Historically, the duties of trustees were clear: trustees were trusted to administer land and property whilst the settlor (typically a knight) was off fighting a war!

Between then and now lie hundreds of years and the concept of trusts and the duties of the trustees have evolved. However, the fundamental principle has remained – trustees must always act in the “best interests” of the beneficiaries of the trust. When interpreting those magical two words, the trustees’ duties are, like fiduciary duties, typically interpreted to be financial benefit. Most trustees will operate on the basis that “best interests” means maximising financial return for the appropriate level of risk.

Global crises need global solutions

The question is, given the global climate crisis, biodiversity loss and rise in pollution, that have changed our world as we know it, should trustees consider the impact of these forces on the interpretation of their fiduciary duties? What responsibility should trustees be taking to address these challenges but also what opportunities does this present?

It is crucial to look at the level of risk the trustees are facing, and the type of assets affected.

It is now commonly accepted that failure to act on the climate crisis represents an existential risk across our society, the natural environment, and the global economy. The Paris Agreement, as adopted by 195 supporting countries in 2015, aims to keep global temperatures to well below 2°C above pre-industrial levels by 2100 and strives for a maximum 1.5°C rise in the overall global average. To achieve these levels, global greenhouse gas (GHG) emissions need to be halved by 2030, we need to reach ‘net zero’ around the mid-century and effectively be carbon negative as we approach 2100. The scale and speed of the transition needed is unprecedented and will require rapid and far-reaching transitions globally. Furthermore, even if temperatures are limited to 1.5°C, significant investment to adapt to the physical, societal, and environmental impacts of the climate change will be needed.

According to the McKinsey Global Institute, to reach net zero over the next 30 years, US$9 trillion of finance will be required annually to support energy and land use systems as part of the net-zero transition and governing bodies are clearly not able to finance this on their own. The current estimated financing gap is between US$3-US$5 trillion per annum. Thankfully, many global corporations have become alive to their responsibilities and have begun to re-engineer business models, policies, and frameworks. McKinsey’s 2022 report on ‘the net zero transition’ confirmed over 1,045 companies have already committed to science-based targets for emissions reduction, representing available market capitalisation to the tune of €20.5 trillion. As such, the drivers to achieve climate neutrality are now an unstoppable force within many corporate sectors globally.

But governmental and corporate capital do not go far enough. The need for private capital to contribute to this challenge has never been clearer. A significant component of private capital sits in trusts.

A long term view

Most private client trusts are typically set up with a long-term view as they serve as succession planning vehicles that should span generations. By extension, in fulfilling their duties, trustees should take a long-term view on the existing assets within those structures. These assets are invariably located all over the world. As we know, climate events are not limited to specific countries, and they can strike suddenly with material impact to lives and assets. When monitoring or acquiring trust assets, it seems logical to consider the impact of climate change on them.

The World Economic Forum’s 2021 ‘Global Risks Report’ places climate action failure in the top two risks by likelihood and by impact over the next 10 years, with extreme weather events being the top risk by likelihood. Environmental and biodiversity issues are less visible to those of us living in cities, but the science is showing the shocking scale of destruction. 

The insurance market has been, for many years looking at climate risk as a material component of the spectrum of factors that can lead to loss. In 2017 the insurance giant AXA warned that a 4-degree Celsius warming would make the world “uninsurable”. The 2018 UN report noted that increases at such levels would lead to intense heatwaves, risking sea levels and loss of wildlife. Worryingly, the latest figures from the EU climate service announced that 2023 marked the first year where global warming exceeded 1.5C across an entire year.

It is therefore surprising that these risks are not discussed more by trustees in the context of asset investment and fiduciary duties. The impact of climate change will inevitably have a marked effect particularly to dynastic structures.

The trustee’s dilemma

The dilemma for trustees is currently that not all impact investments deliver a financial return, at least not short term, and that the traditional interpretation of “best interests” in the trust context linked to a financial benefit does not necessarily match the evolved needs and expectations of the next generations.

There is currently a lack of suitable case law to guide trustees through this dilemma, answering the question as to whether impact investing without any financial return can be made under a standard discretionary trust. The available case law is either very outdated (Re Clore’s Settlement (1966)) and was therefore not able to consider today’s issues or was not made in a standard discretionary trust scenario (Butler-Sloss/the May Trust case).

Some trustees argue that there is no need for change and that sustainable and impact investing do not need to be incorporated as part of a standard discretionary trust. Existing vehicles such as charitable and non-charitable purpose trusts are often considered as a more than sufficient way to cover the revolutionised needs of the next client generation. Charitable and non-charitable purpose trusts are established and have ample guidance and case law to direct trustees in relation to philanthropy and charity. However, a charitable trust will cater only for the charitable purpose but is not set up for the benefit of the private client family.

The clients’ expectations

There is momentum from a growing number of beneficiaries to be doing good with the family wealth and trustees need to be positioned to cater for this ask. These families put immense value on their reputation. Society expects such families to do good in their communities and these families recognise this responsibility. They do not wish to segregate their trust assets. Instead, they want their wealth to be seen holistically and for it all to be applied in satisfying that responsibility.

We are also seeing a shift in society (particularly the younger generations) away from capitalism towards a more socialist stance and populism. When considering the reputation of the family, the legacy they wish to leave behind, and the sentiments of their heirs who may feel conflicted about inheriting wealth that was not generated or deployed in a way they consider ethical, it is difficult to justify divorcing the needs of the planet their children will inhabit from the wealth they will inherit, even within the reductive definitions of “best interest”.

While differences of opinion may prevail for some (particularly along generational lines between settlors and beneficiaries), for the majority of settlors, the most important driver is to create a stable future for their children. Against the backdrop of an escalating climate crisis, and the urgent need for capital to both stabilise the crisis and evolve infrastructure to adapt to a new normal, the interest of many private clients appears no longer purely financial, but also the prevention of climate escalations that will otherwise lead to an unstable existence on a crisis-riddled, inhospitable world beyond repair.

Proactive trustees

In the absence of legislation or evolved case law but with the undeniable evolution of thought, scientific understanding, sentiment and the environmental and social contexts surrounding non-financial “best interests”, trustees will need to tread carefully, working closely with clients to understand their priorities and documenting these meticulously. They will also need to exert care in the selection of investment and other asset managers to ensure that they are authentic and comprehensive in their operations, not merely paying lip-service. New legal frameworks, standardisation of reporting and greater transparency that are currently being developed will assist trustees to make informed decisions and cater responsibly to the needs of their clients.

In the meantime, we have identified a number of steps trustees can take to prepare themselves for the sustainability revolution which you can find in our recent article, ‘Why ESG is old news‘.

We have also partnered with Equilibrium Futures to develop the first ever Sustainable Finance training course dedicated to International Finance Centres. This eight-module video series is led by global though-leader and sustainability expert Andrew Mitchell. Designed with a focus on IFCs like Jersey, the course addresses the specific needs and challenges faced by professionals operating within these financial centres. As the global demand for sustainable finance continues to surge, this comprehensive training programme provides a unique opportunity for financial professionals to enhance their expertise and stay ahead of the sustainability curve. Discover more about the course here.

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Sources:

Bronwyn Clare (2021). Insurance industry must align to Paris Agreement, starting now. Cambridge Institute for Sustainability Leadership (CISL).

Mark Poynting (2024). World’s first year-long breach of key 1.5C warming limit. BBC News.

Grant Thornton (2023). ISSB sustainability symposium – what happened? Grant Thornton Insights.

Jersey Finance (2021). Virtuous Circles: Sustainable Family Governance Models in an Evolving Environment. Jersey Finance Research Report.

If we look for guidance on how trustees should manage their fiduciary duty a useful reference source can be found in the United Nation’s principles of responsible investment (PRI). This is a recognised global framework within the wealth investment space for responsible investment. The United Nations PRI published an index study in 2019 with the title “Fiduciary Duty in the 21 century”. In this report it states that “ESG issues are a financially material factor which have become a core characteristic of a prudent investment process.” The report argues that ESG standards should be incorporated into regulatory conceptions of fiduciary duty. It even goes a step further and states “investors who fail to incorporate ESG issues are failing their fiduciary duties and are increasingly likely to be subject to legal challenges.”

The investment community now commonly regard ESG as a risk-based tool in line with these PRI requirements. It is hard to argue why trustees should not consider investing in the same way. In fact, trustees will have to face up to the real financial risk of not incorporating strategies to protect trust funds from ESG failings, be they in the underlying assets or in the managers appointed to do so. The transparency coming from the financial reporting will give beneficiaries visibility on such aspects and thereby arm them to challenge trustees. As carbon pricing becomes more standardised, those investment portfolios which hold high carbon industries could face valuation issues or risk becoming wasting assets.

Some trustees and investment managers have begun to steer away from classifying their portfolios as ESG mandates. The term “ESG” has faced some headwinds and is now even considered “old news” in some quarters. The reasons for this include:

• With greater transparency from corporate reporting, arguably an unintended consequence of the term “ESG” is that a fossil fuel company can have a better ESG score than a manufacturing meat free company with lesser emissions. For example, in a scenario where despite the latter business being clearly better for the environment, it fails to keep up to the high scoring of the “S” and “G” attributes.
• Reporting transparency has also led to the identification of investment firms who have been “greenwashing”. The selection of such a firm is complicated not least due to the lack of appropriate benchmarks. This poses a risk to trustees who have not done their due diligence to understand the difference between an authentic ESG manager and one who is not.
• The oil and gas crisis arising from Russia’s invasion of Ukraine led to a shift back to fossil fuel investments as these increased in value under the supply/demand economics. The net result was that for a short period ESG investment performance suffered. Investment managers naturally veered away from this. This underperformance has now reversed but the sentiment remains.
• In the US, the ESG debate has become a political hot potato and unfortunately that has polarised opinions.
• The adoption of ESG as a risk screen has become so widespread amongst the investment community it could be argued that it has become normalised into their operations.

With this in mind, private capital has started to gravitate towards impact investments. Investors want better visibility on how their capital can directly address some of the global climate crisis challenges. Many also recognise the potential for financial upside in these investments. Often this deployment of capital is in the form of Private Equity/Venture capital. The focus is on repairing the damage to the world and preventing further damage from happening. They aim to generate specific beneficial social or environmental effects. Impact and financial return are not mutually exclusive and there is a growing likelihood of impact investments bringing above market returns.

On the back of the United Nations Climate Summit meeting (known as COP) government funding is being re-directed towards such investments, and we are starting to see this with private wealth too. Some investors are now asking their trustees to make such investments.

This presents an opportunity to yield significant financial (and other) returns by investing now in businesses that solve some of these global challenges. This is evidenced in the growing willingness from family offices to invest capital in philanthropic and climate crisis driven initiatives. It is estimated that wealth between $30-$40 trillion is set to transfer to Gen X and millennial generations over the coming decades. The reality is that it is the next generation that will have to live with the environmental and climate consequences caused by the current and prior generations. Unsurprisingly they will want to see their family capital being deployed to improve their lives and their “best interests” will extend beyond wealth to also encompass living on a habitable and stable planet.

Some trustees prefer not to hold such investments and would rather make a distribution to the beneficiaries to enable them to make the investment in their own names. The “distribution route” still leaves the question as to whether such a decision taken by a trustee is “in the best interest of the beneficiaries” – there is a high likelihood of tax consequences or asset protection issues coming into play by doing this – potentially leading to a net financial loss for such beneficiaries.

The position becomes further complicated where, within some families, some members of the founder generation are not in favour of ESG/Sustainable or Impact investments and where there is a divergent view on such investments within a family the trustee dilemma is heightened. Some members may also not appreciate the trustees making decisions based on what could be perceived as a moral position of another beneficiary.

So, what do high-net-worth families and individuals looking for both future wealth planning and sustainable investing at the same time do? Do they consider two trusts? One being a purpose trust and another discretionary trust, but the latter does not carry out pure impact investing. It is fair to say high-net-worth families and individuals have been disappointed by the lack of flexibility.

Another issue with impact/sustainable investments is that trustees struggle to monitor them without adequate benchmarking metrics. This risk will wane with better regulation and reporting, both of which are now coming through thick and fast. That transparency has shaken up the ESG market and is being effective. It is worth noting that some beneficiaries are not overly concerned by this lack of industry standardisation as they can often have direct visibility on the impact their family wealth is having on the underlying project.

The wave of international regulation, reporting and best practices that will inevitably come to trust law jurisdictions should provide clarity but considering these anticipated changes, trustees need to have their businesses ready for this and have the knowledge and the reporting tools to do so for the assets under their care.

Here are some ideas trustees can implement to prepare themselves for the sustainability revolution:

• Documenting the clients’ wishes and views relating to sustainability and impact as much as possible in a letter of wishes, a carefully crafted investment policy statement or a family mission statement.
• Reviewing standard trust instruments carefully to include sustainability and ESG wording, to exclude the trustees’ duty to preserve and enhance the trust fund.
• Similarly devolving trustees’ duties and powers on specialist investment managers in the Trust Deed will give trustees more comfort.
• To delegate certain of the trustees’ powers to sustainable finance specialists.
• Including Anti Bartless clauses in the Trust Deed can also help with this.
• The letter of wishes can also set out the intention of the settlor/s to fulfil a purpose.
• A carefully crafted investment policy statement.
• Use of foundations, charitable or non-charitable purpose trust.
  

As always, if trustees thoroughly document their decision making, adopt a broad and holistic view as to what benefit encompasses and adopt prudence in the appointment of investment managers, or indeed in deploying capital, the perceived risks around impact/sustainable investing diminish. The time to embrace this is now. If not, we risk being assessed on today’s decisions in the years to come and it will be hard to argue against the challenge when the consequences of non-sustainable investments being included in portfolios are already well known – the current climate risks are well reported.

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Sources:

Bronwyn Clare (2021). Insurance industry must align to Paris Agreement, starting now. Cambridge Institute for Sustainability Leadership (CISL).

Mark Poynting (2024). World’s first year-long breach of key 1.5C warming limit. BBC News.

Grant Thornton (2023). ISSB sustainability symposium – what happened? Grant Thornton Insights.

Jersey Finance (2021). Virtuous Circles: Sustainable Family Governance Models in an Evolving Environment. Jersey Finance Research Report.

With the largest wealth transfer in history afoot, involving an estimated USD84 trillion being passed into the hands of younger generations between now and 2045,[1] it is prime time for trustees and families to focus on building relationships with the next generation and to concentrate on generational wealth planning.

Although most businesses focus on succession planning and the next generation, many families miss this opportunity and can often be left rudderless when a patriarch or matriarch dies. Regrettably, the saying ‘clogs to clogs in three generations’ still holds true for many families.

Engaging clients to help prepare for and facilitate these conversations may aid in bridging the intergenerational communication gap and preserving wealth across generations. Although traditional estate planning focuses on the mechanics of transferring wealth, what is often overlooked is whether the infrastructure to sustain wealth exists.

Mission statements and family constitutions

The lack of communication that hinders most wealth transfers can be alleviated by the preparation of a mission statement. Mission statements generally reinforce values, purpose, priorities and goals, ensuring that the family is aligned in these areas. The act of coming together to draft and agree a mission statement is, for many families, a valuable exercise in building trust and confidence. Families might also consider preparing a constitution, which is a document that sets out the family’s objectives and governance structures to determine how important decisions will be made. Knowing that the younger generations will be guided by a commonly agreed mission statement or family constitution can be reassuring.

Observers and financial literacy

Access to conversations about family wealth should be seen as distinct from tangible access to wealth, which comes with the inevitable concerns of demotivation for the next generation. An invaluable way in which to enhance an adult child’s financial literacy is to allow them to become observers on boards or investment committees. The right to participate in meetings, take part in discussions and provide input can prove extremely beneficial. This is especially significant when considering that the primary reason cited as a cause for concern when considering a business transfer was that the next generation was not ready.[2]

Sustainable investing and ESG awareness

Including the next generation in investment decisions may have a positive impact on financial returns due to their interest in ever growing sustainability and the environmental, social and governance (ESG) space. This is an area where the next generation could bring something to the table, as they can be more aware of the issues in this space than their parents might be. The next generation are prioritising sustainability, inclusivity and transparent ESG metrics. Further, the next generation are particularly in tune to where assets are likely to become stranded as the world moves away from, for example, fossil fuel investments. Impact investing has graduated from being solely the domain of socially conscious individuals to being on the radar of those seeking top financial and other returns. Now, more than ever, incorporating sustainability thinking into one’s investment decisions is vital and many of the next generation are perfectly poised to provide valuable input on this subject.

Digital acumen

Many of the next generation have amassed knowledge in areas with which the existing generation may not have experience, such as cybersecurity, digital assets, artificial intelligence, machine learning, digital transformation and social communication. Capabilities in these areas can enhance operational efficiencies and, in some cases, are critical in order to remain competitive.

The future

As the stewards of wealth and legacy, advisors’ focus should be concentrated on educating and involving the next generation, and the support of a trust company business in the education process can prove invaluable. Sustainable success for family legacies will only be possible if the transition process is thought through and embraced as early as possible. The next generation can often bring fresh perspectives and innovative approaches that will better position family businesses for long-term success. Although many view the great wealth transfer with trepidation, with the right planning it will provide ample opportunities for success.

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[1] The Cerulli Report—U.S. High-Net-Worth and Ultra-High-Net-Worth Markets 2021: Evolving Wealth Demographics

[2] Family Enterprise Foundation—Preparing the next generation: A family business roadmap

‘Riding the wave’ article first published in the STEP (Society of Trust and Estate Practitioners) Journal – Issue 3 2024