Striking the balance between ESG investing and financial stability as a Cayman trustee
There is a recent trend for the new generation of beneficiaries of discretionary trusts to be increasingly concerned with the way in which trust assets are being invested. This trend has led to increased risk for trustees in that the desire of beneficiaries to align the investment strategy of family trusts with their moral and ethical values (so-called “ESG investing”) may sometimes conflict with their financial interests.
This article looks at considerations that a trustee must have in mind when carrying out this balancing exercise between the investment considerations important to beneficiaries seeking to meet their long-term ESG investing goals, against their more immediate fiduciary responsibilities to maintain or grow the trust fund to meet the needs of present and future beneficiaries.
What is ESG investing?
Environmental, social, and governance (“ESG”) investing relates to the three pillars by which a company or business can be assessed when measuring its sustainability or ethical impact. This term was first used by the United Nations in October 2005 when developing the “Principles of Responsible Investing” (“PRI”)1 and the PRI have now evolved into an international network of businesses and financial institutions committed to supporting these institutions to adopt ESG investing strategies2.
ESG investing in a trust context
In the trust context, a beneficiary may express a wish that trust monies are only used for investments which align with the PRI and can be therefore considered ESG investments. However, ESG investments often underperform when benchmarked against traditional investment in blue chip companies. This disconnect places pressure on a trustee not only to satisfy the wishes of beneficiaries, but also to discharge their duty as a trustee to provide the greatest financial benefit for the present and future beneficiaries3.
A trustee’s overarching duty is to act in the best interests of the beneficiaries4, which in an investment context translates to auxiliary duties to diversify investments, and to invest in a prudent manner, avoiding investments which present unnecessary risk5.
An analysis of these key investment duties was undertaken in the English decision of Cowan v Scargill [1984] 3 WLR 501, which concerned the investment considerations of a coal-mining pension fund. The issue before the court derived from the nature of the pension, which was to provide retirement income for British coal mine workers, and the broader investment strategy for the pension fund. The principle question was whether trustees of the pension fund could refuse to make investments that would directly compete with the coal mining industry and potentially lead to a decline in work for the coal miners paying into the same pension fund. It was held that trustees have a duty to maintain or increase trust assets by investing to produce a maximum financial return, irrespective of all other considerations such as ethical concerns or even the long-term impacts investments might have on an industry in which the beneficiaries have or had a direct interest.
This rule in Cowan v Scargill was held to be applicable to all types of trustees (including pension trusts and discretionary trusts), and the judgment found there was no material difference between the fiduciary duties owed by trustees of a pension fund or charity, and those owed in respect of private or family trusts6. While Cowan v Scargill remains good law, it appears more recent authorities have clarified that it should not be taken to mean trustees are prohibited from considering non-financial factors in their investment strategies. Instead, to the extent such factors exist, it is open to trustees to do so but in a balanced way, taking into account both the financial and philanthropic objectives of the trust.
This balancing act, and the inherent tension which it places upon trustees, was recently discussed in the High Court of England and Wales of Butler-Sloss & Others v Charity Commission for England & Whales & Another [2022] EWHC 976 (Ch). That case concerned the management of charitable trust funds7. The court was asked to determine whether the trustee of a charitable trust, constituted with the principal purpose to protect the environment and alleviate poverty, should be able to adopt an investment policy which excludes many potentially profitable investments because the trustees consider that they conflict with the trust’s stated purpose.
The judgment delivered in April 2022 has helpfully clarified the position and set out the following principles for trustees to consider when making investment decisions:
1. The starting position is that a trustee must first and foremost abide by the terms of the trust instrument, and any relevant legislation, which govern its powers of investment8. Where a trustee is prohibited from making specific investments by the terms of the governing instrument, they cannot be made9.
2. A trustee has a paramount duty to make investments with a view to maximising financial returns, a fundamental objective of any trust. In discharging this duty, a trustee must not only consider a number of factors, including the suitability of the investment and the need for diversification but it must also take appropriate advice to ensure that it achieves the best financial return at an appropriate level of risk for the benefit of the trust and its purposes10.
3. However, a trustee also has an overarching duty to further the purpose of the trust, and exercise any investment strategies in a manner that align with these purposes11. A trustee should factor in non-financial considerations to ensure investments do not conflict, directly or indirectly, with the trust’s purpose. This will mean a nuanced exercise by trustees of balancing the need to comply with the trustee’s overarching fiduciary duty to maximise returns while still meeting the auxiliary goal of not compromising the trust’s purpose12.
4. Where the trustee is of the reasonable view that particular investments potentially conflict with the trust’s purpose, the trustee has a discretion as to whether to exclude such investments and should exercise that discretion by reasonably balancing all relevant factors including, in particular, the likelihood and seriousness of the potential conflict and the likelihood and seriousness of any risk of financial detriment flowing from the exclusion of such investments13.
While the issue of a trustee’s approach to this difficult balancing exercise has not yet come before the Cayman Courts, it is anticipated that it is only a matter of time before judicial guidance is sought. When it is, it is likely that the Cayman Court will consider persuasive the principles discussed in Butler-Sloss and, as a result, Cayman trustees would be well advised to properly understand the proper application of those principles when grappling with the question of ESG investing.
Ogier’s dedicated Sustainable Investment Consultancy supports trustees, foundations, family offices and philanthropists, among others, who are seeking to ensure that the structuring and investment of private wealth has a positive impact from an environmental and/or social perspective. We understand the interaction between fiduciary duties and the sustainable investment of private wealth. We create solutions for clients seeking to incorporate ESG considerations into existing private wealth structures or establish private wealth structures with ESG, sustainable or impact investment objectives.
1 The term ESG was first used by the United Nations: United Nations Environmental Programme A legal framework for the integration of environment, social and governance issues into institutional investment (Freshfields Bruckhaus Deringer, October 2005). The following year in April 2006, ESG factors were required to be incorporated in the financial evaluations of companies listed on the New York Stock Exchange.
2 As of March 2021, the PRI has over 4,800 signatories to the framework across 80 countries. By signing up to the PRI, investors agree: “to act in the best long-term interest of their beneficiaries and, as part of this fiduciary role, recognise the importance ESG factors have on investment portfolios.”
3 Cowan v Scargill at p 515C.
4 At p 513D and p 516G.
5 Learoyd v Whiteley [1887] UKHL1 at 733 per Lord Watson: “Businessmen of ordinary prudence may, and frequently do, select investments which are more or less of a speculative character but it is the duty of a trustee to confine himself to the class of investments which are permitted by the trust and likewise to avoid all investments of that class which are attended by hazard.”
6 Cowan v Scargill at p 516G.
7 Butler-Sloss and Others v Charity Commission for England and Wales and Another [2022] EWHC 974 (ChD).
8 At [78(1)].
9 At [78(5)].
10 At [75(3)].
11 Charities have no beneficiaries, they are trusts for a public benefit purpose. The overriding duty of charitable trustees is to further the purposes of the charity. Harries v Church Commissioners for England [1992] 1 WLR 1241 at [45]-[46] (and p.124A) citing Children’s Investment Fund (UK) v Attorney General [2022] AC 155 at [50], [78] and [200].
12 At [75(2)].
13 At [75(6)].
