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Charities and ethical investments: what is the balance between responsible investing and producing a return?

  • United Kingdom
  • Corporate

29-06-2022

Charities are established with purposes and values which have moral and ethical foundations. They seek to improve the world we live in, particularly by meeting the public benefit requirement. Where they have surplus funds, trustees of charities have a responsibility to decide on an approach to the investment of these funds, including whether to adopt an ethical approach.

With the current climate crisis and the focus on ethical supply chains as a result of issues such as modern slavery, many charities have been reviewing their investment portfolios and considering the ethical nature, or otherwise, of their investments.  Ethical investments are described by the Charity Commission as investments which reflect the charity’s values and ethos, and which do not run counter to its aims.

The typical example is charities deciding to exclude investments linked to fossil fuels, animal testing, armaments or tobacco, or excluding companies or suppliers which operate against the charity’s values. The trustees must be clear about the reasons why particular sectors or businesses are excluded, and balance any risk of lower returns against the potential risks of alienating supporters or damaging the charity’s reputation.

What does the law say about ethical investing?

The leading case in this area until recently was Harries v The Church Commissioners for England [1992], widely known as the Bishop of Oxford case. The judgment stated that the purposes of a charity are ordinarily best served when the “maximum return” is sought from investments made. However, the judgment also recognised that in rare cases, where the objects of the charity conflict with certain investment types, the trustees may not invest so long as that decision would not involve a risk of significant financial detriment.

A more recent case in the High Court (Butler-Sloss and Others v Charity Commission for England and Wales and another [2022]) provided further guidance on the investment powers of charity trustees in considering environmental, social and governance (ESG) factors. The High Court declared that charity trustees were permitted to adopt a policy that aligned their charity’s investments with the charitable purposes. The case in question involved prioritising the Paris Agreement climate outcomes, even though such an approach risked reducing financial returns.

This case provided a helpful clarification on the law in respect of the ability of trustees to consider ESG factors when making investment decisions. In the judgment, it was held that the Bishop of Oxford case did not establish an absolute prohibition on making investments that directly conflict with a charity’s purposes and trustees have discretion when exercising their powers of investment.

Interpretation of the legislation in this area was also clarified. Section 3 of the Trustee Act 2000 sets out the general power of investment of trustees of unincorporated charities (and is usually expressly mirrored in the governing documents of charitable companies and charitable incorporated organisations), but trustees also have a primary and overarching duty to further the purposes of the charity. The standard investment criteria that must be considered is set out within section 4 of the Trustee Act 2000, and this includes the suitability of the investments and the need for diversification. (It should be noted that social investments are usually made using separate statutory powers.)

When investing, trustees must take appropriate advice to produce the best financial return at an appropriate level of risk for the benefit of the charity and its purposes. Provided that the trustees undertake a proper balancing exercise between the extent of potential conflict against the charity’s purposes and the risk of any financial detriment, and adopt a reasonable and proportionate investment policy, they will have complied with their legal duties. Trustees must be careful in making any investment decision purely on moral grounds as among the charity’s supports and beneficiaries there may be different moral views on issues.

In 2011, the Charity Commission released guidance CC14 (accessible here) which, at section 3.3, sets out whether a charity can decide to make ethical investments. The guidance sets out that a charity can decide to invest ethically, even if it means that the financial rate of return is lower than a different investment may provide. However, the trustees must be able to justify why it is in the charity’s best interests to invest in that way.

The Charity Commission received feedback from a number of charities that the current guidance does not provide trustees with enough assurance that they are able to make responsible investment decisions. A consultation has taken place and the guidance is currently under review. The 2022 case (discussed above) provides clarification on the law in this area and the Charity Commission should release the final revised guidance later this year. The draft updated guidance can be located here.

Is there a significant shift towards charities investing ethically?

The Charity Commission’s draft guidance highlights a number of ways that charities may make ethical investments, including:

  • negatively screening: avoiding investment in companies or sectors engaging in specific activities which are harmful to the charity’s own interests;
  • positive screening: investing in portfolios of companies or sectors supporting the charities values; or
  • stakeholder activities: where the charity (as a shareholder) exercises its voting rights to influence a company’s policies which reflects its ethos and values

It is clear that making responsible and ethical investments is becoming increasingly important to charities and their trustees. The updated guidance from the Charity Commission will state in clear terms that charities are able to make ethical investment decisions, reflecting the recent High Court decision, so long as they align with a charity’s ethos and purpose. The trustees must also be able to prove this, meaning it is important that meetings and discussions regarding the choice of investments are sufficiently and accurately recorded, and a thorough decision-making process is followed. The High Court judgment, alongside the forthcoming updated guidance on this area, will assist in reassuring trustees that they are able to invest in a responsible and ethical way which reflects their charity’s aims.