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01 October 2020
Can trustees invest to address the threat of climate change?
Will focusing on climate change have a detrimental effect on investment performance?
What are the other risks posed by ignoring climate change?
What steps should trustees be taking?
How should trustees identify their asset strategy?
Climate change will no doubt continue to be a worldwide concern and will affect everyone. The science is clear and reinforced by the extremity and increasing frequency of recent climate-related disasters such as typhoons, floods, droughts and wildfires.
BlackRock, the world's biggest fund manager, has put climate change and sustainability at the heart of its strategy, doubling the number of green funds in which it invests and curtailing its investments in coal companies. In the world of investment, there is growing momentum for change, with investors calling for their money to make a positive impact on society and the world at large.
Generally speaking, a Jersey trustee's powers of investment are wide. Article 24(1) of the Trusts (Jersey) Law 1984, as amended (Trusts Law), states that a trustee of a Jersey trust enjoys all of the same powers as a natural person acting as the beneficial owner of such property. However, this power is tempered in two regards – namely, the trustee may exercise such powers only in the interests of the beneficiaries and only in accordance with the terms of the trust. Historically, beneficiaries' best interests have been considered their best financial interests.
If a settlor, when establishing a trust, wishes for the trustee's investment outlook to be bound by concerns about the climate, the trust instrument can be adapted accordingly. For example, certain express provisions can be included prescribing an investment outlook which is sensitive to carbon emissions.
Alternatively, settlors can reserve certain powers to direct investments as set out in the Trusts Law. Article 9A of the Trusts Law provides that a trustee acting in accordance with any direction given would not be acting in breach of trust. This could, for example, assist with mitigating the risk for a trustee in respect of environmental, social and corporate governance or impact investing which may lead to below-market returns.
If beneficiaries of an existing standard discretionary trust, without the kind of bespoke provisions referred to above, approach a trustee to request that their investments do not contribute to global warming, the trustee must carefully consider such requests in the context of their investment duties. When it comes to the choice of investments, as regards the general duty of care expressed in Article 21(1) of the Trusts Law, the draftsperson seems to have had in mind the ordinary, prudent business person. In other words, the trustee should take the same care as an ordinary prudent person would when making an investment for the benefit of other people for whom they feel morally bound to provide.
The starting point is that there is no absolute duty as to what an investor should or should not invest in. Consistent with the prudent investor is the emphasis on good process which, in the context of addressing the risk of climate change, means the trustee using a framework to evaluate climate risk in terms of its investments.
It is often assumed that an investment strategy which considers environmental factors will not be as lucrative. However, more and more financial forecasts are pointing towards climate change as being not only an ethical issue, but also a pure financial consideration for trustees.
A 2018 Cambridge University study suggested that $1 trillion to $4 trillion of value could be lost from the global economy in the next few decades from fossil fuel assets alone. In addition, the Bank of England has started paying attention to the problem of 'stranded assets' (ie, investments in carbon-intensive assets and industries that risk being caught in a downward spiral of falling valuations and fire sales). The Bank of England has estimated as much as $20 trillion of assets may be at risk of stranding and has proposed climate-related stress tests for banks and insurers.
People are increasingly wanting to understand how their money is being invested and whether such investment is consistent with stabilising the climate. The funds industry has always strived to maintain the highest standards of professionalism. However, a potential risk is that trustees are held accountable in the future for failing to treat climate change as a relevant consideration when acting in the best interests of beneficiaries.
A pragmatically broad concept of 'benefit' has been taken in the authorities in connection with the exercise of a trustee's dispositive powers under a trust, including being able to consider a beneficiary's moral wellbeing. It is not that much of a stretch of the imagination to see such an analysis being applied to investments.
If a trustee deems it in beneficiaries' best interests to decarbonise their investment strategy, what steps should it be taking? The standard for judging whether a duty has been breached under the Trusts Law is that of a reasonable trustee.
Therefore, there is no automatic liability if, with hindsight, the wrong decision was reached when deciding whether to invest if, at the time of such investment, the trustee acted reasonably. The courts accept that there is not always one way for a trustee to act. However, given the law's emphasis on trustees' actions being viewed through the lens of investment performance, trustees should carefully record the considerations that have been taken into account in giving weight to climate risk in determining investments.
When dealing with investments, a trustee will typically delegate the functions of administering assets to an investment manager. It is good practice to have an investment policy statement in place from the outset of any delegation. Such statement will be particular to the trust in question considering the needs of the beneficiaries and the attitude to risk.
If appropriate, trustees should include in their statement their broad-based concerns about climate change and its potential impact on the performance of the trust assets. A policy of socially responsible investing may be adopted whereby pollutant stocks or potential stranded assets are actively eliminated. Alternatively, an approach may be adopted whereby it is insisted that the investment manager applies a climate risk overlay in terms of stock analysis.
Noting the continuing duty to monitor the performance of an investment manager under the Trusts Law, any statement should be regularly reviewed in the context of performance. If the statement remains unchanged, this should be noted accordingly so that files record the fact that the trustees considered the matter.
Trustees must determine how proactive they want to be and what actions they will take. The degree of concern over the impact of investments on climate change may alter with technological developments, generational changes or even just changes in the beneficiaries' circumstances.
Therefore, an incremental approach to implementation is recommended to evaluate the effectiveness of the strategy and recognise that further steps may be taken over time as necessary. Further, businesses which currently have a relatively high carbon footprint but which are high performing and developing clear solutions to carbon emissions should not be ignored.
It is said that the 2020s are a critical decade for tackling global warming. There will almost certainly be more disclosure about what fiduciaries are doing and people will increasingly want to know how their money is being invested. While there has undoubtedly been a lot of take up in terms of corporates and asset managers making climate-related financial disclosures, there is likely to be an ever-stronger spotlight on real actions taken in terms of, for example, negative screening or formal divesting of carbon-related assets. Arguably, there is a heightened duty for trustees to consider climate change issues actively as a matter of course from a fiduciary perspective. As a forward-thinking jurisdiction, Jersey has been active in sustainable finance for some time. Being a jurisdiction with a wide range of flexible structures and with the knowledge, expertise and international relationships to support them, Jersey is well placed to ensure that settlors and trustees make the right choice to suit an investment outlook bound by climate risk concerns.
An earlier version of this article was published on the Jersey Finance website.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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