We have always believed that good governance underpins effective and successful organisations. That is how we opened our blog on the draft Scottish Governance Code for the Third Sector. We think it also equally applies as an introduction to the draft document from OSCR on “Charity Investments: Guidance and Good Practice”. It is great to see Scotland have its “own CC14” in order to give Scottish trustees pointers, food for thought and, above all, guidance. We also find it a welcome read as it puts governance and the fundamental trustee duties at the heart of the issue.

The draft guidance is currently out for consultation and you can get involved in the process via OSCR’s website.

Let’s have a look at some parts of the guidance.

What is an investment?

It is a great starting point. Deceptively simple. It notes that investments are intended to create returns; be that through capital growth or through income. It is powerful to read in that first paragraph an immediate introduction to wider notions of “return”; namely non-financial returns. This fits well with the growing ideas of the impact sector and impact investment.

As well as the deceptively simple topic of what is an investment, the guidance also sets out examples of what an “asset” is. An asset could be shares, a building that is rented out, cash on deposit or anything that produces income. We also think there is merit in the guidance recognising and trustees generally being alive to the fact that an asset is any property that could be capable of capital growth, generating an income or achieving a social or impact mission return. To be an ‘asset’, the thing need not do something; just be able to be deployed to do something.

That capability as a factor is recognised where the guidance notes that “there are risks involved in both deciding to invest, or deciding not to invest.” (our emphasis) It can be easy to think that no investment decision has been taken with an asset where the status quo is maintained. But that is not correct. A decision not to use an asset to invest is itself a decision. In some cases that decision not to invest the asset should be carefully recorded. Of course, often an asset will be invested in a social or impact sense through the asset in question being used to directly deliver (or physically home) the charity’s work and activities.

By looking at “what is an investment”, it allows the guidance to consider “what is investment”.

“Stop,

wait a minute” (Mark Ronson ft Bruno Mars, Uptown Funk)

“It is worth reflecting on why a charity might want to have investments”

“If your charity already has investments, it can be helpful for charity trustees to take a moment to reflect.”

The guidance moves from identifying what is an asset and high level notions of investment (produce some form of return) to asking what is the rationale for having or keeping investments. Following on from the point above about the positive nature of maintaining the status quo with assets, the guidance notes that the current state of play with assets and investments might be based on previous decision making. That decision making might need to be re-considered as part of the on-going job of monitoring, managing and utilising charity assets.

As well as understanding why the assets and investments are held in their current form, the suggested line of questioning in the guidance also raises important points around the proposed use of investments and whether or not there are any restrictions attaching to their use.

Having reflected on what the current position is with the charity’s assets and investments, the guidance turns to powers and duties.

Investment powers

The next part of the guidance is helpful in (perhaps obliquely) myth-busting. The port of call for charity trustee investment powers is not sections 93-95 of the Charities and Trustees Investment (Scotland) Act 2005. Remember the rules found in that part of the 2005 Act make up the “Trustee Investment” legislation are entirely distinct form the “Charities” legislation in the Act. It is as if these two pieces of legislation where on the same train but in different carriages and carriages with a limited interconnecting passage. Limited only to charities constituted as a trust (which we know is extremely unusual for new charities).

The guidance asks charity trustees to consider the terms of the charity’s governing document together with the relevant legislation applicable to the legal entity used by the charity in order to identify the investment powers. The relevant legislation and general law applicable to the type of legal vehicle might set out default or additional powers to what is contained in the governing document.

So, where do powers comes from? Let’s summarise here:-

  • companies have articles of association and have the Companies Act 2006 and general company law
  • trusts have a trust deed and the Trusts (Scotland) Act 1921 and general trust law
  • unincorporated associations have a constitution and really very little else
  • SCIOs have a constitution and the 2005 Act (but not sections 93-95)
  • charities constituted under a variety of statutory mechanisms or enactments will have the powers contained in the Act, Royal Charter etc
  • He-Man has it by the power of Grayskull and thus “I have the power!”

It might be that there is merit in the guidance highlighting that section 93-95 are not necessarily the trustee investment rules and duties for all charities.

(Investment) duties “With great power comes responsibility” (Voltaire, Spide-Man, others?)

We think the next section of the guidance is absolutely fundamental. Investment, as with all actions of charity trustees, is firmly and primarily rooted in the general charity trustee duties. While readers may not need a reminder on those duties, they are:-

  • act in the interests of the charity, and in particular:-
    • seek, in good faith, to ensure that the charity acts in a manner which is consistent with its purposes; and
    • act with the care and diligence that it is reasonable to expect of a person who is managing the affairs of another person.

The fundamental general duty to act in the interest of the charity and within that acting in a manner consistent with the charity’s purposes has often led us to talk about “purposes-led investments“. Whatever the charity’s approach to investment is, it is “purposes-led” and fundamentally grounded in and focussed on furthering the charity’s constitutionally stated purposes.

It is pleasing to see that, as with the draft Governance Code, the draft investment guidance makes an important nod to collective responsibility. All trustees are involved in such decision-making irrespective of any trustees holding apparent specialist knowledge or experience.

Beyond the fundamentals of seeking to further the charity’s purposes, the guidance gives attention to the need to apply care and diligence and to apply the higher standards expected of charity trustees compared to other offices. Care and diligence that is reasonable to expect when looking after another’s affairs. These are not your own affairs to which you can take undue risk because you wish to do so and are happy to take that risk. Charity law works on the basis that the charity assets are being marshalled and held as guardians by the trustees and the level of prudence in the risk/reward analysis flows from there.

Moving on from those key duties, the guidance sets out some suggested questions for trustees to pose when making decisions about investments. While the questions drill into specific points such as diversification, risk and appropriate advice, they are grounded in governance and duties: purposes, consistency with the governing document and exercising care and diligence.

Endowments and restricted funds

Not every asset can be realised, liquidated and spent. In some cases there will be specified conditions attaching to funds gifted to or held by a charity. Sometimes the restrictions will be about using funds for specified projects (a “restricted fund” in accounting and 2005 Act terms). In others, the restrictions will be such that some assets cannot be realised, liquidated and spent: i.e. the capital cannot be used and the asset can only be used to generate an income. This is known as a “permanent endowment” and has accounting treatment consequences. It is historically unusual (but not unheard of) in Scotland to have a “permanent endowment”. But if there is a permanent endowment that means three things:

The guidance quite rightly makes the distinction between an endowment that restricts an assets from being realised, liquidated and spent as compared to an endowment that restricts any change at all to the asset – it cannot be realised, liquidated and converted into another asset to continue to generate an income or be the base for the charity carrying out its activities. And spending, in this situation, would definitely be a bridge too far.

“It’s not all about the money, money, money” (Jessie J)

A real feature of the guidance is considering the place of non-financial returns in how charity assets are invested. It is ‘purposes-led investment’ that is promoted in the guidance. Every decision and reason for a decision is founded in furthering the charity’s purposes. Within ‘non-financial’ returns, the guidance considers social and environmental returns. As an aside, we are not 100% sure why ‘environmental’ is given a particular place here: it could be anything that produces an advancement in the charity’s purposes and impact. Maybe it is ‘impact’ that matters.

We like that the draft guidance does not adopt the “mixed-motive” terminology found in CC14 (admittedly, while CC14 still uses the phrase it has had a little spring-clean). We think the language and approach in the draft guidance is much more positive and helpful for trustees engaging in what, for some, is a newer way at looking at ‘investment’. Of course, English law has moved on in this regard and the guidance notes the statutory definition of “social investment” now found in English law.

In looking at financial returns, attention turns to the factors (or screenings) that might be taken into account (or used) when deciding in what to invest. The guidance notes that charity trustees do not have a duty to maximise financial returns, which is correct. However, whatever the way trustees choose to invest must be grounded in what is best for the purposes, which might or might not demand a greater or lesser focus on producing cash to be used to further the purposes.

Investment policy: it is a team game

The key elements on building an investment policy are next considered. Not a specific requirement under Scottish charity law, but would seem to fall squarely into an aspect of discharging the duty of acting with care and diligence. As in the draft Governance Code, we are very pleased to see again (and in bold type too!) reference to the trustees recognising collective responsibility. Of course, within collective responsibility is responsibility itself and the guidance reminds trustees that they cannot wholesale delegate matters to committees and the like. Guidance and advice from others with particular knowledge and insight is very helpful, but cannot substitute for the trustees’ overall responsibility.

All very well having a policy, but it needs to be implemented

The guidance talks about implementing the policy including thoughts on questions to ask of prospective investment managers and financial advisers before moving onto the reviewing the charity’s approach to investment from time-to-time. It also gives some case examples on this, including a very useful example around investment in community shares and basic elements on the thought-process underpinning that decision. With the governance and duties pillar of care and diligence, we wonder whether there would be merit in extending discussion around the process of more day-to-day (of course, not actually ‘day-to-day’) Black Swan) monitoring investments over time and not just at milestone moments where there is a wider review of investment matters.

Governance is good

We are mere lawyers! And cannot, and would not want to try to, give financial and investment advice. But that is just it. This guidance underlines the critical and perhaps universal importance of: the fundamentals of good governance; doing one’s best to fulfil trustee duties; and further the charity’s purposes. Universal as these apply to issues as apparently diverse as GDPR, safeguarding, service delivery as well as caring for a charity’s assets and making investment decisions.

This guidance is very welcome and will provide a very usueful base for trustees engaging in a more informed and, hopefully, effective conversation around all things ‘investment’.