Doing well and doing good: can charities be social investors?

 

The Law Commission last week put out a consultation on “Social Investment by charities”. Having now read through the document I thought it was worth a quick blog post to highlight why I think this consultation is important and what it means for charities.

 

The key word in the consultation is “by”. This is not abLaw_Commission_logoout charities as the recipients of social investment, which often tends to be the case. Rather, it is about charities as organisations with assets that they might potentially want to use to make social investments as well as commercial ones. This shouldn’t be surprising – many charities have assets that they cannot spend straight away, and investment is the most common way of putting them to use.

 

 

In the past the approach would have been to try to maximise the risk-adjusted financial return on investments, in order to generate more money to spend on charitable activities. And this would most likely have ignored any negative impacts produced as a result of the way the assets were invested. Increasingly, however, organisations are thinking about how they can use their investment as well as their spending to further their mission. The purpose of the Law Commission consultation is to try to identify some of the barriers (particularly the legal ones) that are currently preventing charities from doing this, and see whether they can be overcome.

 

 

Despite the slight caricature presented above, of charities investing with only financial considerations in mind in order to generate more income to fund their charitable work, the idea of charities using their mission to guide their investments has in fact been around for some time. There has been a growing focus on the role that ethical investment plays in the financial management of charities (see my blog about the trouble Comic Relief found itself in last year for a further discussion of some of the relevant issues). And beyond the “negative screening” approach of avoiding investing in things that conflict directly with a charity’s mission or values, there has been interest in the more positive idea of actively seeking to invest in things that deliver social value. This has been seen most clearly in the foundation world, where “programme-related investment” (PRI), in which a foundation makes investments that are intended to further its mission has become a significant trend in the US and, to a lesser extent, here in the UK.

 

 

The problem for charities is that the current framework within which they operate is not really designed to deal with the idea of using money to achieve mixed financial and social returns. There has tended to be a binary distinction between investment (which is about financial return) and spending or grant making (which is about social return). This is reflected in the fact that many charities have separate processes or committees to deal with the two activities.

 

 

The question is then, “how does a charity deal with social investment, which does not really fit either description?” This is a question that can be circumvented if the social investment can be justified either solely on investment or on spending grounds and thus fit within the existing framework. And the latter approach is the one that many foundations currently take in practice- simply justifying PRIs as a form of spending. However, this will not work in all cases. The difficulty comes when there are social investments that are not justifiable as pure investments or pure spending, but which could be justified if financial and social criteria were considered in combination.

 

 

When would this situation arise? I.e. why would a social investment not be a viable investment or justifiable as spending but still worth considering on its own merits? It seems to me that the failure to qualify as a viable investment is fairly easy to understand: most social investments will involve some acceptance of reduced financial return, and if this reduction is significant then it may be hard to justify the investment if there is no additional mention of the social return it produces. The failure to qualify as spending is less clear-cut, and as mentioned above, some charities and foundations have felt to this point that they can justify making social investments using their spending powers.

 

 

The problem comes at the crossover point, where a social investment is expected to make a low financial return (or possibly only a return of capital) as well as delivering social value. In this scenario, it does not look like a very good financial investment but it is also difficult to classify as spending, given that there is an expectation that the money will be returned.

 

 

The practical challenge for trustees is that most of them are uncertain what powers they have in this situation, and what their liability might be. Despite the fact that the Charity Commission issued updated guidance on investment by charities in 2011 (CC14), and this included extensive detail on social investment (including so-called “mixed-motive investment”), there is still widespread concern about the overall legal position given that CC14 does not have statutory force. This means that it is difficult for trustees to authorise social investments because they do not have confidence that they will not fall foul of charity or trustee law.

 

 

The aim of the Law Commission consultation is to address this problem by determining exactly what the current law does and does not allow. Hopefully by doing this, it can assuage the fears of trustees who would like to dip a toe in social investment but currently do not feel confident in doing so. Given that charities and charitable foundations are among the most likely candidates to act as socially-motivated investors, removing barriers to their involvement is hugely important for the development of the social investment market.

 

 

Rhodri Davies

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