Charities and responsible investment: putting your money where your mouth is

Responsible investment is an increasingly important topic for charities, given the growing public expectation that charities should consider the wider social impact of their investment strategies. Over the past 30 years there has been a significant shift in attitudes and an increasing recognition of the important role of the financial sector in meeting global challenges, such as climate change.

However, responsible investment remains an area of confusion for many charity trustees, who are concerned about the extent of their powers to adopt a responsible investment strategy, and worry about the risk of breaching their legal duties as charity trustees.

In January 2020, the Charity Commission began a “listening exercise” regarding its regulatory approach to responsible investment. Many charity trustees expressed the view that the current guidance does not provide sufficient assurance that charity trustees have the power to adopt responsible investment policies, particularly where large parts of the economy that are environmentally damaging are screened out and therefore (at least in the short term) result in a less diverse portfolio.

The Commission’s response was to publish a consultation on draft updated guidance on 8 April 2021 (the consultation closed on 20 May). Shortly after publishing the consultation, in the case of Butler-Sloss v Charity Commission [2021] 4 WLUK 58, the High Court granted permission for two charity trustees to bring proceedings to seek declaratory relief and directions in respect of their powers to adopt a responsible investment policy.

What is responsible investment?

The PRI defines responsible investment as “a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment decisions and active ownership”. However, somewhat confusingly, the Charity Commission’s definition focuses on taking into account your charity’s purposes and values:

“Responsible investment is, rather than just focussing on the financial return on an investment, taking into account your charity’s purposes and values when making financial investments.”

For some charities, particularly large institutional charities and foundations with large endowments, it can be difficult to justify a responsible investment strategy on the grounds of the charity’s objects and values.

The Bishop of Oxford case

The leading case on this subject is the case of Harries v The Church Commissioners for England [1992] 1 WLR 1241, which is widely known as the Bishop of Oxford case.

The Bishop of Oxford and others sought declaratory relief that, in managing investments, the Church Commissioners were obliged (or at liberty) to have regard to the charitable purposes of advancing the Christian faith or other non-financial considerations, in particular in circumstances where to do so would result in the making of investments which were or were likely to be financially less advantageous.

In his judgment, Sir Donald Nicholls VC drew a distinction between assets held for functional purposes and assets held for the purpose of generating money (whether from income or capital growth) with which to further the work of the trust. In respect of the latter, he commented that:

“Prima facie the purposes of the trust will be best served by the trustees seeking to obtain there from the maximum return, whether by way of income or capital growth, which is consistent with commercial prudence. That is the starting point for all charity trustees when considering the exercise of their investment powers. Most charities need money; and the more of it there is available, the more the trustees can seek to accomplish…

In most cases this prima facie position will govern the trustees’ conduct. In most cases the best interests of the charity require that the trustees’ choice of investments should be made solely on the basis of well-established investment criteria, having taken expert advice where appropriate and having due regard to such matters as the need to diversify, the need to balance income against capital growth, and the need to balance risk against return.”

He then set out the “comparatively rare” minority of cases where there might be other factors to consider.

Conflict with objects

The objects of the charity might conflict with investments of a particular type, such as a cancer research charity investing in tobacco shares. In this case, his judgment was that they “should not so invest” even if it would result in significant financial detriment (although he commented that this would be unlikely, as the exclusion of certain types of investments would not leave the trustees without an adequately wide range of investments to choose from for a properly diversified portfolio).

Alienating beneficiaries or supporters

There might be a risk that particular investments would deter supporters or alienate beneficiaries. In these circumstances, Sir Donald’s comments were as follows:

“In these cases the trustees will need to balance the difficulties they would encounter, or likely financial loss they would sustain, if they were to hold the investments against the risk of financial detriment if those investments were excluded from their portfolio. The greater the risk of financial detriment, the more certain the trustees should be of countervailing disadvantages to the charity before they incur that risk.”

On moral grounds, provided there is no risk of significant financial detriment

Sir Donald suggested that there might be instances where supporters and beneficiaries take widely different views on a particular type of investment where there are “no certain answers”. In that case, his judgment was that:

“Trustees may, if they wish, accommodate the views of those who consider that on moral grounds a particular investment would be in conflict with the objects of the charity, so long as the trustees are satisfied that course would not involve a risk of significant financial detriment.”

Governing document requirements

Finally, there might be express requirements in the governing document for non-financial criteria to be taken into account.

The Bishop of Oxford case: is it outdated?

The case is 30 years old and is arguably outdated in respect of modern investment strategies and public expectations of charities. In addition, there have been a number of key legislative developments since then. In particular, the Trustee Act 2000 (which applies to charitable trusts) provides a general power of investment, but includes no express duty to maximise returns, and s172 of the Companies Act 2006 (which applies to charitable companies) includes a duty to “have regard to the impact of the company’s operations on the community and the environment” and “the desirability of the company maintaining a reputation for high standards of business conduct”.

More recently, the Charities (Protection and Social Investment) Act 2016 introduced a new statutory power for charities to make social investments, which came into force on 31 July 2016. This new power is particularly noteworthy, because it confers an express power for charity trustees of all types of charities to make investments “with a view to both (a) directly furthering the charity’s purposes; and (b) achieving a financial return for the charity”. A “financial return” in this context is achieved merely by the outcome being better than simply expending the assets.

During the House of Lords debates on the 2016 Act, Lord Bridges of Headley commented that:

“The power of social investment is a permissive one which is intended to encourage trustees who can see the potential of social investment but have lacked the confidence to take it further. By providing a framework in law, the power of social investment will give confidence to charity trustees to add social investment to their existing armoury.”

We have, therefore, seen several legislative developments since the Bishop of Oxford case, which indicate a shift in approach and an increasing recognition of the importance of charity trustees taking other factors into account when making investment decisions.

Charity Commission’s updated guidance: a new interpretation of the law

The Charity Commission’s updated guidance is intended to make it clearer that charity trustees do have the power to adopt responsible investment strategies. Both the revised guidance and the updated legal underpinnings state that responsible investment is a type of financial investment, and subject to the same considerations and legal duties as usual.

In order to reconcile this with the Bishop of Oxford case, the Commission draws a distinction between a charity’s general funds, and funds held subject to a duty to invest (e.g. permanent endowment funds):

“The judge’s starting point was that charity trustees may hold property for use in the pursuit of their objects (i.e. functional property) or may hold property for the purposes of generating more money with which to pursue their objects (i.e. investment property). The judge stated that trustees cannot use property held as an investment for non-investment purposes… The judge plainly assumed that there was a duty to invest the capital fund… However, in the case of a charity holding a substantial cash balance with no liabilities and no permanent endowment, the trustees are free to decide whether to invest or whether to spend. In such a case, there is simply charitable property and there is no distinction between investment and functional property… As such, given that the court in Bishop of Oxford was considering limited facts, and applying legal principles to those facts, the Commission believes that the principles… relating to responsible investment set out in the Bishop of Oxford case only apply to those charities where there is a duty to invest as set out in the charity’s governing document.”

The Commission’s revised interpretation of the law, therefore, is that the principles set out in the Bishop of Oxford case only apply to funds where there is a positive duty on the trustees to invest. This is a fundamentally different interpretation of the law to that set out in the current guidance.

Butler-Sloss v Charity Commission

In light of the uncertainty regarding the legal position, and whether or not the Commission’s revised interpretation of the law is correct, two trustees applied to the High Court for permission to bring proceedings to seek declaratory relief and directions regarding:

• the nature and scope of their powers of investment as charity trustees; and
• how they might properly discharge those powers in circumstances where particular investments or investment policies might be seen to be inconsistent or in direct conflict with their charitable objects.

The proceedings concern the Ashden Trust and the Mark Leonard Trust, both of which have as their main charitable purpose environmental protection or improvement. The trustees of those charities wish to adopt investment policies to exclude, to the extent possible, investments that are not aligned with the Paris Agreement. However, there is a concern as to whether this would be lawful and consistent with their duties as trustees, because it is likely that, in the short term at least, this policy would result in reduced investment returns.

Sian Ferguson, Trust Executive at the two charities, said:

“My trustees are unclear what they are obliged or permitted to do with their investments, bearing in mind their wish to achieve good financial returns now, and in the future for grantmaking, and not drive climate destruction through their investments.”

In granting permission for the proceedings to be brought, Mr Justice Michael Green stated:

“There is uncertainty as to the law in this area. The leading and nearly only case in this field… was some 30 years ago now, and things have considerably moved on since then in terms of both so-called ethical investment policies and the severe impact of climate change…  In any event it can safely be said that the proposed proceedings raise highly topical issues that are seemingly unresolved by legal authority. It is clear that a further judgment of the court in this area will not only provide the necessary protection to these trustees but will also provide much needed clarity to charity trustees generally.”

Specifically on the issue of the Commission’s revised interpretation of the Bishop of Oxford case, he commented:

“The Charity Commission appears to be trying to limit the Bishop of Oxford case to its facts, by interpreting it as dealing only with a charity that it says has a permanent endowment. Whether that is right or not, it seems to me that it only adds to the claimants’ application that this needs to be looked at afresh by the court.”

What happens next?

The Charity Commission is in the process of reviewing the consultation responses, many of which included criticisms that the guidance does not go far enough. However, in light of the development in Butler-Sloss, the Commission intends to await the outcome of that case before progressing the process further.

In the meantime, charity trustees wishing to adopt a responsible investment strategy may take comfort in the fact that many ESG funds are now outperforming traditional funds, which means that choosing to invest responsibly may also be the best way to maximise financial returns. For those charities looking to adopt a more restrictive approach, particularly where this might result in lower financial returns, it might be prudent to await the outcome of the case, which we hope will be later this year and will, hopefully, bring much needed clarity to this uncertain area of law for charities.

If you have any questions about your duties or powers in relation to investment, or any other matters affecting your charity, please do get in touch with Liz Brownsell or another member of the Birketts Charities Team.