This article was first published in IFC Review, May 2012.

Trends Driving Demand

The spectacular economic growth going on in China has been accompanied by great changes to the Chinese financial services market in the last 30 years. When it comes to the development and use of trusts in the country, the sector's transformation though nascent, is expected to grow just as dramatically. However, a number of notable trends look set to drive considerable future demand for trust products, with the advent of 'overnight millionaires', who are predominantly first-generation, self-made entrepreneurs, likely to fuel much of the appetite on the mainland.

In many ways it is the speed of the wealth creation in China that will drive a move into trust products. In Hong Kong and Taiwan many of the self-made millionaires have set up family offices and trusts structures to ensure a smooth passing of the baton to their second and third generations. Similarly we are today seeing a rapidly growing awareness amongst the mainland's high net worth individuals for the need for a more considered approach toward compliant structures for wealth and succession planning.

In recent years the previously discreetly-handled issues surrounding the management of private wealth have spilt out into the public domain, highlighting a need for action. Perhaps most high profile was the case of Asia's casino tycoon Stanley Ho Hung-sun, who started court action to wrest control of his multi-billion dollar private holding company – a major shareholder in several listed companies and business interests – in a power struggle involving the offspring of his various wives.

And then there was the case of the heir to a property tycoon who was ordered to pay his ex-wife more than US$157m in one of Hong Kong's biggest divorce settlements. Such cases provide a wake-up call to many Chinese families about the need to structure their businesses and assets well.

The Key Challenges

The challenges facing China's new generation of entrepreneurs combine the classic complexities of family and business life. On the private client side, succession from a single patriarch to multiple siblings and/or spouses can prove difficult, as can navigating the complexities thrown up by divorces and other elements of patchwork families. Members of Chinese high net worth families have considerable international mobility and multiple residences, giving rise to the further complexity of dealing with different tax and regulatory regimes. On the business side, there is a desire for the continuation of family businesses into future generations, which means the preservation of business assets, brand names and IP rights and the need for professional and institutional partners.

All of these challenges are rising up against a backdrop of greater regulatory and reporting requirements, demanding more transparency and disclosure of sources of funding and increasing the cost of compliance.

Trusts and Foundations as Solutions

In such a context, it will come as little surprise that the demand and use of trusts and foundations in mainland China is expected to grow. Trusts and foundations can be used to hold assets, allowing families to consolidate their worldwide wealth into a single coherent structure that facilitates longterm ownership and is not dependent on a particular individual, such as the patriarch or favourite child. Private trust companies can be established as a bespoke trustee and run by a board of directors comprising trusted members and professional advisers, which is often preferable to individual trustees or impersonal public trustees. When it comes to stock market listings, trusts can prove invaluable to the process.

In the run-up to an IPO, and especially with Chinese businesses in certain sectors, we see owners looking to give long-term employees or investors (usually family and friends from their pioneering days) a chance to participate, and it is often most efficient for these beneficiaries to hold shares collectively through a trust. So doing eases the listing process, as there is a single trust on the share register rather than countless small shareholders. The same is true of founders' family trusts, which allow for the extended family to participate in a listing through a trust at the time of the IPO, instead of a substantial shareholding being held by the founders personally.

Post-IPO, employee share option plans can be used to encourage loyalty and to incentivise and better align employees' interests with that of the company. These share option plans can be effectively and efficiently administered through trusts, where the trust converts gains into cash to give to international employees across different countries, which often have differing restrictions on the holding or offering of shares, foreign exchange controls and tax regimes.

For those more familiar with the concept of corporate entities, a foundation has the advantage of being incorporated, with its name registered on a public register. It is a distinct legal entity, and acts through a council, which governs the foundation in accordance with its charter and regulations.

Useful Features of Offshore Trusts

With its civil law background, China's trust law is currently undergoing review and revision. Even in Hong Kong the trust law is undergoing long-overdue reform, in light of criticism that it cannot meet modern needs. By comparison, the major offshore trust jurisdictions are well established, supported by a strong framework of trust laws and have well-drafted provisions that have kept up-to-date with developments. Experienced trust practitioners and established licensed trustees provide practical and efficient advice to high net worths and their families.

The major offshore trust jurisdictions (such as Jersey, Guernsey, Isle of Man, Bermuda, Cayman and the BVI as well as rising ones such as Mauritius and Seychelles) offer useful features, including:

  • no restrictions on perpetuity or remoteness of vesting;
  • protection against foreign law claims of invalidity;
  • private trust companies;
  • purpose trusts;
  • no trustee intervention obligations, suitable for investment-holding family businesses;
  • restrictions on beneficiaries' right to information and enforcement; and,
  • foundations with legal entity.

To look at these in turn, under common law the rule against perpetuity created difficult and sometimes unexpected outcomes. Statutory provisions in the Jersey trust legislation remove such a rule, and hence significantly reduce uncertainty.

In other instances, there could be foreign law claims of invalidity based on infringement of forced heirship rules under shariah law, lack of recognition of the trust, or personal relationship with the settlor, for example. Again, statutory provisions in the Cayman, Bermuda and Jersey trust legislation can protect against such claims.

Purpose trusts allow for trusts to be established without naming beneficiaries, and may be used for a mixture of charitable and non-charitable purposes, such as building schools in poorer regions of the country, education fund for the family's future generations, or gifts of heirlooms and family properties to family members.

Under common law, trustees have fiduciary duties that compel them to act as a 'prudent man of business' and as such require them to enhance the value of the trust assets and maximise the return on investment, including selling when the price is good. On the other hand, the settlor's intentions are often that the shares be held long-term by the trust, and that the family company's business affairs are managed by its directors without trustee interference. The BVI VISTA trust does away with intervention requirements, and allows the trustee to hold and retain trust assets in this way.

In many cases settlors may not wish to allow the beneficiaries of the trust to demand information on the assets and matters relating to the trust, especially where there are complex and sensitive family relationships. Under common law, beneficiaries may have rights to information and enforcement, meaning they can require trustees to accept their instructions. The Cayman STAR trust statutorily limits such rights of the beneficiaries. This can work in a family trust scenario where the settlor wants to benefit family members without information being disclosed, or in the succession of family businesses, to ensure the assets remain within the trust for the long-term growth and development of the business for future generations.

A Jersey, Isle of Man or Seychelle foundation is a distinct legal entity that can exist for an unlimited duration. It allows extensive rights to be reserved to the founder and the beneficiaries, if any, have limited rights in that they have no interest in the foundation's assets and are not owed any fiduciary duties.

Growth on the Horizon

Lately there has been a further trend among China's high net worths, fuelled by muchpublicised visits by Bill Gates and Warren Buffett, towards philanthropic giving. The philosophy that wealth is good, and even virtuous if well managed and given back to society, has taken hold. Such thinking is in tune with the Chinese people's strong sense of business acumen, providing for future generations and giving back to the society. As the Chinese saying goes, "yin shui si yuan", "remember the spring as one drinks water". With the increasing sophistication of entrepreneurs and the return of their younger generation trained in finance, law and management in the US and Europe, there is a growing awareness and appreciation of compliant and bespoke trust structures. In Hong Kong and Taiwan, the growth of the trust sector that began a few decades ago continues. Now it is the turn of the more youthful successes of mainland China to bring their own unique demands to the trust industry and hasten its development.

Expect exciting times ahead as the market takes shape.

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