In the evolving landscape of finance and investment, ESG (environmental, social and governance) has emerged as a pivotal concept. While ESG principles have influenced investment decisions for years, recent heightened interest raises important questions for private wealth advisers.

Fred Milner (pictured), counsel in the international trusts and private client team at Mourant, a law firm-led professional services business, explores what ESG means for investors and how we look forward during this surge in focus, despite challenges in defining and measuring ESG criteria.

What is ESG and how does it affect private wealth advisers?

ESG is not new: for thousands of years people have been trying to do things better by applying a quasi-ethical lens. Similarly, and often with a degree of overlap, philanthropy seems to be ingrained in the modern human psyche. ESG in the investment space isn't new either: whether in the context of personal decisions about not making a particular investment, or the ESG influence on US state pension funds, ESG and investments have always had an interaction. But why the recent noise, and what does it mean for private wealth advisers?

ESG usually refers to a loose set of concepts used to measure an organisation’s impact through its environmental, social and governance practices. These factors are typically considered in investing, but they also apply to businesses generally and, arguably, all organisations and individuals.

A core problem with ESG to date has been the lack of widely agreed metrics with which to measure it. The UN's Sustainable Development Goals (or SDGs) were established in 2015; since then, an industry has developed around the measurement of ESG factors, with mixed success. In addition to the fundamental difficulties of what to measure, how and why, an issue has been the establishment of validation schemes (for example in relation to carbon credits) where the profit motive has tainted the validation process itself. With apologies for the (non-Next Gen) Latin: quis custodiet ipsos custodes?

The International Financial Reporting Standards (IFRS) organisation launched the International Sustainability Standards Board (ISSB) at COP26 in 2021 and it is likely that there will continue to be (healthy) competition and innovation in the measurement space. Greater agreement as to metrics could be very powerful; owning those metrics could also be very lucrative.

What are ESG investments and what is sustainable finance?

Typically, these are funds which prioritise investment in companies with strong ESG practices. There was a notable increase in the availability of ESG-labelled investments in the years following COP21 in 2015, but more recently there has been a tailing off of enthusiasm because of poor performance and accusations of greenwashing. There had been, and still is, a perception that younger generations in particular wanted these investments and there was an unedifying rush to meet the perceived demand. However, clients are now becoming more sceptical about the label.

Sustainable finance is difficult to distinguish from ESG (to the knowledge of the author, neither term is legally defined anywhere) and the terms are sometimes used interchangeably. However, sustainable finance is often used to refer to the process of taking ESG considerations into account when making decisions in the financial system: macro rather than micro.

Impact investing and social investment are other terms one sees, particularly in the philanthropy/charity context.

Do trustees need to consider ESG criteria?

Trustees have a fiduciary duty to act in their beneficiaries' best interests which is likely to involve consulting them as to their wishes. As a result, considering ESG factors was arguably already part of fulfilling this duty, and is now more likely to be achievable as ESG related information is increasingly collected and disclosed.

In the EU for instance, the Sustainable Finance Disclosure Regulation (SFDR), launched in 2023, requires financial market participants to disclose how they integrate ESG factors into their investment decisions. Trustees will also need to consider (but not necessarily follow) a settlor's letter of wishes, which may indicate a preference for a more ESG tailored investment strategy.

However, ESG considerations are not part of the traditional investment performance toolkit and are often classified as "non-financial": measurement of the diversity of board composition is different to the measurement of financial return or volatility for example. The result is that trustees can feel confused about their responsibilities and worried about the additional risks they may be taking (and for which they may be liable) when investing in an ESG influenced manner.

There is some case law on this and in Butler-Sloss v The Charity Commission for England and Wales [2022] EWHC 974 (Ch), the High Court clarified that charity trustees have the discretion to include non-financial considerations when carrying out their investment functions. The application to non-charitable trusts is debatable, but the trend is clearly one way: trustees need to be able to consider these issues and potentially factor them into their decision making. In the author's view there are some straightforward ways to achieve this, notwithstanding the difficulty around the assessment of non-financial factors and ESG more generally.

What does ESG have to do with private wealth?

ESG considerations are increasingly relevant for private wealth management, as they are not only potential factors in the assessment of risks associated with investing, but in some cases they are the actual driver, rather than the yard-stick. Many UHNWIs are engaged in philanthropy and it is a common feature of the family office advisory space.

A desire to do good, whether through ESG investments, impact investing or full-on charity is surely commendable. However, the factors involved are more complex than simply a human philosophy: tax systems and cultural/religious factors are also often substantial drivers.

Wealth accumulation and distribution also inform the discussion. There are probably few communists in the private wealth industry but the increase in the number of billionaires since 2000, their financial success (absolute and relative) during Covid, and most importantly, reflections on wealth inequality, must surely be food for thought.

Tax ESG or less tax and more philanthropy?

ESG can be applied to many things, and tax ESG is a real thing even if it isn’t always called that. Many individuals and families choose to pay more tax than may be legally necessary and that is somewhat surprising to many lawyers and tax advisers. While a desire to pay more tax is by no means the norm, there are various high profile campaigns, notably in the US and Europe, such as Patriotic Millionaires and Tax Me Now.

But some billionaires don’t trust governments to spend tax take wisely and so would rather minimise their own taxes (nothing wrong with that) and give back through their personal philanthropic endeavours (a good thing, surely?). However, the extent to which public works, such as schools and hospitals, should be funded by billionaire philanthropists, rather than the state, is an interesting thing to ponder.

Where does that leave us?

ESG and philanthropy have to be a good thing: who would say otherwise? And working with wealthy individuals and families who want to pursue ESG investment policies and be philanthropists is very rewarding. However, in this ever more transparent and connected world, there is some evidence that people are becoming increasingly individualistic. If we can teach our children one thing, perhaps it might be the importance of being interested in, and understanding, other people and the wider world. As ESG continues to show us: it's not all about the badge.

By Fred Milner, counsel in the international trusts and private client team at Mourant