OPERATIONAL GUIDANCE

TRUSTEE ACT 2000

GENERAL POWER OF INVESTMENT

OG 86 B1-8 February 2002

Purpose: This guidance outlines the new power of investment for those charities referred to at section 5 of this OG. It explains what we mean by investment and sets out the requirements for trustees when exercising the general power of investment.
Please note: throughout this OG series, "the Act" refers to the Trustee Act 2000, not the Charities Act 1993.

Divisional responsibility

For action:

All operational divisions

For information:

All operational divisions

1. What is the general power of investment?
2. The Charity Commission's role in investment matters affecting charities
3. Derivatives
4. When is the use of derivatives authorised by the general power of investment?
5. Who can exercise this power?
6. How the general power of investment fits in with existing governing documents
7. Steps the trustees must take in relation to investing charity funds

Meaning of expressions - list of Glossary terms used in this Guidance
Index to further related information

1. What is the general power of investment?

1.1 Scope
1.2 Land
1.3 Tax

The general power of investment set out in section 3 of the Act allows a trustee to invest trust funds in any kind of investment, excluding land, in which they would be allowed to invest if they were the absolute owner of those funds. This is the automatic power that trustees will have where there is no specific provision within the charity's governing document which restricts or excludes the power. The general power of investment applies to a corporate trustee as well as to an individual trustee in these circumstances. Constitutional or statutory limitations on the investment powers of a particular corporate trustee relating to the management of its corporate property do not apply to the management of property it holds on trust. This point is particularly relevant to NHS Trusts, which do have statutory limitations on the way in which they invest their corporate property. See section 6 below as regards the relationship between the statutory power and any explicit investment provision in the governing document of a charity.

1.2 Land

Although land is excluded from the power in section 3 of the Act, the power to acquire land as an investment is included in section 8 of the Act. Many charities already have a default power to acquire land as an investment under section 6 of the Trusts of Land and Appointment of Trustees Act 1996.

1.3 Tax

Although the Trustee Act 2000 gives very wide powers of investment, not all investments will automatically qualify for tax relief. Schedule 20 of the Income and Corporation Taxes Act 1988 defines which categories of investment do attract relief: paragraph 9 of the schedule identifies certain investments (such as investments in private companies) which only qualify for tax relief if the Inland Revenue are satisfied that they have been acquired in the interests of the charity and not for the avoidance of tax.

2. The Charity Commission's role in investment matters affecting charities

2.1 What do we mean by investment?
2.2 Examples of investment assets
2.3 What are not investment assets?

The Charity Commission is not an investment adviser. We can provide trustees with advice on the provisions of the Act and on the process of investment generally. However we are unable to offer trustees advice about the merits of a particular investment or investment strategy. For example, we are unable to give trustees advice about the suitability of buying shares in a particular company or units in a hedge fund.

When asked for advice on such matters caseworkers should remind trustees of their general fiduciary obligations and the requirements imposed on trustees by the Act (see section 7 below.)

2.1 What do we mean by investment?

The term investment is not defined by the Act. The boundaries of what constitutes an investment, as interpreted by the courts, keep on expanding. The key court decisions in this developing process pre-date the Act but they influence judgements about how the term investment should be interpreted.

Investment is the process of acquiring and an asset with the aim of obtaining a financial return (whether from income or capital growth) from that asset. In order that an asset can be regarded as an investment, funds must at some stage have been provided by an investor to an "investee" who agrees to provide some form of benefit in return for the use of these funds. Whilst ownership of an investment asset may change many times whoever owns such an asset at any particular time can be regarded as an "investor". The benefit to the investor can take a number of different forms. For example, it can take the form of:

• a share in the profits of the investee's business (for example, dividends);

• payment by a tenant of rent for the use of land; or

• interest payments, or repayment by the investee of a higher sum than the investee has received by way of loan from the investor.

When making any investment decision trustees must always consider, amongst other things, the need for diversification of the charity's investments taking account of the circumstances of the charity - for example, the ability to diversify may be limited by the small amount of funds which are available for investment -see section 7.3. Trustees must also consider the suitability to the trust of its investments: when deciding whether or not an investment is "suitable", trustees will need to look at the contribution which the investment makes to the portfolio as a whole.

The definition of investment given in the Financial Services and Markets Act 2000 determines the scope of regulation under that Act. It is not the same as the legal concept of investment and cannot be relied upon as a definition for the purposes of deciding what is legally an investment.

Investment is one of a number of methods of generating resources for use by a charity. There are other methods which are not investment, such as the sale of goods and services (trading), gambling, and seeking donations through fundraising activities.

2.2 Examples of investment assets

The following are examples of investment assets:

• Company shares. When people refer to investments they are often referring to shares in companies. The "investee" is the company, which uses the funds subscribed for the shares in the development of its business. The investee rewards the investor with a share of the profits of that business. Both the availability or expectation of profits for future distribution to shareholders and the current level of dividend influences the market price of a share.

• Land which is let to produce a rental income. Here the "investee" is the tenant, who pays the owner of the land for the use of it.

• Tradeable debt. This includes for example, corporate, government and local authority loan stock. It is "tradeable" because the right to receive repayment of the debt can be purchased or sold on the open market through an established stock exchange at any time before the debt is repaid. Tradeable debt can be interest bearing, or can have built-in capital appreciation resulting from the issue of the debt at a discount to the value at which the debt is repaid, or both. Some debt may sell at a premium to the value at which the debt is repaid and the actual investment return will be the interest received less the capital depreciation. For example, a government stock which carries interest at 10% and which is repayable within 10 years will cost more to buy than the repayment price. This is because the interest rate which is payable is much higher than prevailing rates of interest. Here the "investee" is the debtor.

• Non-tradeable debt, eg deposits at banks and building societies. Again, the "investee" is the debtor.

• Units in common investment schemes, whether income or accumulation. Here the "investees" are the companies in which the managers of the schemes invest the funds subscribed by the unit-holders.

2.3 What are not investment assets?

In our view, if there is no "investee" in the sense outlined in sections 2.1 and 2.2 above, there is no "investment". There is no "investee" where the trustees simply purchase an asset in the speculative hope that they will eventually be able to obtain a higher price from a purchaser than they have paid for the asset, or where the trustees are, in substance, merely gambling with the charity's funds.

On the basis of the explanation above, the following are not investment assets:

• Commodities, eg gold, or vintage wine acquired with a view to re-sale. The only prospect of a positive economic return lies in the hope that the trustees will be able to obtain a higher price for the commodity in the future than they paid for it. The purchase of commodities for such purposes will usually be regarded as the exercise of a trade. Trustees should be aware that there is only limited tax relief for charities in respect of trading profits. The sale of donated goods is not trading;

• Works of art. The same considerations apply as to the purchase of commodities;

• Premium bonds. Clearly it is a gamble whether there is any return or not; and

• Derivatives (but see section 3 below).

3. Derivatives

3.1 What are derivatives?
3.2 Examples of types of derivative transaction

3.1 What are derivatives?

A derivative is a financial instrument which, outside of an investment strategy, may well be of a purely speculative nature. It is not itself an investment (see section 2.1 for a definition of investment). The value of a derivative is dependent on, or originates from, price movements in other assets specified in the derivatives instrument. These assets could take the form of currencies, equities, equity indices, fixed-income indices, interest rates, bonds and/or any combination of these.

3.2 Examples of types of derivative transaction

In this section we describe futures and options which are both types of derivative transactions. These are not the only types of derivative transaction and caseworkers should seek legal advice in any case involving a different type of derivative.

Futures

These would typically involve the charity or its trustees (as one party) agreeing with another person (the counterparty) to make payments to each other based on future movements in the value of shares or in a stock-market index, such as the FTSE 100.

Generally, trustees can buy or sell equity-related futures to achieve the overall investment exposure they wish to have. If they buy futures, and the shares or index to which the futures contract is related increase in value, they will receive payments from the counterparty. (In the market these are called variation margin payments.) The size of the payments will depend on the amount of the capital on which the futures transaction is based, and the extent of the rise in the shares or index to which the contract is related.

Conversely, if the shares or index decrease in value corresponding payments must be made by the trustees to the counterparty. If the trustees sell futures the process is reversed. A fall in the share or index value will result in a payment to the trustees. A rise in share or index value will result in a payment by thetrustees.

Options

An option is the right to trade (purchase or sell) an asset at a set date in the future, at a pre-determined "exercise" price, in an agreed quantity. An example of an asset is a company share. The price paid for the option depends on an assessment of the likely share price at the future date. This option "premium" is paid by the purchaser to the vendor at the time the option is taken out.

In the case of an option to purchase (a "call" option), if the shares stand above the exercise price at the end of the contract, the option may either be sold, realising a cash return, or the option can be exercised, allowing the trustees to buy the underlying shares at an advantageous price. In assessing profit or loss, account will need to be taken of the option premium paid at the outset. If the shares stand below the exercise price, the option simply lapses with no further action by purchaser or vendor.

In the case of an option to sell (a "put" option), the purchaser has a right to sell shares at a fixed price. So, if the share price falls, the value of the option increases. If the shares stand below the exercise price at the end of the contract, the option may either be sold, realising a cash return, or the option can be exercised, allowing the trustees to sell the underlying shares at an advantageous price. If the shares stand above the exercise price, the option simply lapses.

4. When is the use of derivatives authorised by the general power of investment?

4.1 What do we mean by ancillary to the investment process?
4.2 Examples of situations in which the use of derivatives is ancillary to the investment process
4.3 Trustee duties when the use of derivatives is ancillary to the investment process

The general power of investment is explained in section 1.1. Although derivatives are not intrinsically investments the use of derivatives may be authorised by the general power of investment in the Act when that use is "ancillary" to the investment process.

This guidance is not concerned with derivative transactions which are ancillary to operational (as distinct from investing) activities. The use of derivative transactions in these circumstances is not investment and so is not authorised by the general power of investment. A charity's governing document may however, authorise the purchase of derivative transactions for operational purposes. Where a charity's governing document does not contain a specific power to enter into derivative transactions for operational purposes (and such a power cannot be implied from he charity's objects) we may be willing to give the charity a suitable power by Order - see OG 1 - Orders and Schemes.

4.1 What do we mean by ancillary to the investment process?

For the use of derivatives to be "ancillary" to the investment process the following conditions must be satisfied:

• There must be an investment transaction or intended transaction to which the derivatives use is ancillary. In Example 1 in section 4.2 the related investment transaction is the proposed sale of the shares to raise the required money. In Example 2, the related investment transaction is the making of the interest-bearing deposit. If the related investment transaction is one which is proposed for the future, but the proposal is then changed or abandoned, the derivatives transaction may, as a consequence, cease to be ancillary. In such a case the charity should normally "close out" the derivatives transaction as soon as it is economically sensible to do so. What this means is explained in the examples. In other instances it may be necessary to enter into a new derivatives transaction, or to terminate or restructure an existing one, if the nature of the related intended investment transaction itself changes. A derivatives transaction may be ancillary to more than one investment transaction, and more than one derivatives transaction may be ancillary to a single investment transaction. Different derivatives transactions may be ancillary to a single investment transaction even though they are entered into at different times.

• The intention must be to manage risk, or to manage transaction costs (or both) within the investment process. Examples given illustrate what this means. Advice for trustees on the identification and the management of areas of risk to their charity can be found on the Commission's web site. The guidance, called Charities and risk management may be found as part of the Useful Guidelines section, in the Supporting Charities area of the web site.

• The derivatives transaction must be "economically appropriate". This means that trustees when entering into and reviewing it should be satisfied that its value is such that the transaction can fairly be regarded as related to the objective of managing risk, or of managing transaction costs in the investment process. The economic appropriateness of the transaction will be determined by the relationship between the size of the payments which are to be made or received under it and any fluctuations in the value of the investment transaction(s) to which it relates. The amount of the capital on which the derivatives transaction is based should not significantly exceed the capital of the investment transaction. But a precise correlation between the value of the derivatives transaction(s) and the value of the related investment transaction(s) is not required. Such a correlation would often, in practice, be unrealistically expensive to achieve.

4.2 Examples of situations in which the use of derivatives is ancillary to the investment process

Example 1

• A charity which needs to raise cash in 6 months time and holds a broadly based portfolio of UK company shares, buys put options to sell the shares in the portfolio in 6 months time at the price prevailing at the time the options are bought. The object is to eliminate or reduce the risk of a loss to the charity if there is a significant fall in the value of the shares in the 6 month period, while continuing to participate in any increase in their value over that period. The capital on which the option transaction is based should correspond to the value of the portfolio of shares.

• What if there is a change of plan after 3 months, and the charity decides that it no longer will need to raise cash at the end of the 6 month period? The charity should normally then sell the put options as soon as it is economically sensible to do so, as the derivatives transaction will no longer have any related intended investment transaction.

Example 2

• A charity buys a futures contract based on the FTSE 100 index and invests an equivalent amount of its cash resources to "back" the purchase of this contract in an interest-bearing deposit. The effect is similar to buying a portfolio of the FTSE 100 constituent company shares, provided the capital on which the futures transaction is based corresponds to the amount deposited. The costs of obtaining exposure in this way can be significantly less than those which would arise with the actual purchase of the underlying shares.

4.3 Trustee duties when the use of derivatives is ancillary to the investment process

The steps the Act requires trustees or their investment managers to take when exercising powers of investment are explained at section 7 below. These requirements apply to the use of derivatives when their use is ancillary to the investment process. The use of derivatives for the purposes of income generation when this is not ancillary to the investment process, or when the trustees fail to discharge the statutory investment duties in relation to such use, would normally be a breach of trust.

A charity can sustain significant losses as a result of poor investment strategies and processes, including the misuse of derivatives. If losses arise from a breach of trust the trustees and /or managers may be liable to make good those losses. Where issues of mismanagement arise we would consider opening an inquiry into the charity's administration.

Charities which use derivatives in the investment process need to ensure that their governance arrangements are appropriate to ensure the proper identification and management of the risks to which such use may give rise.

5. Who can exercise this power?

The new general power of investment may potentially be exercised by the trustees of any charity, the assets of which are held on a trust. This includes charitable unincorporated associations, charitable trusts, charities governed by Scheme, charities governed by charter and unincorporated charities governed by Act of Parliament and other legislation. The powers are also available to trustees of pool charities but do not apply to:

• property which is not held on trust (eg the corporate property of charitable companies); or

• common investment funds (other than pooling scheme funds) and common deposit funds established by schemes under sections 24 and 25 of the Charities Act 1993 (or their statutory predecessors).

The general power of investment would allow trustees to pool the investments of different charities which they manage without the authority of a pooling scheme but there are drawbacks to this as set out in OG 49 A1.

6. How the general power of investment fits in with existing governing documents

6.1 Synopsis of this section
6.2 Basic principles
6.3 Governing document has no power of investment
6.4 Governing document provides powers "prescribed by law for the time being"
6.5 Governing document provides wider powers than available default powers
6.6 Governing document provides wider powers but with specific restrictions or exclusions
6.7 Governing document restricts or excludes the statutory power of investment
6.8 Examples

6.1 Synopsis of this section

The general power of investment does not simply wipe out what has gone before; much will depend on provisions of existing governing documents and the date that those provisions were made. This section looks at how the Act may be applied in a variety of circumstances.

6.2 Basic principles

All charities to which the Trustee Act 2000 applies have access to a new general power of investment except where the governing instrument contains a "restriction or exclusion".

A provision will only be a "restriction or exclusion" if it is intended to prevent the trustees from making a particular form of investment which would be within the scope of the general power, or if it is intended to apply a procedural restriction to the making of an investment (for example, a unanimous decision by trustees). A provision which is simply part of the definition of a power of investment intended to enlarge the default power of investment in force at the time when the provision was made, is not a "restriction or exclusion".

A provision in a power of investment which merely sets out to explain its effect should not be treated as a "restriction or exclusion". This point is particularly significant in the context of the changed perception about whether a power of "investment" can authorise the use of derivatives referred to in section 3. Some of our Schemes providing wider investment powers contain provisions which state that the powers given do not authorise the use of derivatives, and suggest that our specific authority is always required for such use. At the time these Schemes were made, our policy in this area was that the use of derivatives could not be a part of the process of "investment" at all. These provisions reflect this and were a statement (a declaration) of our (then) policy. The declaratory statements cannot be considered a "restriction or exclusion" from the investment process, as the use of derivatives was not considered part of that process in the first instance. The general power of investment now available to trustees will authorise the use of derivatives as indicated in section 3.

A provision which is a "restriction or exclusion" will be overridden - and the general power of investment will be available - if the provision is contained in a "trust instrument" and was made before 3 August 1961, the date when the TIA 1961 came into force.

When deciding whether the general power of investment is or is not subject to a restriction or exclusion we may need to consider:

• the nature of the investment provision ; and

• how the trusts were created.

These questions are explored in sections 6.6 and 6.7 below, whilst examples can be found at 6.8.

A "trust instrument" includes a trust deed, will, declaration of trust, constitution, or charter, but not an Act of Parliament or subordinate legislation. So, if the relevant restriction or exclusion is contained in legislation, it cannot be overridden, regardless of the date when the legislation took effect. It is not entirely clear whether a Scheme made before 3 August 1961 is a "trust instrument" but it is unlikely that such a Scheme would, in any case, contain a "restriction or exclusion".

6.3 Governing document has no power of investment

Where a charity's governing document does not provide specific powers of investment the charity trustees' powers will be those prescribed by law. The Trustee Act 2000 sets out the legal powers upon which the trustees can rely when investing charity funds; in other words, the trustees have the general power of investment.

6.4 Governing document provides powers "prescribed by law for the time being"

The governing document will sometimes provide that the trustees' powers of investment are as prescribed by law for the time being. The trustees of such a charity will have the new general power of investment. Although as indicated above, the Act does not apply directly to the corporate property of charitable companies, a provision in the memorandum and articles of association to the effect that the powers of investment will be those prescribed by law would, as a matter of construction, give the general power of investment to the directors of the company.

6.5 Governing document provides wider powers than available default powers

Until the Act took effect, unless the governing instrument bestowed on the trustees wider powers of investment, they were restricted to the default investment powers contained in the Trustee Investment Act 1961(TIA 1961), and in other legislation, such as section 24(7) of the Charities Act 1993. The powers contained in the TIA 1961 were for some years regarded as too restrictive for modern circumstances. Under the TIA trustees were compelled to divide charity assets between narrower and wider range authorised investments. Typically, narrower range investments were interest-bearing securities and the wider range investments were dividend-bearing securities. Strict rules applied to the division of funds between ranges.

As a result many settlors amplified the default rules applying to trustee investment by specific provisions in the governing document. In addition, some charities acquired wider powers through Schemes made by the Courts or the Commissioners. Where the powers bestowed by the governing document do not contain any specific exclusions or restrictions, as a result of the Trustee Act 2000 the trustees will have the new general power of investment in addition to the provisions of the governing document. The effect may well be, (depending on the terms of the powers bestowed by the governing document in each case), that as a result of the new powers the trustees will have wider powers (and in some cases significantly wider powers) than they did before.

There may be a few cases where the trustees may suggest that the powers given to them by their governing documents are wider than the powers given to them by the Act . Because the general power of investment is as wide as the legal meaning of the word "investment" it is likely that any additional powers available to trustees are not, strictly, powers of investment, but are rather powers to generate income by other means.

6.6 Governing document provides wider powers but with specific restrictions or exclusions

The position is the same as in 6.5 except that the general power of investment, whilst amplifying the provisions in the governing document, will not override any "restriction or exclusion" (as explained in section 6.2).

6.7 Governing document restricts or excludes the statutory powers of investment

If the governing document seeks to restrict or exclude the powers of investment available under the TIA or otherwise, then the general power of investment will be available but still subject to these restrictions or exclusions. In relation to any charity established after the Trustee Act 2000 came into force with restrictions or exclusions attached to the power of investment, the new general power will be available subject to these restrictions or exclusions.

6.8 Examples

The following examples highlight the importance of both the date on which specific trusts were created and whether the nature of those trusts is consistent with the Act:

• An express power in a governing document made on or after 3 August 1961, which said trustees could invest "only in government bonds" would now be taken to exclude the general power of investment. The intention of the settlor at that time would have been that the trust's investment powers should be narrower than those available under the TIA 1961. However, if that governing document was a "trust instrument" and had been created before 3 August 1961 such restrictions would have been removed by the implementation of the TIA 1961, and the restrictions are not revived by the Trustee Act 2000. The general power of investment would now be available.

• a governing document made on or after 3 August 1961 allows for investments "in shares quoted on the London Stock exchange, but not in shares of X plc". The provision relating to investment in shares quoted on the London Stock Exchange is not a restriction or exclusion, but the provision excluding the shares of X plc is. This would now take effect under the new Act as a general power of investment subject to the restriction on investing in X plc. Shares quoted on the London Stock exchange would have been a wider provision than that of the TIA, but the investment in X plc was a restrictive measure which remains as such. Again, if the governing document was a "trust instrument" and had been created before 3 August 1961 we would now take it that a general power of investment applies without any restriction.

• The position would be different if, instead of excluding shares in X plc, the provision had, say, provided only for investment in companies with a subscribed capital at least £750,000 or if the provision had been expressed the other way round so that it excluded companies with a subscribed capital of less than £750,000. In each case the same range of companies for investment would have been authorised. Neither formulation involves a restriction or exclusion: the words used are merely the means to define the power itself. As a result the general power of investment under the Trustee Act 2000 would not be restricted or excluded.

A table showing the effect of governing document provisions on the general power of investment can be found in OG 86 C1. This table only applies if the governing document is a trust instrument.

In anticipation of the Trustee Act 2000 we made Schemes granting wider powers of investment that accord with the powers now set out in that Act. The powers provided in these Schemes are superseded by the Act.

7. Steps the trustees must take in relation to investing charity funds

7.1 Statutory duty of care
7.2 Requirements for trustees when exercising investment powers
7.3 Standard investment criteria

7.1 Statutory duty of care

Subject to any contrary indication in a trust instrument, the statutory duty of care applies to trustees when exercising the general power of investment. This duty also applies (subject to any such indication) to trustees when exercising other powers of investment. In addition, this duty applies (subject to any such indication) to trustees when discharging the duties in sections 4 and 5 of the Act as set out in 7.2 and 7.3 below.

Further detail on the statutory duty of care can be found in OG 86 B6.

7.2 Requirements for trustees when exercising investment powers

Not only must trustees discharge the general duty of care but there are specific requirements to which they must adhere when exercising investment powers. They must also review the investments which they have made, and consider whether they should be varied. When making or reviewing investments trustees should:

• have regard to the standard investment criteria set out in section 7.3; and

• take proper advice (unless the trustees reasonably conclude it is unnecessary or inappropriate to do so).

7.3 Standard investment criteria

Section 4(1) of the Act lays down standard investment criteria. The criteria state that trustees must;

• have regard to the suitability to the trust of the investment to be made or being reviewed; and

• have regard to the need for diversification of the trust's investments, in so far as is appropriate to the circumstances of the trust.

Suitability relates both to the kind of investment proposed to be made, or being reviewed, and to the particular investment as an investment of that type. It will include considerations as to the size and risk of the investment and, in the case of endowed charities, the need to be even-handed between the interests of present and future beneficiaries of the charity. It will also include any relevant ethical considerations as to the kind of investments that are appropriate for the trust to make.

The following words and phrases are defined in the Glossary of Terms:

•
•
•

common investment fund
common deposit fund
trustees

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