21st Century Fiduciary Duty: a three step framework for private wealth practice.

Century

Fiduciary Duty

Foreword

Ocorian is committed to sustainability and is its fervent advocate.

Our objective in supporting the International Sustainability Institute Channel Islands ('ISICI') in developing this sustainability framework for fiduciaries is to find a way to encourage a wider acceptance that a new, more sutainable approach is needed in assessing our responsibilities.

The UN published its final report on 21st Century Fiduciary Duty in 2019

The fiduciary framework set out in this report by the ISICI is consistent with the thinking in that report.

Can the Channel Islands be a 'force for good' and facilitate positive change. Can practice here have global influence?

The Channel Islands have been leaders in this field, both have set out clear strategies to develop sustainable finance and are members of global UN initiatives. Guernsey created a specific regulatory regime for green funds some time ago and last year its regulator made consideration of climate change risk a requirement for Boards with revisions to its Code of Corporate Governance taking effect this year

In terms of general policies and prescription of the regulatory requirements these are minimal in comparison to those of the large onshore global centres. Mandatory TCFD based climate disclosures are required by regulators across the US, Canada, the UK and EU, Singapore, Japan, Hong Kong and Australia.

Yet, such a situation does indeed provide for an opportunity. The Channel Islands may be a global policy takers in many areas but in the arena of private wealth administration, they have demonstrated leadership many times.

Regulation of trust and corporate services providers has been in place for nearly two decades, where it still remains an unregulated sector in major onshore centres.

The Channel Islands enjoy a significant market share of the global private wealth sector. Together they administer around a tenth of offshore private wealth. With their geography, language, and, importantly, constitutional and legal status their global influence is magnified. This influence can also be amplified through the networks of the many global firms present on the islands.

We strongly believe the Channel Islands, through leadership and the adoption of the three-step framework set out in this report, can positively influence the arrangements for the $10 trillion of offshore private wealth assets administered globally.

ISICI has created a 'frame' for fiduciary professionals to use and exploit to develop their practice in line with modern fiduciary duties which incorporates consideration of sustainability and ESG issues, and in particular climate.

It is the first stage.

The next question is how best to build out the framework, ensure it becomes common practice in industry and embed sustainability thinking amongst fiduciary professionals.

We would hope that stakeholders will come together to put the flesh on the bones of the framework as suggested by the ISICI. I am committed to help drive this process and delighted with the support given by Ocorian.

Michael Betley

Global Head of Private Clients

'The Channel Islands, through leadership and the adoption of the three-step framework set out in this report, can positively influence the arrangements for the $10 trillion of offshore private wealth assets administered globally.'

is an important factor in the long-term success of a business.

as

any other issue related to the prudent management of capital,

sustainability is not only important to upholding fiduciary duty, it is obligatory.'

Our synopsis: a three-step framework

In recent times fiduciaries have been bombarded with reports, papers and articles covering a smorgasbord of sustainable finance themes: impact investing; responsible investing; ESG investing; green finance; climate finance; sustainable finance; and more.

Paradoxically, there is so much 'out there' exhorting and extolling sustainable finance and 'taking an ESG approach' to investing it has created complication and confusion. In short, it is, understandably, very difficult what to make of it all.

Not least when 2022 has seen a genuine debate about the benefits of many of the ESG approaches. Serious and credible commentators have queried the practicalities of many of the prescribed approaches.

All of this for a private wealth sector that has been through (and some might argue not yet concluded) a major debate as to whether any of this is consistent with the common law expectation of fiduciary duty.

Despite the United Nations having 'called it' in favour of the '21st Century Fiduciary Duty' some time ago, inertia prevails and exclusive focus on capital preservation and return maximisation continues to reign as the safe sensible default for fiduciary duty for many.

Furthermore, in the Channel Islands, there is an absence of the backdrop of statutory requirements that are driving developments in the onshore world. Practitioners across Switzerland, Luxembourg and Liechtenstein have formed a powerful caucus driving development through the United Nations.

This is a shame, because it is an area we believe where just a few simple steps could create genuine leadership in the Channel Islands

There was once green shoots of a movement towards promotion of the 21st Century Fiduciary Duty concept across the Channel Islands But we believe progress has become bogged down by confusion and the conflation of the topic of ESG with investment purpose. Together with a reticence to introduce new practice that some (erroneously) view as undermining the legal fiduciary duty of capital preservation.

What we believe is required to reinvigorate this movement is the articulation of a simple narrative of such duty. A straightforward, 'how to' guide, that is a framework setting out a process and procedure. One that can be explained as consistent with both this 21st Century Fiduciary Duty and the traditional common law interpretation.

We have spent the summer developing such a framework and it is presented in this report

At the conceptual level, it requires consideration of just three initial questions.

• Whether the calculation and review of climate metrics is taking place?

• Whether the risk management process of the investment process takes into ESG factors?

• Whether there are specific investment goals of the trust that relate to sustainability objectives?

On these simple foundations, this paper sets out a simple framework to help fiduciaries align with both the 21st Century Fiduciary Duty concept and traditional concept of fiduciary duty and ensure assets under their stewardship are invested according to sustainability principles and with regard to environmental, social and governance factors.

'This paper sets out a simple framework to help fiduciaries align with both the 21st Century Fiduciary Duty concept and the traditional concept of fiduciary duty and ensure assets under their stewardship are invested according to sustainability principles and with regard to environmental, social and governance factors.'

'ESG principles can all be boiled down to a few simple truths: we all have responsibilities as citizens, and we should all act ethically, and we should invest in ways that don't contribute to human suffering or the detriment of the planet that we all inhabit. Do we really need endless regulations and legislation to understand these basic facts?'

Fiona Reynolds CEO, UN PRI, 2013 2022

The cause of sustainable finance should be simple, but there is sadly much self interest and many self-interested parties sowing complexity and confusion.

What once seemed simple a concern for financing climate change mitigation or a desire to make a positive contribution to the lives of impoverished communities in sub-Saharan Africa... has morphed into a marketing driven tsunami of confusion.

Without clear guidance or an unambiguous road map, practitioners would be forgiven for feeling overwhelmed and exercising caution.

Capping it all, the regulatory community have introduced a global regulatory reporting standard on climate risk. And global accountancy bodies are working on their own climate risk reporting standard.

Three years have passed since the publication of the UN's final report on 21st Century Fiduciary Duty. Both Guernsey Finance and Jersey Finance have published assessments of issues and barriers to its practice in the Channel Islands In these years discussion has moved forward but only a little

The International Sustainability Insitute Channel Islands, with the support of Ocorian, has therefore set out to develop

and establish a framework for fiduciary professionals to use and exploit to develop working practices in line with modern fiduciary duties (which incorporates consideration of sustainability and ESG issues, in particular climate).

This framework is set out in this report.

It is simple, straightforward and practical yet comprehensive. It encompasses the broad perspectives of all the 'variants' of the sustainable finance agenda. Its purpose to guide fiduciaries along the sustainable path.

In this report we first provide a little background and describe the current environment. We begin with a brief synopsis of the key strands of sustainable finance. This is followed by a discussion of the Fiduciary Duty and climate risk, the concept of the 21st Century Fiduciary Duty (as advocated by the UN) and Fiduciary Duty and purpose.

We then discuss pros and cons of prescription versus principle-based guidelines, using the context of recent changes to the corporate governance code made in Guernsey. We then set out our proposed framework, followed by an explanation of how it is consistent with the 21st Century Fiduciary Duty concept.

We provide a little granularity to the framework, but we leave the completion of the full details to a latter stage to be completed with the involvement of a range of stakeholders

We then provide for context a discussion of the last decade of increasing regulatory burden and reporting requirements for the private wealth sector We conclude and provide some FAQs as an appendix.

'We all have responsibilities as citizens, and we should all act ethically, and we should invest in ways that don't contribute to human suffering or the detriment of the planet that we all inhabit. Do we really need endless regulations and legislation to understand these basic facts?'

Fiona Reynolds CEO, UN PRI

The scale of sustainability driven marketing in finance has become, to excuse the deliberate pun, unsustainable. The scale conflates, confuses, and sadly presents a real risk of the legitimate cause of climate change mitigation (and many others) being undermined by the questionable nature and depth of much of the material published.

Even without the hype, the subject has a capacity to confuse. A myriad of initiatives, standards, principles, and international quangos all compete to be the 'one version of the truth'. There are numerous topics and many terms, some interchangeable, some not. Together with a rapid pace of development the scale of the hype risks turning many people away.

Here we provide nothing more than a 'thirty second', 'bottom line' summary.

Climate change and green finance

Climate change and green or 'climate' finance is perhaps the simplest thread of sustainable finance to understand There are two sides to the green finance coin.

1 Climate finance: the deployment of capital to the task of climate change mitigation and adaption*.

2 Climate risk: the need to incorporate consideration of climate change on the value of physical and financial assets and to act accordingly.

Climate finance can be thought of as one part of the sustainable finance theme. Indeed, climate action is the UN's social development goal 13 Climate risk is basically the E of the ESG investment philosophy.

Determining climate risk to be so great a threat to financial markets and financial stability, regulators have seen fit to roll out a new set of global regulations in the guise of the TCFD (Taskforce on Climate Related Financial Disclosures) requiring firms disclosure how they measure and assess climate risk. Regulations first directed at global banks and insurers are now more broadly applied across fund managers and pensions funds too.

ESG and Risk

‘Sustainable investing (or, as some call it, responsible investing) isn’t anything new, but it has undergone some evolution. What started a few decades ago as a somewhat basic ethical assessment of business activity has matured into a more thorough integration of environmental, social and governance (or, ESG) factors via quantitative and qualitative assessments.’

World Economic Forum

ESG integration, commenters explain, is the consideration of ESG factors as part of prudent risk management and a strategy to take investment actions aimed at responding to those risks**.

The World Economic Forum goes on to explain that it views ESG as the consideration of ‘ESG factors’ as part of prudent risk management and strategy.

Sustainability and the 'SDGs'

The 'SDGs' are the United Nation’s 17 Sustainable Development Goals which set out targets across a range of environmental and societal objectives to be achieved by 2030.

This strand of sustainable investing broadly encapsulates the thinking that humanity cannot continue along its current path, that we consume too much of the planet’s resource and that countries and societies are too unequal and unfair Here the investment philosophy is that capital should be directed towards investments and projects that make a positive contribution to a better more 'sustainable' future.

It is this theme, discussed later, which corresponds to a sustainable trust 'purpose' .

Impact investing falls within this strand of sustainable finance where the 'purpose' of the investment is to create 'impact' as much as generate return, often attempting a measurable objective aligned with one of the SDGs. Whether or not there is a trade-off between the two is a matter for personal preference. The more return is sacrificed the more investments have the characteristics of philanthropy.

duty and climate risk

‘Climate change poses material risks to the financial sector and it is, therefore, within the mandate of supervisors to ensure that the financial system is resilient to climate risks.’

The Network for Greening the Financial System

And thus the case for regulatory action is made.

TCFD, published in 2017, provides a set of recommendations regarding climaterelated financial disclosures; in the framework of four key pillars covering governance; metrics and targets; strategy; and risk management

Now mandatory for listed companies and many financial institutions in Europe, Japan, Canada, New Zealand, Australia, Singapore and Hong Kong, and with its introduction in the United States this year, TCFD has become, in just five years, the bedrock of international sustainability standards and climate disclosures.

Regulators identify climate risk as presenting financial stability issues, a logical endorsement that climate risk has pecuniary impact, and require on prudential grounds financial firms take account of such risks within their business strategy.

Thus, whether or not climate disclosure rules presently relate to the assets of a trust, the prudent fiduciary should ensure that they are properly informed. Our view is that calculation and knowledge of TCFD type metrics relating to trust assets is clearly consistent with fiduciary duty.

The more than merely academic question is whether regulators have a mandate for transposing TCFD type rules and practices onto the sector.

Many will argue that the prudential and conduct principles that provides legislative legitimacy in public markets is lacking in private markets.

Irrespective of the strength of this case, climate risk is real and has the potential to significantly impact asset prices.

Knowing that such risk has an impact on price clearly means it would be an abrogation of fiduciary duty not to assess portfolios against this risk. Logically It would be perverse to purchase an asset today where no attempt has been made to consider the impact of climate on its price tomorrow1.

The metrics at the core of TCFD, in particular 'Scope III, Category 15' financed emissions, provide the foundation for understanding the impact of climate risk on portfolios and assets.

Common sense dictates that prudent stewardship of assets would entail calculation of climate (TCFD) metrics.

Baringa Partners' report on the role of private finance supporting the transition to net zero commissioned by Guernsey Finance recommended that fiduciaries should 'measure and disclose portfolio emissions in line with industry standards (PCAF) or develop solutions to support measurement of portfolio emissions'.

We believe that if owners of private capital have no other information about climate risk, knowledge of their emissions intensity and of their assets and portfolios is vital for prudent stewardship

Furthermore, as outlined by ISICI earlier this year2 the use of streamlined or a singular measures of climate risk serves is a cost effective proxy measure of sustainability.

A route to be encouraged and a position endorsed by the Economist this summer.

"A recent but remarkable development since assessment round five is that climate change has been explicitly recognised by financial supervisors as a source of financial risk that matters both for financial institutions and citizens’ savings.”

The 21st Century Fiduciary Duty and ESG

“Empirical and academic evidence demonstrates that incorporating ESG issues is a source of investment value. ESG analysis assists investors to identify value relevant issues. Neglecting ESG analysis may cause the mispricing of risk and poor asset allocation decisions and is therefore a failure of fiduciary duty ”

United Nations

The basic premise of the World Economic Forum is that consideration of ESG factors is nothing more than sensible, sound risk management practice

Historically, this view has been contentious with some arguing that such an approach conflicted with the traditional concept of fidcciary duty of maximising return. This perceived conflict being particularly pronounced in common law jurisdictions and of particular relevance to the private wealth sector.

In an attempt to clarify the issues, the United Nations with the public backing of Al Gore and Generations Investment Management, established the global initiative,The 21st Century Fiduciary Duty, in 2016, to demonstrate that the traditional and modern concepts were not mutually exclusive.

Over the course of three years, the project worked with governments, investors and intergovernmental organisations to develop and publish a global statement on investors duties and obligations. The project concluded that modern fiduciary duties does indeed impose a requirement on managers.

We would put it slightly differently. Any prudent exercise of fiduciary duty, modern or traditional variant, should incorporate consideration of ESG risks with a potential material impact on price in any investment management process.

The UN summarised its view of the requirements on fiduciaries as being to:

• Incorporate financially material ESG factors into investment decision making, consistent with the timeframe of the obligation

• Understand and incorporate into decision-making the sustainability preferences of beneficiaries/clients, regardless of whether these preferences are financially material.

• Be active owners, encouraging high standards of ESG performance in the companies or other entities in which there are investments

• Support the stability and resilience of the financial system.

• Disclose the investment approach in a clear and understandable manner, including how preferences are incorporated into a scheme’s investment approach '

The UN justified this position by providing three key reasons why the fiduciary duties of loyalty and prudence require the incorporation of ESG issues.

1 ESG incorporation is an investment norm

2 ESG issues are financially material

3 Policy and regulatory frameworks are changing to require ESG incorporation.

Considering a broad range of risks is to us the sign of a good investment manager. And doing so does not preclude a wealth maximising objective. Nor does it require investment in particularly 'impactful' assets This is a separate choice variable of the beneficial owner.

If there remain concerns as to the conflict of ESG and the capital preservation and maximisation duty of a fiduciary, these should be erased by the ERISA amendments of the Trump Administration These made it clear that consideration of ESG factors, where they had a pecuniary impact, was consistent with the primary investment objective of the trustee duty, that is maximising pecuniary returns.

‘ESG factors and other similar considerations may be pecuniary factors and economic considerations... if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories.'

To us this is little different, merely a change in emphasis, from the perspective of the World Economic Forum and the United Nations.

ESG as it should be understood relates to consideration of ESG factors as part of prudent risk management.

Thus being assured that the risk management process relating to investment of the trust assets is broad, taking ESG type factors into account, and that proper governance processes exist to ensure this is so, is the extent of the required actions consistent with the general fiduciary duty.

‘ESG factors and other similar considerations may be pecuniary factors and economic considerations... if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories.'

duty and

'Where trustees are of the reasonable view that particular investments or classes of investments potentially conflict with the charitable purposes, the trustees have a discretion as to whether to exclude such investments and they should exercise that discretion by reasonably balancing all relevant factors' Judgement extract, Butler-Sloss

The Butler-Sloss case in the UK recently clarified that investment policies can and (some would suggest) should be aligned with (in this case) charitable purpose. The Judge explicitly ruled that the proper exercise of fiduciary duty in the charitable trust case can in certain circumstances be at the expense of financial return (subject to full prior consideration being applied by the Trustees).

That is the 'purpose' of a (charitable) trust overides the return maximisation principle.

A trust can be set up with any investment goal. There is plenty of case law and experience to demonstrate how trust articles can be written or varied to accommodate specific investment objectives. Both Guernsey and Jersey Finance have published papes explaining how trusts can be constituted to direct investments to a specific goal or type. So if the Settlor of a trust wishes to ensure their capital is deployed for a particular purpose for example one specific SDG there is a clear roadmap.

With clear objectives and governance established at the outset, it should be a straightforward task for fiduciaries to ensure investments are aligned with any specfic sustainability objectives of a trust. The next stage is integrating these objectives into an investment policy framework.

This should be more reassuring to trustees worried that they possess themselves little experience or expertise in the sustainable finance field.

purpose

As we previously outlined whereas economically targeted investing can be viewed as is investing with the aim to provide financial as well as collateral, non-financial, benefits and this is not the same as incorporation of ESG issues into investment management procesess.

In 2021, Guernsey Finance published a report which set out five factors holding back local adoption 21st Century Fiduciary Duty.

• Limited clarity on trust can be structured to explicitly enable the trustee to pursue a sustainable investment strategy.

• A limited understanding about what sustainable investment is and whether financial return must be sacrificed for sustainable credentials.

• What best practice measures a trustee should take to ensure the set up and ongoing monitoring of a high quality sustainable investment strategy

• How trustees should report the nonfinancial elements of the investment strategy.

• Limited local codes and guidance on responsible investment.

This paper is in direct response to this last factor but the first two above betray a lack of confidence of those spoken to. Once again, we see the conflation of the lack of return issue and sustainability. We have clearly outlined (as did the UN in some depth in 2019) that returns are not necessarily negatively impacted by 'sustainable investment strategies'.

What is true is that is a sustainable investment purpose, over and above the core fiduciary duty of capital preservation, for instance climate change mitigation, is something that requires discussion and incorporation into trust documentation Something that is best done on inception.

We believe that concerns expressed about inabilities to measure and report non financial elements is a red herring and is in many respects fuelled by the confusion and complexity sown by the 'white noise' of marketing communications.

A sustainable investment strategy is one where returns are sustainable long term once ESG type risks have been taken into consideration. And at the general level, reporting of investment performance remains a matter for the investment manager.

Measurement of non-financial benefits, in line with any purpose set out in trust deeds, need not be a complicated exercise but may require expertise hitherto previous not employed.

When everything is said and done the stumbling block is the residual concern that future beneficiaries may seek to challenge the 'purpose' of the trust, if not clearly defined and expressed, as a proxy for general claims for compensation for poor returns.

And it is this one issue that is the bottleneck in our opinion Dialogue and advisory on this point is a higher level conversation for fiduciaries. Establishment of appropriate trust documentation is a fairly surmountable exercise, but it is one within the mandate of the trusted advisor.

This should not and does not preclude fiduciaries first moving forward on the climate and ESG aspects of sustainability and this is the rationale behind the three step, three level, three stages of the framework we outline in this report. We see the development of sustainable finance practices as a journey.

Developing a framework: prescriptive rules or principles?

“The primary risk for trustees in making sustainable investments is around breaching their overarching fiduciary duties to act in the best interests of beneficiaries.”

Trustee Responsibilities and ESG: Identifying Opportunities, Mitigating Risk and Finding Consensus, Jersey Finance

And yet despite all the reasons we have provided about the consistency of ESG and fiduciary duty, concerns are still expressed that the inclusion of consideration of ESG type factors risks undermining fiduciaries’ duty.

We explained that this thinking was front of mind for the Trump administration when revising ERISA. But the UN, through its 21st Century Fiduciary Duty initiative, ruled that consideration of ESG factors was a very much necessary exercise.

In early sections, we discussed the global implementation of the TCFD reporting requirements. The private wealth sector is, as yet, broadly untouched by these regulatory requirements.

But as discussed later, the reporting and regulatory environment in the private wealth sector is unrecognisable from a decade ago and change we believe is inevitable.

Guernsey's regulator has led the way in the offshore world with the introduction of consideration of climate risk to its corporate governance code. A discussion of these changes provides some helpful illumination of the issues to hand.

‘5.2.1 Climate Change

The Board should consider the impact of climate change on the firm’s business strategy and risk profile and, where appropriate in the judgement of the board, make timely climate change related disclosures'

Revisions to the [Guernsey] Corporate Governance Code, 2021

Quite clearly the Code of Corporate Governance relates to regulated firms in the Bailiwick of Guernsey. It prescribes very little other than Board’s should (our italics) consider how climate change may (or may not) affect their business strategy and risk assessment. So, this clearly relates to the Board of the regulated fiduciary and has no impact on the running of any trusts by the firm. Or does it?

What does the regulator mean by the impact of climate change on the firm’s business strategy? Does it mean whether the firm will employ climate change deniers or insist on a walk to work policy? Or should the Board consider the issue more broadly? That is, how and what it will a firm do with regard to climate change and how it relates to, and impacts upon, its clients and their capital entrusted to it?

Once it is accepted that climate change is real and impacts on the future (and current) price of assets, it rapidly becomes clear this issue cannot be swept under the carpet and its consideration is clearly an aspect of fiduciary duty. Afterall, a trustee cannot ignore a risk that might erode capital value.

Far from it being a consideration that might be queried as undermining fiduciary duty, it rapidly becomes apparent that its non consideration is the situation that will undermine the said duty. It becomes clear that the risk in the future is being legally challenged from failing to ensure its consideration. Running through a few questions quickly informs that this is not a tick box exercise.

Does the firm have concerns with its own reputational risk? What risk appetite does the firm have for stewardships of client investments in fossil fuels? Does the firm need to consider reputation risk for its clients in terms of the investment in nontransition energy sources?

The exercise becomes rapidly quite profound when the firm needs to determine how it will treat the risk when considering its fiduciary duty. It is then that it becomes obvious that the assessment of the impact of climate change risk becomes a necessary action.

Afterall, it is not hard to imagine the hypothetical future case of failing to draw attention to a high level of exposure of investment portfolios to high carbon emissions intensity assets and a 'candidate for blame' being sought through the courts. In this respect, is it not just sensible working practices to seek to pre empt such issues.

Taking this all into consideration, it becomes quite straightforward to appreciate that the approach taken to clients’ risk becomes a fundamental component of a firm's business strategy.

How do we advise our clients treat this risk? How do we quantify such risk? What implications does this have for portfolio mix? What assessment process do we need to ensure takes place? What reporting do we advise is required? What internal processes are required? How do we document our approach? How often is this reviewed? All pertinent questions.

None of this detail is prescribed by the Guernsey regulator. But that is the nature of a principles based approach. It is for firms themselves to determine their own working practices and 'rules'.

We take a similar principles based approach to creating the framework, providing the first few of levels of guidance. Leaving it to practitioners or industry bodies to develop more granularity if desired

A sustainability framework for fiduciaries

"Standards are the agreed level of quality requirements, that people think is acceptable for reporting entities to meet.

A standard can be thought of as containing specific and detailed criteria or metrics of ‘what’ should be reported on each topic. Frameworks on the other hand provide the ‘frame’ to contextualize information. Frameworks are those that are normally put into practice in the absence of well-defined standards."

Global Reporting Initiative

The purpose of this report is to set out simple guidance to demonstrate to practitioners a set of simple steps to ensure they can approach fiduciary duty in a manner consistent with the modern concept of 21st Century Fiduciary Duty and also the traditional common law interpretation, that is a clear framework setting out a process and procedure that conforms to both.

This is the task we have set ourselves for this paper. We do not believe that we need to confuse or conflate or over complicate. We do not feel the need to refer to numerous competing sets of principles. We satisfy ourselves with setting out a simple straightforward 'frame' to steer the actions of professionals in the sector A frame that is simple and straightforward and easy to adopt.

Three Step Framework for meeting 21st Century Fiduciary Duty

We break down the required considerations into three distinct areas. Creating three sequential steps for a fiduciary to consider in exercising its fiduciary duty in line with sustainability and the 21st Century Fiduciary Duty concept. These steps we introduce as questions:

1 Whether or not the calculation of climate related metrics is taking place and being regularly presented and assessed?

Making for a required climate assessment.

2 Whether the risk management process of the investment process duly takes into account ESG factors that have pecuniary impact on the returns achieved?

Integration of ESG in the investment risk management process.

3 Whether or not there are specific investment goals of the trust that relate to sustainability objectives (and thus how these are achieved)?

Determining a specific purpose of the capital over and above straightforward capital preservation.

Completing these three steps should ensure fiduciaries follow a modern 21st century approach to fiduciary duty in tandem with their traditional core duty to preserve and enhance capital.

The two are not mutually exclusive.

of the steps with 21st Century

Fiduciary Duty

We set out three sequential steps for fiduciaries to consider in excising their duties in line with the 21st century concept. The choice of the label step is quite deliberate. We believe the process of incorporation of the modern concept is not a binary transition. Each step can be taken independently of the other and each can be seen to build upon the last as the premise for each becomes a little more impalpable Time can be taken to embed and digest the implications of each before consideration of moving on to the next. In that respect each can be thought of as moving up a level. That is each step can be seen as a separate leg of a journey with an allowance for pause and rest after each.

Conceptually climate risk is the easiest to understand As set out in section four the transmission mechanism of climate risk to impact on asset prices is a straightforward concept. The notion that fiduciaries ought at least to make beneficiaries aware of such risks is not a difficult sell.

Exactly what and how is a matter of discussion The ISICI has previously set out its view that a set of simple metrics relating to carbon emissions intensity together with the temperature alignment of assets and portfolios is all that is necessary to provide a sufficient level of intuition and understanding of the climate characteristics of a portfolio. From this base level of information an informed discussion can then be had with experts on likely future impact on prices and rebalancing of portfolios We believe that this step is pretty incontrovertible, and trustees should be seeking as a matter of urgency to provide the climate assessments as we outline.

In a similar vein, step two, the case that ESG risks can and will have some impact on asset pricing is in our view not contentious

That the Trump administration insisted on such risks as needing to have pecuniary impact to qualify for inclusion for consideration only served to clarify the point in our opinion. Cause and effect is not as straightforward as in the case of climate, there is no one simple metric such as carbon emissions to be able to report. The relevant action for the fiduciary here is to ensure that the risk management process of the investment management process takes ESG factors into account. Not to rely on them solely. But logic suggests that a broader assessment of risk is common sense.

Finally, step three, a consideration of purpose over and above that of preservation of capital. Step three moves the conversation on to having capital that in addition to making private financial returns is also deployed to serve the interests of others.

We are now clearly in the realms of the role of trusted advisor. Fiduciary duty in this context encompasses such matters as ensuring that structures, governance, objectives and documentation are properly aligned with aims and preferences.

The graphic sets out a short summary of how each of these three steps qualifies in the traditional sense of fiduciary duty. Each of these steps can be viewed as separate and stand alone. Combined, we believe they provide for a comprehensive check list for meeting the 21st century sense of fiduciary duty

Climate assessment

ESG integration

Setting a purpose

Climate ASSESSMENT

Is the calculation of climaterelated metrics taking place and being regularly assessed?

ESG integration

Does the risk management process of the investment process consider ESG factors that have pecuniary impact?

Investment PURPOSE

Are there specific investment goals of the trust that relate to sustainability objectives?

The impact of c imate change on asset prices is recognised as so s gnf cant as to create f nanc a s ab l ty issues Ca culation of metrics form ng g oba d sc osure requ rements for pr vate assets s common sense

A broad considerat on of risks dur ng the nvestmen process s a reasonable expectat on Th s ncludes consideration of ESG type factors that may have long term impact on returns

A trust may be establ shed with a specif c investment object ve or po icy in m nd, eg ach eving socia deve opment goals or al gnment w th PCC targets, set out w th n trust deeds

Procedures shou d be rev ewed and processes estab ished to ensure the regular ca cuat on o such c imate metr cs to ensure the susta nab l ty of the assets can be periodica ly assessed

Investment pol cies and ns ruct ons to nvestment managers should be reviewed o ensure that cons derat on of signi icant ESG r sks is part and parcel o the asset select on process

Trust deeds should be wr tten to clar fy such goals Governance and po ic es shou d be rev ewed to ensure a ignment w th the prescribed ro e for capital and ensure he nvestment manager s properly d rec ed

The fiduciary duty remains in

preserve and

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The fiduciary du y rema ns in law to preserve and enchance the value of the trust property Ensuring that due cons derat on of ESG factors and the r mpact on return takes p ace is cons stent w th his duty To be c ear this s not to prescribe investment n particu ar ESG assets

The fiduc ary duty remains n aw o preserve and enchance the value of he trust property But th s is cond tioned by any over riding ob ectives set out n the trust deed, hat s these wou d set a constra ned choice for nvestment UK case aw has demons rated his precedent n the chari ab e rust case

Guidance and working in practice

The UN's final report on 21st Century Fiduciary Duty in 2019 made clear that it felt Trustees should:

'disclose their investment approach in a clear and understandable manner, including how preferences are incorporated into the scheme’s investment approach.'

The clear read across for the purposes of the three-step framework set out here is that the approaches taken for all three pillars should be transparently recorded and documented.

Good governance requires clear documentation of the approaches taken for all three pillars is a necessary requirement. Together with explanation of thinking and rationale for any decisions together with alternatives considered.

If for no other reasons than to be able to review, revise and improve arrangements in time and also to be able to assess success criteria.

We would not wish to prescribe another layer of burdensome bureaucracy but a principles type approach where common sense prevails and simple recording of the thoughts, decision processes, options reviewed, and actions taken in line with each of the pillars would be advisable. All of which will be second nature to firms regulated in the Channel Islands where documentation of process and procedure is fully second nature

It is not within the bounds of our discussion to begin to prescribe minutiae and detail of documentation in this report. As we set out in the conclusion, we are hopeful relevant stakeholder groups take this framework forward to develop the meat around the bones of this three-step framework to speed its wholesale adoption.

However, it is clearly appropriate to provide a level down degree of granularity to the three steps. If nothing else to provide a starting point for working groups to develop and move forward.

We are strongly of the view that this one layer down of detail will prove sufficient for the more expert and confident private wealth professionals. We would hope these could provide example and guidance to others to speed widespread adoption.

Climate assessment

ESG integration

Setting a purpose

Engage, discuss views and preferences with clients.

Review ESG expertise and processes of manager

Revise risk assessment to incorporate climate risk.

Establish climate risk dialogue with clients

Determine investment objectives

Establish governance framework

Review trust documentation

Calculate and report carbon emissions metrics for portfolios

Produce quarterly assessments to help inform investment manager

Revise and review investments and investment strategy in light of risks.

Establish investment parameters Set performance monitoring framework

Establish investment powers and duties

Develop risk tolerance and investment objectives

Determine investment asset allocation and monitoring

10 What a difference a decade makes

‘If owners of private capital have no other information about climate risk, knowledge of the temperature alignment of their assets and portfolios will be vital for prudent stewardship. Knowledge of the potential impact on the value of assets of climate change is clearly consistent with fiduciary duty of preservation of value of capital which is a duty of care set out in trust laws throughout common law jurisdictions.’

TCFD, Climate Risk and Private Capital ISICI, 2022

The operating environment for those servicing private wealth has changed beyond recognition in the last 10 years or more. The above statement, published in the summer of 2022, implying that transposing some of the global climate change regulations to the private wealth sector might be no bad thing caused not a murmur of dissent.

Making a similar suggestion 15 years ago might have seen the author run out of town.

But we do believe that a lite touch lift or ‘cherry picking’ of a few elements of the TCFD requirements around the calculation of climate change metrics is a sensible route for private wealth.

In the last decade or more there have been several significant waves of new regulation.

• The generic increasing prudential and conduct regulatory requirements in response to the global financial crisis

• Significant ratcheting up of AML rules and regulations and supervision of the offshore centres

• A raft of new global tax transparency reporting requirements

All this change occurred against a cultural backdrop that moved away from principles to rules based (and an accompanying increased reporting burden) making of financial regulation as a result of the dominance of EU thinking.

Against this backdrop, the role of quality fiduciaries has grown, necessarily so, into a broader 'advisory' role.

The general investing environment has changed in other ways too. Culturally the sustainable finance movement has had a big impact on client concerns and objectives, particularly so in the area of private wealth where beneficial owners have perhaps the good fortune to be able to consider such issues.

This change sees the fiduciary, at least those qualified and able, to take on a trusted advisor role and be able to engage productively in a discussion of the motives and objectives of those with significant private wealth for whom deploying capital with, and/or for a purpose is a prime concern.

Given the backdrop of so much regulatory change, it would be a welcome development if 21st Century Fiduciary Duty were to be defined by practitioners rather regulation

Thus, we have laid out a proportionate framework setting out working practices and guidance that can be defined in more detail by professional consensus.

'If owners of private capital have no other information about climate risk, knowledge of the emissions intensity of their assets and portfolios is vital for prudent stewardship.' ISICI TCFD, Climate Risk and Private Capital What relevance public dislosures to private markets?

The reasoning behind developing this paper was that momentum that had once been building in the fiduciary sector towards wide-scale adoption of the principles of 21st Century Fiduciary Duty had tapered off.

This despite or maybe even because of the tsunami of ESG marketing in recent years.

There is so much flotsam and jetsam in the field of sustainable finance that practitioners could be excused for avoiding the issue altogether.

Particularly, in mid 2022 when investors' attention is drawn to more traditional economic issues such as rampant inflation and probable global recession following supply and demand shocks in the aftermath of pandemic and war

In our view this would be a shame. The threat of climate change has not abated. Achieving the global development goals set out by the UN in 2016 is still a far away event And global regulators will continue to incorporate the green and sustainable finance agenda into new rules and regulations.

Our objective with this paper was to create and establish a clear framework to provide guidance to fiduciary professionals in the Channel Islands. A framework simple enough to provide clarity, robust enough to provide confidence and practical enough to be useful.

In short, a framework that enables practitioners to cut through the current white noise and follow a roadmap to ensure their working practices, process and procedures aligned with the modern concept of fiduciary duty.

We strongly believe the three-step approach set out in this paper does just that.

This framework is not the complete article We believe it is upon practitioners and their representative groups to build upon the foundation presented here, putting meat on the bones as it were in a more granular fashion.

But it is a framework that ensures consideration of the purpose of the capital under stewardship is front and centre.

It is a framework that ensures consideration of ESG factors in the investment process is taken into account

And it is a framework that ensures that global climate change metrics are produced and provided to ensure its impact on asset prices is assessed

In our view completing these three undertakings will enable fiduciaries to follow a modern 21st century approach to fiduciary duty in tandem with their traditional core duty to preserve and enhance capital. The two are not mutually exclusive.

Indeed, quite the opposite, they are symbiotic

References

Beringa Consulting, Private Finance and Its Role in Supporting the Transition to Net Zero, (2022)

Employee Retirement Income Security Act (ERISA), US Department of Labor, (2021)

England and Wales High Court (Chancery Division), Decisions, Butler Sloss v The Charity Commission: the pursuit of charitable purposes through ESG investing, (2022)

Global Reporting Initiative, Reporting Standards (2022)

Guernsey Financial Services Commission, Code of Corporate Governance, (Updated 2021)

Guernsey Finance, Fiduciary Duty in the 21st Century. Understanding Guernsey's Position, (2021)

Jersey Finance, Trustee Responsibilities and ESG: Identifying Opportunities, Mitigating Risk and Finding Consensus, (2022)

International Panel on Climate Change, Working Group III, Sixth Round Assessment, (2022)

International Sustainability Institute of the Channel Islands, TCFD and Private Capital What relevance public disclosure rules to private capital?', (2022)

Network for Greening the Financial System, First Comprehensive Report, (2021)

OECD, ESG Investing. Practices, Progress and Challenges, (2020)

Partnership for Carbon Accounting Financials, The Global GHG Standard, (2020)

Task Force on Climate Related Financial Disclosures, Final Report, (2017)

The Economist, ESG should be boiled down to one simple measure: emissions. (July, 2022)

United Nations PRI, Fidiuciary Duty in the 21st Century, (2015)

A - No-one should or can force anything on a client. The framework sets out guidance for those who want to be able to follow a sustainable path. It provides a 'frame' for discussion and engagement and should help bring beneficiary and fiduciary closer in understanding.

Q - Do I risk being sued by beneficiaries for foisting an investment philosophy on them?

A - It's unlikely that specific ESG regulations exist in an offshore world. Climate risk considerations perhaps. But supervisors should be reassured by such active oversight.

Q - How does this all sit with my regulatory duties?

FAQs

A - Investment powers, procedures, governance, and instructions should be aligned with trust documentation, letter of wishes etc. Setting of investment objectives and performance management in line with purpose is necessary.

Q - The trust has a purpose. What does that mean for investment objectives?

Climate assessment

ESG integration

Q - Producing mTCFD etrics sounds Icostly. s it nreallyecessary?

A - Climate metrics are one of the very few quantitativemeasures that global policy makers agree on. Financed emissions and future temperature alignment provide simple, easy to understand measures of climate risk to portfolios. Pricing of assets will incorporate climate risk anddiscounting of assets with higherexposures to climate risk iwill ncrease in time.

Setting a purpose

Q - Isn't climate reporting

an exercise that can be done

by the investment manager.

A - It can. The fiduciary duty is to ensure it is

course. Thirdpartyproviders have

focussed on listed securities to

date but no doubt new tools will appear in time.

done. Very few managersyet have the capability andprovide such reporting as a matter of

A - The framework doesn't require fiduciaries to be investment experts, merely sufficiently knowledgeable to effectively communicate investment objectives of the client to the investment manager. And then to ensure effective reporting and performance management. A situation that should be no different in practice to the current general case.

Q - How do I review the investment objectives of my client?

Q - There are uno nderlying osustainability bjectives of the Ntrust. ow what?

A - The pframework rovides a 'frame' for Dengagement. iscussion could catalyse a orevision f investment objectives and ra equirement to revisit dtrust ocumentation.

developing sustainable research and thought

Research programme

The policy of the ISICI is to set out a proposed research programme and invite support from individuals and firms sharing our philosophy and thoughts This can be found on our website The research programme of the ISICI relies on patronage and sponsorship Commissions are accepted

Research briefings outlines the backdrop in thinking to our present proposed programme in sustainable finance The basic premise being that the new ideas and new methods are needed to faciliate private capital of the scale required and accelerate cross border flows

Support for the programme or individual papers is welcomed Abstracts are available on request

In the first instance email contact@isici org

About the ISICI

Founded by Dr Andy Sloan, the International Sustainability Institute Channel Islands was established to further the development of sustainable research and thought, advocating global fiscal, environmental and financial sustainability

The Institute provides a forum for the exchange and development of new ideas between stakeholders across the Channel Islands

The work of the Institute is concentrated in three key areas: global fiscal, environmental, and financial sustainability Areas where the Channel Islands have intellectual capital, natural resource, and professional expertise that be harnessed in the pursuit of global good Through the development of a core research programme, the Institute contributes to global thinking on strategy and policy in these chosen policy areas

It publishes a forward looking schedule of planned research topics Its research programme is open to proposals, contributions, and commissions

The Institute also provides advocacy and advisory services Through a network of experts and researchers and leveraging the expertise of its founder, it can draw on experience of international policy work at the highest levels in fiscal, economics, finance services regulation and green and sustainable finance accrued over three decades