Ethical investments by charities: divesting from fossil fuels

This article looks how charities can help in the battle against climate change by "divesting" from fossil fuel companies.

According to various scientific analyses, between two thirds and four fifths of the world's fossil fuels must be left in the ground. That is if global warming is to avoid surpassing the 2°C climate change "speed limit" set by the United Nations for increases in world temperatures above pre-industrial levels. This means, that in order to sustain human life on the planet, up to around $20 trillion worth of fossil fuel reserves will need to be left untouched. At present, world reserves are already being burnt at a rate several times greater than is believed to be capable of keeping climate change in check.

Divestment – what is it?

Fossil fuel divestment is the stigmatisation of companies extracting fossil fuels, as a result of the targeted removal by investors of investment assets (including stocks, bonds, shares and investment funds) from such companies. This can place significant pressure on the finances and reputation of such companies. As a result of that pressure, fossil fuel companies may be encouraged to invest in energy sources of a more renewable and sustainable nature, assisting the path to a better future for all.

A number of well renowned people and organisations have already made decisions to divest from fossil fuels:

• September 2014, the Rockefeller Brothers Fund announced it would be divesting its fossil fuel investments totalling $60 million.
• April 2015, the Prince of Wales announced his intention to eradicate all fossil fuel investments from his financial holdings.
• A number of charities, foundations, churches and universities have announced their intention to divest from fossil fuels, most notably the Divest – Invest Group, the Mark Leonard Trust, the JJ Charitable Trust, the Ashton Trust, the Waterloo Foundation, the Tellus Mater Foundation, the Polden-Puckham Charitable Foundation and the Frederick Mulder Foundation.

Can charities divest their investments from fossil fuels?

In investing the assets of their charity, charity trustees are required to act in the best interest of the charity and in furtherance of the objects of the charity. This is usually seen as being achieved by charity trustees seeking the "best financial return" from investments, at an acceptable level of risk.

Could a charity make investments that do not offer the best financial return? Before answering that, let's look at the level and nature of the return that fossil fuel companies offer. Whilst investments in them have traditionally offered reasonable rates of return, there is increasing evidence that they do not offer the best financial return in the longer term for a number of reasons:

• If fossil fuels are burnt at an unsustainable rate, they could become "stranded". Stranded assets, known in relation to fossil fuel companies as the "carbon bubble", occur when the reserves of fossil fuel companies are deemed so environmentally unsustainable that they must be written off. Currently, the price of a fossil fuel company's shares is calculated using the assumption that all of that company's fossil fuel reserves will be consumed. This means that the true cost of carbon dioxide in intensifying global warming is not taken into account in a company's stock market valuation. Should their assets become stranded, this could have a catastrophic effect on the value of fossil fuel companies.
• Pledges by governments to act on climate change, coupled with tumbling renewable energy costs, will inevitably lead to increased competition from renewable energy sources. Again, this may lead to the significant loss of value of fossil fuel companies due to their inability to compete commercially.

Therefore, the trustees of a charity could determine that whilst divesting investments from fossil fuels may have a negative short term impact for the charity, such divestment offers significantly better returns (be that financial or otherwise) in the longer term. However, if this argument fails, to what extent are charities permitted to divest from fossil fuels on an "ethical", rather than best financial return basis?

Charity Commission guidance

The Bishop of Oxford case in 1992 stated in permissive terms that a charity may make ethical investment decisions in certain circumstances.  The Charity Commission provides further guidance on this in CC14 (section 3.3). It provides that the trustees of a charity can decide to invest ethically, even if the investment might provide a lower rate of financial return than an alternative investment. However, a charity's trustees must be able to justify why it is in the charity's best interest to invest in this way.

The law permits ethical investments by charities for the following reasons:

• A particular investment conflicts with the aims and objects of the charity – for example, it would be inherently contradictory for an environmental charity which aims to protect the wildlife and the environment to invest in a company whose core businesses threaten the world into which people hope to retire, grow up, or work in a few decade's time.
• The charity might lose supporters if it does not invest ethically – that is to say that the reputation of the charity could suffer as a result of a non-ethical investment.
• The investment can be said to be made on moral grounds and there is no significant financial detriment to the charity in making the ethical investment.

Trustees must ensure that any decision they take about adopting an ethical investment approach can be justified within this criteria. They must be clear about the reasons why certain companies or sectors are excluded from, or included within, their charity's investment portfolio. They should also evaluate the effect of any proposed policy on potential investment returns and balance any risk of lower returns against the risk of alienating support or damaging their charity's reputation. This determination is not an exact science and is something through which charity trustee's need to think carefully.

An ethical investment approach may involve one, or a combination, of the following approaches:

• Negative screening – a charity avoids investment in companies or sectors of companies undertaking a particular activity, or operating in a way which may be harmful to the charity's interests.
• Positive screening – a charity invests all or part of an investment portfolio in companies or sectors which reflect a charity's values in areas like environmental protection, or in a wider range of companies that demonstrate good corporate social responsibility and governance.
• Stakeholder activism – a charity exercises its voting rights in order to influence a company's practices and policies in a way that reflects its values and ethos. This could mean that a charity invests in companies whose environmental policies it does not approve of in order to encourage more responsible business practices within those companies. This could also mean a charity not only engaging with companies in its existing investment portfolio, but also actively targeting new companies and investments.

In many ways, stakeholder activism is an argument against the divestment of charity assets from fossil fuel companies. This approach is one adopted by a number of charities who have elected against fossil fuel divestment on the basis they think holdings in fossil fuel companies allows them to actively engage with such companies, giving them a more effective strategy for environmental progress. They argue that their portfolio means they are meeting, on a regular basis, the key management and boards of fossil fuel companies, allowing them to support their best environmental initiatives and to challenge their worst.

Another argument against full divestment is that, like them or loath them, excluding fossil fuels entirely from an investment portfolio on grounds of ethics may be difficult to justify given conventional wisdom that some fossil fuels will inevitably be needed in the future. Fossil fuels will no doubt have some role to play in a balanced strategy to combat climate change.

Notwithstanding the above, it could, depending on the circumstances, be perfectly reasonable for the trustees of a charity to divest, at least to a partial extent, from fossil fuels towards alternative investments with lower financial returns.

What does the past tell us about the success (or otherwise) of divestment?

Divestment is all well and good, but does it actually work? After all, the reality is that the fossil fuel industry has considerable financial and political power to influence government policy and regulation. To understand whether it works, its worth taking a look back in time to see what lessons history has taught us.

Undoubtedly the best known example of divestment occurred during the 1970's and 80's in response to the apartheid regime of South Africa.

The conventional wisdom is that divestment from South Africa was a success. However, that success is largely attributed to the mass public pressure that helped force the South African regime to comply with the divestment activists' demands. It is not thought that divestment had a particularly significant impact on the financial markets in South Africa, or that companies, targeted by the campaign, experienced any direct discernible financial pressure. Shares in them were largely reallocated from socially responsible investors to those of a more indifferent nature.

There is therefore evidence that divestment can bring about its intended consequences, but perhaps more through political, rather than financial, pressure. Charity trustees need to be mindful as to exactly how the intended consequences of divestment might be brought about, in light of the charity's particular circumstances.

Conclusion

A decision by charity trustees to divest from fossil fuels can be a perfectly sound decision, but a number of matters need to be considered in the process. What is clear is that in respect of investments, charity trustees do not have an absolute fiduciary duty to invest in all sectors (spreading risk to protect funds) or to maximise financial returns. The ability for charity trustees to invest should be seen in light of the aims and objects of the charity and crucially charity trustees should not do anything which may run contrary to those aims and objects.

Another thing is clear - in the battle against climate change, divestment is a card that may only be played once and so needs to be part of a wider concerted programme and whole series of meaningful measures and rhetoric.