With a step-change afoot in the ESG investment space, settlors and beneficiaries are increasingly demanding that trustees take exclusion-criteria and sustainability-themed or impact approaches to investment. This article considers what challenges this poses for trustees of private family trusts and what options are available to mitigate these risks, including the use of non-English law structures.
In England, trustees are required to preserve and safeguard trust assets and follow statutory rules relating to the exercise of their investment powers, although these duties can be restricted or excluded by the terms of the relevant trust deed.
In the case of new trusts, flexibility can be baked into investment powers at inception. The trust deed can 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. In this way, trustees may be permitted to avoid certain sectors or asset classes such as arms or gambling companies or invest in riskier asset classes where the trust deed permits them to do so.
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.
However, ESG investment can leave trustees vulnerable to claims from disgruntled beneficiaries who regard ESG considerations as irrelevant. That is because trustees are required to put aside their own views on ESG issues and seek maximum financial return from their investments by way of income or capital growth. For example, claims could be made against trustees that ESG considerations have dinted investment performance when compared to an alternative investment approach and the trustees should be liable for the loss.
Such concerns can be allayed in the case of new trusts, or where it is possible to vary the terms of an existing trust by the trust deed providing that trustees have no liability for loss due to the acquisition and retention of ESG investments corresponding to a particular description.
Existing trusts, however, are less straightforward, particularly where there is no power to vary their terms as 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.
In such cases trustees may want to seek releases or indemnities from beneficiaries in respect of potential claims relating to an ESG investment approach. Indemnities, however, can be of limited benefit in practice, for example, as the indemnifier may no longer have the required assets to meet their obligations under the indemnity.
Taking The Beneficiaries' Views Into Account
Under English law, 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.
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.
Use Of Non-English Law Structures
Where new trusts are being established, families and trustees might also consider the flexibility and protection afforded by mechanisms and structures in certain non-English law jurisdictions.
Cayman Islands law “STAR trusts”:
A Cayman STAR trust can have either beneficiaries or purposes (or both) and is therefore well-suited to ESG investments. The trust can have the specific purpose of making ESG investments within certain defined parameters, allowing the trustees to invest, shielded from criticism, as long as the investments are permitted under the terms of the trust. An enforcer, which can be the settlor or a corporate entity controlled by family members, ensures the trustees give effect to the terms of a trust, affording the family an element of influence and direction over the trust. Nevertheless, the beneficiaries have no inherent ability to claim against a trustee in a STAR trust, nor can they force the trust to be wound up in a Saunders v Vautier style action.
Foundations can have advantages over certain trusts when it comes to holding speculative or high-risk assets. That is because, in contrast to most trusts where trustees are generally required to invest a trust fund prudently, a foundation must be administered in accordance with its purposes. This can allow for the holding of specific assets for beneficiaries, making them potentially suitable for ESG investments, particularly where there is a risk of criticism that investment profits have suffered due to a particular ESG investment approach. In addition, foundations, like STAR trusts, can (but are not required to) have beneficiaries.
Non-charitable purpose trusts:
Non-charitable purpose trusts established in jurisdictions such as Jersey or Guernsey may also be an option for ESG-minded settlors. A non-charitable purpose trust has no ascertainable individual beneﬁciaries and instead has specific purposes which need not be charitable and so can be related to ESG investment. An enforcer, who is separate from the trustee, is required to enforce the trust in relation to its non-charitable purposes.
English non-charitable purpose trusts on the horizon?
England may soon have its own non-charitable purpose trusts. 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.
Reserved powers trusts:
In many offshore jurisdictions, a trust can be created with powers reserved to a third party who can then direct the trustee as to its investment decisions. In this way, the trustee could be directed to make an investment by the reserved power-holder, such as an investment committee, and the trustee would be relieved from any liability associated with following that direction.
Private Trust Companies:
Another way for a settlor and his family to exert influence over a trust’s ESG investment strategy is via a private trust company which acts as trustee and whose board comprises family members. However this can add costs to the structure, especially where the shares in the trust company are owned by a purpose trust.
ESG Going Forward
Trustees will need to keep adapting their approach to ESG investment and communicate with families about the issues impacting trustees and family stakeholders alike. Ultimately, how trustees should pursue an ESG policy will be a question of balance and degree, as is so often the case when it comes to trustee investing.
Matthew Radcliffe TEP
Matthew provides advice to offshore, onshore and multi-jurisdictional individuals, families, trustees and beneficiaries regarding taxation, trust and estate planning matters. He is familiar with devising and coordinating tax and estate planning across a number of jurisdictions and in particular specialises in tax and estate planning where there are US, UK and Canada cross-border issues. He also has expertise in advising on the UK tax treatment of foreign entities including foundations and trusts and UK residential property holding structures.