ESG issues if they perceive that might limit returns.”

As with trustees having differing attitudes to ESG investing, different beneficiaries may also have different attitudes, leading to the risk of family dysfunction.

Family dynamics can often lead to tensions.

Mr Arr acknowledged that different generations and different family members disagree about how family wealth should be structured.

“Most of the differences about investing are intergenerational,” he explained.

Within families, wealth creators often have a different view from their descendants about how the wealth should be managed and what it should be used for, Mr Arr said, adding that another source of significant tensions was between siblings.

At the same time, Mr Arr said it was important to remember that ESG conversations should not just involve the family members.

“It’s also a conversation for the family plus the trustees and their investment managers.”

Discussing these difficult legal issues can put pressure on relationships. Mr Arr warned this formalises discussions in a way that can be unhelpful.

This is when the issues of an individuals’ wishes versus legal barriers arise.

“Trustees are not able to sacrifice returns in a way that some family members may want.”

This creates “three-way tensions” between family members, trustees and their investment managers, Mr Arr stressed.

These tensions could escalate to the level where the trustee feels the need to go to court to obtain approval of its investment policy.

Overall, he believes ESG is something that trustees and families have got to recognise as something they need to pro-actively talk about before it becomes a “hot button issue”.

Overall, Mr Arr stressed the “fundamental issues” for the private wealth industry is what ESG means for the sector.

“Defining ESG is difficult: for some it means an element of sacrifice - giving something up in order to achieve social good.”

This is because some may want to maximise returns and pay less attention to ESG issues if they perceive that might limit returns, he added.

To combat issues, communication is important, Mr Arr noted.

A “common and agreed policy” will enable managers and trustees do the right thing, he advised.

“Talking about things early and often is always the best thing.”

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