Why ESG is Just Part of a Trustee’s Duties

The first is a concern that trustees do not have the power to invest in ESG products or take ESG factors into account when selecting investments. Article 24(1) of the Law states: “Subject to the terms of the trust and subject to the trustee’s duties under this Law, a trustee shall in relation to the trust property have all the same powers as a natural person acting as the beneficial owner of such property.”^[2] (Many trust deeds also include an express provision that is equivalent to Article 24(1).)

The case of Equiom Trust (C.I.) Limited v Mattas and others ^[3] considered the width of Article 24(1) and confirmed that a trustee would have the power to undertake any activity that an individual could if they owned the asset. The powers under Article 24(1) are as broad as the drafting would appear to provide. However, Sir Michael Birt, Commissioner, commented, “We should of course emphasise that, although the trustee has the legal power to [undertake the proposed transaction] the question of whether it would be a breach of trust to do so is of course a very different matter and Article 24(1) itself makes clear that the power to carry out transactions is subject to a trustee’s duties under the 1984 Law… the exercise of any such… powers would still be subject to the trustee’s fiduciary duties.”

As an individual is able to invest taking into account ESG factors then it is clear that a trustee would also have this power, given the permissive nature of the Law in this area. However, this does not of course mean it is a proper exercise of that power.

 

Whilst not all ESG investments necessarily means lower returns (in fact, sometimes it may be the contrary), trustees can become concerned that if the ESG elements of an ‘investment’ outweigh the financial returns to a sufficient degree, then this would not be an investment but a form of distribution, whether or not by means of a philanthropic or charitable endeavour. In simplistic terms, in order to be an investment, there is a requirement at the outset for a genuine expectation of either capital growth and/or income generation. The fact that the capital growth or income generation does not transpire does not prevent the action being an investment, but the intention or expectation must have been there.

Therefore, the motivation and reality behind any ‘ESG investment’ must be considered. For example, companies undertaking community or charitable initiatives may have multi layered motivations for the activities chosen, including positive publicity and its own staff retention and engagement and therefore can view even a ‘charitable donation’ as a form of ‘investment’ to improve the overall profitability of the business. Although such factors may not apply to a private trust in the same way, there can be complex motives involved when considering ESG factors for investments. However, if a transaction is to be an investment there must always be a financial motivation. This does not mean that the only motivation must be financial or that there must always be a motivation of the highest short term financial gain and financial motivations can be non-direct. There could be both a financial objective and an ethical/environmental motivation; the two are not necessarily mutually exclusive. Similarly, with diversification and mixed portfolios, trustees will take into account security, risk profiles and stability and have a range of investments with different likely degrees of and time scales for financial returns – trustees are able, and even expected, for example at times to trade potentially higher returns for greater security.

There are many situations in which trustees have always had to consider the question of whether monies being paid out of the Trust Fund are in fact investments. This can include following directions in a settlor investment directed trust, investing in failing family-owned businesses at the request of the beneficiaries and making loans. If a trustee were asked to invest in a family business that requires a cash injection the trustees can consider not only the likely financial returns but also wider factors relating to that family, such as whether the family business employs the family beneficiaries. However, ultimately, if the trustee determined that the ‘investment’ was not going to prevent the business from failing and therefore the funding would be lost, then the trustee should not classify this as an actual investment, regardless of any other benefits to the beneficiaries. In such a situation the trustee could potentially still make the payment, but this may be on the basis that it would be a distribution for the benefit of the beneficiaries^[4].

It is becoming increasingly clear from case law that a consideration of the benefit to and interests of beneficiaries can take into account factors that are wider than purely financial ones, such as moral obligations. ^[5] Some requests for the trustee to take into account ESG factors when making investments could be said to be no different from the types of situations mentioned in the above paragraph. Trustees have always faced situations where there are other considerations in addition to strictly financial ones. A trustee would have to consider if there is a genuine expectation of capital growth or income generation and distinguish the former from, for example, distributions to beneficiaries by way of a purely philanthropic activity or donation to charity. If there are multiple considerations, such as a positive environmental change and generation of income, then financial and ESG factors will need to be balanced to ensure that the financial considerations are given sufficient weight to make it an investment. The question of whether a transaction is an investment at all is not the same as whether that investment would be a proper exercise of investment duties, which is considered below.

Misunderstandings over the use of terminology in the sustainable finance sector does not always assist. Discussions of ‘ESG investments’ can lead to the suggestion that these are specific types of investments and everything else is a ‘non-ESG investment’, and therefore for the latter ESG factors cannot be relevant. There are of course investment products where the ESG components are emphasised or which are branded as ‘ESG investments’ or ‘sustainable investments’. However, ESG or sustainable investing should not be viewed as being limited to particular investment products, but instead such factors would be incorporated into an analysis of every investment, or indeed could feature as the actual investment purpose itself. So called ‘impact investing’ and its relationship with ‘sustainable finance investments’ can be a difficult area for trustees. Impact investing (as opposed to sustainable investing) is where an investment strategy is seeking to achieve social or environmental goals, as well as generate profit (which may be compromised in order to achieve a sustainable goal). The balance between the social/environmental goals and the financial elements can differ significantly depending on the investor and some impact investment programmes are very close to being exclusively philanthropic. If the balance tips too far towards the social/environmental element that the financial rewards become so secondary or minimal or a ‘lucky coincidence’ then this may need to be analysed in terms of a distribution for the wider benefit of the beneficiaries. Impact investing can sometimes be viewed as an extension of philanthropy rather than an actual investment policy; and in such cases the financial element needs to be considered to ensure that it is also an investment. Clearly a professional impact investment manager would view this area in a very different light and would see such activities very much as investments. Trustees should always make sure that they have the appropriate skills or have taken relevant advice when dealing with these areas^[6].

If trustees take as their starting point a consideration of whether there is the intention for financial reward and then weigh up the ESG or impact factors, the concern about whether ESG investments are ‘investments’ should fall away. Instead, the question becomes whether that investment is a proper exercise of the trustee’s investment powers.

The third concern expressed, and most difficult for trustees, is whether it is a breach of trustee duties to take non-financial factors into consideration when selecting investments and, if not, the weight that can be given to these. When exercising its powers, a trustee has a duty to take into account relevant factors and not take into account irrelevant ones. The question can arise whether ESG factors (in the event they do not carry financial implications in their own right) are irrelevant on the basis that the only aim should be to maximise financial returns and therefore this would not be compliant with the duties of trustees.

The Influence of Cowan v Scargill

The starting point has traditionally been the English case of Cowan v Scargill^[7]. The facts are well known and involved questions over the investment policy to be pursued by the trustees of the National Coal Board pension scheme. In this case Megarry VC stated: “The starting point is the duty of trustees to exercise their powers in the best interests of the present and future beneficiaries of the trust… This duty of the trustees towards their beneficiaries is paramount. They must, of course, obey the law; but subject to that, they must put the interests of their beneficiaries first. When the purpose of the trust is to provide financial benefits for the beneficiaries, as is usually the case, the best interests of the beneficiaries are normally their best financial interests. In the case of a power of investment, as in the present case, the power must be exercised so as to yield the best return for the beneficiaries, judged in relation to the risks of the investments in question; and the prospects of the yield of income and capital appreciation both have to be considered in judging the return from the investment” [our emphasis]. Megarry VC further provided that when trustees consider investments they must put aside their own personal views and interests and, if an investment would benefit the beneficiaries more than another type of investment, they must not refrain from that investment due to their own held views.

Some trustees and advisers traditionally viewed this case as meaning that trustees can only take into account financial returns and therefore considering ESG and/or impact factors when selecting investments would be a breach of their duties. However, this appears to be an over restrictive reading of the judgment and perhaps based on a misplaced assumption that there is necessarily always a trade-off between financial returns and ESG factors. The judgment provides that it is not for trustees to impose their own moral or ethical standards when investing the trust fund; but this is hardly surprising given a trustee’s duty is to act in the interests of the beneficiaries rather than the interests of the trustees. In our view, and particularly in the modern investment climate, this case does not mean that ESG factors must be ignored and in fact, as discussed below, a failure to consider ESG factors could lead to liability for breach of duties given the changing investment environment.

As far back as 2014, the English and Welsh Law Commission, when commenting on English pension law, concluded that when considering long term investments trustees may take into account factors such as long-term sustainability and treatment of customers, suppliers or employees.^[8] The Law Commission stated in its summary document:

“We conclude that the law permits trustees to make investment decisions that are based on non-financial factors, provided that:

• they have good reason to think that scheme members share the concern; and
• there is no risk of significant financial detriment to the fund.”^[9]

More Recent Case Law

The more recent 2021 English case of Butler-Sloss and others v Charity Commission^[10] clarified certain areas of interpretation of investment duties in a charity context and held that trustees have wide discretion to exclude certain types of investments on non-financial grounds in the context of that case. Some commentators seemed to take this case as conclusively permitting trustees to focus on ESG factors rather than financial returns. However, this appears to be an overstatement and instead in our view for the private wealth area the case means that there is a balancing exercise which should take into account the purposes of the trust, but did not authorise trustees just to ignore or deprioritise financial return considerations.

Recent Jersey case law shows support for the ability of trustees to take into account ESG factors when exercising their powers. In the matter of the May Trust ^[11] the Court held that moral obligations and views of beneficiaries can be taken into account when managing trust assets in the interests of the beneficiaries and determining whether making a distribution is for the benefit of a beneficiary.

In that case, Sir William Bailhache, Commissioner, stated:

“At the heart of the debate is the nature of a trust which, as a result of the trustees’ legal ownership of an asset, is focussed on how that asset should be managed in the interests of the beneficial owners. It is therefore inevitable and right that trustees should… look at the broader interests of those beneficiaries which must be viewed both from an objective and a subjective standard.

In considering the question of benefit, both the Court and the trustee must be able to identify objectively the benefit which it is said would arise from the exercise of a power legitimately conferred upon the trustee.

Secondly, there is a subjective element, namely the wishes of the beneficiary in question, which is bound to be a relevant consideration, to be weighed with and against all other relevant considerations.”^[12]

He further provided:

“In summary, the decision of a trustee that a particular appointment is for the benefit of a beneficiary in the case of a discretionary trust must of course be one to which the trustee could reasonably arrive having regard to the terms of the deed. In making that journey, the trustee will have regard to the law which is to the effect that “benefit” is to be widely construed. Thus, unless the deed otherwise provides, “benefit” as a matter of principle:

(i) goes wider than financial benefit and includes donations to charity (In re Wigwam), the payment of debts to HM Revenue (In re Marc Bolan) and avoiding the detriment of parents of beneficiaries facing large tax claims arising from the transfers into the trust which they have made (In re N).

(ii) may include the application of trust monies to provide social or educational benefits for the beneficiary in question.

(iii) may include the application of trust monies in discharge of a moral obligation which the beneficiary, in receipt of the appointment which the trustees have resolved to make in his favour, accepts is one that should be discharged from that appointment.”^[13]

Although this case involved whether a distribution was for the benefit of a beneficiary, the same reasoning would still seem to apply when making investments. Investment powers under the trust deed are subject to the same duties under Article 21 of the Law as any other trustee powers and must be exercised in the interests of the beneficiaries.

The reference in the May Trust case^[14] to both objective and subjective considerations being relevant would mean that different approaches to ESG could quite legitimately be taken between trusts to reflect the views and approaches of the relevant beneficiaries and/or the settlor. However, again the important factor to note is that it is the moral views and well being of the beneficiaries that is relevant and not the moral considerations of the trustees themselves.

Cconsiderations for Trustees and Views of Beneficiaries and Settlors

The issues referred to above are not of course unique to ESG factors. Trustees of private trusts have always taken into account the views and situation of the settlor and beneficiaries, not only on matters relating to distributions but also investments. This would involve factors such as risk levels, currency base, income generation compared to capital growth, choice of jurisdiction and industry sectors. If beneficiaries are based in one part of the world then it would not be unusual for trustees also to invest in that region for reasons of familiarity. Investments in property which provide accommodation for the beneficiaries and in family run businesses can also be made within trust funds. Trustees hold diversified portfolios with varying risk factors and are prepared to sacrifice prospective financial returns for security and stability over part of the trust fund. Some of the investment parameters relating to risk and stability may be affected by the type of investments held by the beneficiaries outside the trust structure. For example, if the family’s wealth outside the trust consists of a family business in a higher risk and volatile area then trustees may be justified in holding lower risk assets as a large proportion of the trust fund to counterbalance the risk in the family’s overall wealth. Similarly, if families feel strongly about the human rights records of certain countries or the ethics and integrity of certain industry sectors, trustees have always been able to take this into account and consider other areas of investment.

Trustees should not have been surprised in one sense by the findings In the matter of the May Trust. If analysed, trustees must be aware that they do not make distributions to beneficiaries just to increase that beneficiary’s wealth in its own rights – the considerations would always have been based on how the beneficiary would use, and the need for, the funds and how this would affect their life. There have been various cases over the years where trustees have been asked to make a distribution to a beneficiary in the knowledge that the beneficiary would then pay those funds to someone else, such as a creditor, a former spouse or just simple payment of school fees. Therefore, the trustee is making that distribution in the full knowledge that the beneficiary will not just be retaining those funds for the purpose of increasing their bank balance, but instead to stave off bankruptcy or avoid a contempt of court or just to provide their children with their preferred education. Distributions can be made to fund holidays or other leisure activities with no prospect of the beneficiary’s long term financial wealth being increased. This may seem obvious, but the interests of or benefit to the beneficiaries are much more complex concepts than just maximising financial returns. Although the emphasis may be very different when considering investments as opposed to distributions, the overall consideration is to act in the interests of the beneficiaries and similar complexities can also apply. Issues such as reputation management may also be important for the welfare of beneficiaries and can have a bearing on investment decisions. This may be a particular factor for impact investing. Trustee decisions are seldom linear.

Letters of wishes often refer to investment policies and guidance and not just distribution policies. For high net worth families, there is increasing use of family charters or wealth purpose statements which often consider moral and ethical issues as well as investment preferences on matters such as risk. Such documents may set out a philanthropy policy for the family. Trustees have a duty to consider the contents of a letter of wishes, although it is accepted that trustees are not bound by the contents, as any action must always take into account the interests of the beneficiaries at the time of that act. Similarly, family charters or wealth purpose statements are matters that a trustee should take into account. It has been accepted by the Courts that documents setting out wishes may change from time to time as circumstances affecting the family and the trust may also change.^[15] This position is long accepted and it is difficult to see why ESG factors, where the beneficiaries have a preference or view, should be treated any differently from any other view or wish. Ethical and strategic objectives amongst family members are often particularly important for long term family, and family businesses’, cohesion so can be very relevant for trustees’ consideration.

Changing Needs and W-ishes

Trustees clearly have a duty not just to follow a beneficiary’s request, but do have a duty to give it proper consideration. The contents of a letter of wishes or family charter would be a relevant factor for the weight to be given to ESG factors for investments. Beneficiaries may have both long and short term aspirations with respect to the trust’s investments and part of a trustee’s duty must be to continue dialogue to understand these. As with distribution policies, investment policies need to adapt over time to changing needs and wishes.

The purpose of the trust and likely duration have also always been very relevant factors and the views and needs of the current beneficiaries would be considered in the context of whether the trust fund is also intended to provide for future generations. In life interest trusts, trustees are accustomed to balancing the views of the life tenant who would normally wish for larger income generation against the remaindermen who would prefer greater capital growth. Trustees would not seem to view these considerations as other than just being part of their role. The weight to be given to the views of current as opposed to future beneficiaries and to any one beneficiary will always vary from trust to trust.

Financial Implications and ESG

It is not suggested that financial returns would not always play a significant part in an investment decision and consideration of trustees’ duties. As discussed above, this is the very nature of an investment. However, there is no prohibition on trustees taking into account ESG factors where these are in the beneficiaries’ interests, and there is both appropriate consultation with beneficiaries and reasoning applied to decisions.

Debate on this area can sometimes focus on ESG factors as though such considerations are purely moral or ethical issues with no financial elements. This is not of course the case. As the world is changing, ESG factors are becoming far more important when considering financial prospects than might have been the case some years ago where such elements were perhaps seen as more niche. ESG factors are becoming integral to businesses’ long term sustainability and capital raising capabilities and trading prospects for companies viewed as having poor ESG credentials can be affected. Stranded assets^[16] are perhaps the most basic example of this and equipment to manufacture or support certain products which are due to be phased out on environmental grounds would likely not be a prudent long term investment. Environmental issues such as extreme weather events and challenges in supply chains can be very relevant for the value of assets. Such issues are rarely clear cut, however, and involve a balancing of risks. Given the goals of many governments worldwide and significant sectors of consumers, it would now seem very difficult for a trustee to invest for financial returns without ESG factors being taken into consideration, regardless of whether this has been requested or led by the views of beneficiaries and settlors. This is particularly the case for private family trusts which traditionally are of long duration to protect generations. The measurement of a business’ ESG credentials can also be a contentious area and trustees would need an awareness of international standards and the risks of so called “greenwashing”. Education in this area would be an important issue for all professional trustees given the current and likely future investment climate.

Even if a beneficiary requests that the trustee pays funds to, for example, an environmental project that has no anticipation of profit then the trustee may still be able to do so, but potentially by nature of a distribution for the benefit of that beneficiary^[17]. If a trustee is proposing an investment then it must always consider financial factors, and this applies to “ESG investments” and impact investments as much as to any other type. It is the weighting of the various factors that can cause issues for trustees. Impact investing and philanthropic activities could be carried out through a purpose trust which may remove many of the issues concerning financial returns. However, if an existing trust for beneficiaries wishes to transfer funds to such a purpose trust then the same type of considerations would need to apply about the justification for such a transfer and whether this is a distribution or investment or within the powers of the trustees of the trust for beneficiaries.

The leading cases in this area have not tended to involve private family trusts.^[18] Whilst still covered by the same trustee duties, the approaches required in large pension schemes, such as the one in Cowan v Scargill, compared to a private family trust can be very different. In the former type scenario, it may be much more difficult, and therefore less appropriate, for trustees to try and incorporate moral or ethical considerations to reflect the views of the beneficiaries than for the latter where trustees can have meaningful discussions with and knowledge of the individual beneficiaries and therefore can make a genuine assessment as to the interests of those beneficiaries. As mentioned above, letters of wishes or family charters can be very important factors for trustees to take into account in private trusts. This aspect is another indication that the comments in Cowan v Scargill cannot just be applied to all private family trusts as a hard and fast rule.