Seeking to add another string to its financial services bow, the Hong Kong government has issued comprehensive proposals to update the territory’s trust laws, which are designed to better cater for the needs of modern-day trusts, strengthen the competitiveness of the jurisdiction’s trust business segment and consolidate the status of Hong Kong as an international asset management centre.
Unlike most offshore jurisdictions Hong Kong has not tampered with trust laws in order to make the jurisdiction a more attractive jurisdiction in which to create a settlement. Hong Kong has, therefore, not normally been a suitable location for an asset protection trust. However, it seems that this is about to change with the proposed amendments to the Trustees Ordinance, which seeks to bring Hong Kong into line with other modern trust jurisdictions.
As the consultation document on the draft legislation notes, Hong Kong is a major asset management centre in Asia. At the end of 2010, total combined fund management business amounted to some HKD10 trillion (USD1.3 trillion), representing an increase of 18.6% over 2009. Funds sourced from overseas investors accounted for about 66% of the total fund management business (excluding real estate investment trusts). Asset management, which accounted for the largest share of the combined fund management business, amounted to HKD6.84 trillion, and recorded an impressive growth rate of 17.5% in 2010. Although statistics are hard to come by, it is felt that trust business accounts for a relatively small proportion of Hong Kong’s wealth management industry, and the government and practitioners seem to agree that the time has come to review the Trust Ordinance (TO), which hasn’t been substantially reviewed or updated since it was enacted in 1936. In particular, the government is looking to recent reforms in other major common law jurisdictions as a template for its own proposals, particularly the UK, which introduced the Trustee Act in 2000, and Singapore, which overhauled its Trustees Act in 2004. In addition, the Perpetuities and Accumulations Ordinance (Cap. 257) (PAO), enacted in 1970 to amend the common law rules regarding perpetuities and accumulations of income and largely based on the UK’s Perpetuities and Accumulations Act 1964, has also not been substantially reviewed and amended since its introduction.
The reforms currently on the table have been a long time in the making: the process began in 2007 when the Hong Kong Trustees’ Association and the Society of Trust and Estate Practitioners – Hong Kong Branch formed a Joint Committee on Trust Law Reform and submitted proposals to the government advocating comprehensive reform of trust law in Hong Kong to create a “modern, predictable and equitable trust law” that will attract more trust business for Hong Kong. The review of the existing trust law framework was then launched in early 2008 with the following objectives: modernizing Hong Kong’s trust law to facilitate more effective trust administration; reforming the TO for the protection of, and to offer guidance to, settlors, trustees and beneficiaries by prudential default provisions; the clarification of issues and the removal of uncertainties in the existing law; and the promotion of asset management in Hong Kong. The government launched a three-month public consultation on the review of the TO and related matters in June 2009. The consultation paper was circulated to the Joint Committee on Trust Law Reform, relevant professional bodies and practitioners, trust service providers, chambers of commerce, financial services regulators, major charitable organisations and academics. It was also made available to the public. A total of 36 submissions were received. The consultation conclusions, which summarised the views collected and stated the Government’s positions on the individual issues, were issued in February 2010. In short, all the respondents indicated general support for most of the proposals and many respondents considered the review timely and necessary. The consultation conclusions were then reported to the Legislative Council’s Panel on Financial Affairs in March 2010. Next, detailed legislative proposals were prepared by the government, and it is these that the new consultation, launched on March 22, 2012, is based.
Currently, the trust law regime in Hong Kong is mainly based on the principles derived from rules of equity. They are supplemented by several pieces of legislation, the most important one being the TO. Essentially, there are two categories of trust law provisions. The first category comprises “mandatory” rules, i.e. those statutory provisions that cannot be derogated from by the terms of the trust instrument. Examples are the rules against perpetuities and excessive accumulations of income. The second category is “non-mandatory” or “default” provisions which apply to a trust if there is no trust instrument or where the trust instrument is silent on a particular issue. For example, the TO provisions on trustees’ powers belong to the second category.
The major new proposals in the draft bill include the following:
Provisions on the new statutory duty of care for trustees, i.e. a trustee must exercise such care and skill as is reasonable in the circumstances, having regard in particular to any special knowledge or experience that the trustee has or holds out as having, and if the trustee is acting in the course of a business or profession, to any special knowledge or experience that it is reasonable to expect of a person acting in the course of that kind of business or profession.
The statutory duty of care will apply to trusts whether created before or after the commencement date of the amendment bill, but does not affect the legality or validity of anything done before the commencement date. It also does not apply where a trust instrument indicates that the statutory duty of care is not meant to apply.
The statutory duty of care should apply to trustees when they are carrying out certain prescribed functions, including exercising the power of investment, appointing agents, nominees and custodians, taking out insurance, etc.
The TO will also be amended to make it clear that a trustee will not be responsible for loss under those sections if a trustee has discharged the statutory duty of care.
The TO recognises that a trustee might be temporarily unable to exercise his powers and discretions. While the section empowers a trustee to delegate the exercise of his powers and discretions by a power of attorney, it also provides several safeguards, including that the attorney must not be the trustee’s sole co-trustee except for a trust corporation. However, it is felt by the government that the provision as it stands may not be an effective safeguard because all the trustees may appoint the same attorney or all but one trustees delegate to the remaining trustee as the co-trustee. There are also concerns about the overlap and inconsistency between the Enduring Powers of Attorney Ordinance (Cap. 501) (“EPAO”) and the TO regarding trustees’ power of delegation.
Therefore, to better protect the interests of beneficiaries from excessive delegation under the TO, the government is recommending that the law be amended so that, if a trust has more than one trustee, the exercise of the power of delegation should not result in the trust having only one attorney or one trustee administering the trust, unless that trustee is a trust corporation.
In addition, it is proposed that, to avoid the overlap of the TO with the EPAO in the area of delegation, the relevant section of the EPAO will be repealed so that the power of delegation by trustee is entirely governed by the TO and the inconsistency between the TO and EPAO will be removed.
Appointing Agents, Nominees and Custodians
Under the TO, trustees of a trust may collectively employ agents, such as solicitors, bankers and stockbrokers, to carry out administrative functions in relation to properties in Hong Kong and may employ agents to exercise all functions, including executing or exercising any discretion or trust or power, in relation to properties situated outside Hong Kong. Trusteeship may require various professional skills that trustees may not possess. To enable trustees to effectively administer a trust, there is a need that trustees (other than trustees of a charitable trust) be given a general power to appoint agents to exercise any or all of their functions except for certain fundamental functions.
It is proposed that trustees will be given the power to appoint agents to exercise any or all of their functions other than: a function relating to distribution of trust assets; a power to decide whether a payment is to be made out of income or capital; a power to appoint a person to be a trustee; and a power to delegate their functions or to appoint nominees or custodians.
For trustees of charitable trusts, it is recommended that agents should be allowed to carry out functions of generating income to finance a charitable trust’s purposes, but not the execution of those purposes.
Furthermore, to protect the interests of the beneficiaries, the government is proposing to adopt similar safeguards as exist in UK and Singapore trust legislation. These safeguards include:
The TO provides trustees with a power to insure any building or other property against any loss or damage by fire and typhoon to any amount up to the full value of the building or property, and pay the premium for such insurance out of the income of the trust. However, the existing power is insufficient because it does not empower trustees to insure any loss or damage by events other than fire and typhoon, nor does it empower trustees to insure up to market value or full replacement value of the property. Moreover, as the TO only empowers trustees to pay insurance premiums out of the income of trust properties, this will favour capital beneficiaries at the expense of the income beneficiaries, if they happen to be different people.
The government therefore recommends that trustees are given a wider power to insure along the lines of UK and Singapore trust law. Trustees will be empowered to insure any trust property against risk of loss or damage by any event and pay the premiums out of the trust funds. The current restriction of insuring up to the full value of the property will be removed, so that the property can be insured up to its market value or full replacement value.
Generally, trustees are not remunerated, because they have a duty not to profit from the trusts, and allowing trustees to receive remuneration may give rise to conflicts of their fiduciary duties and personal interests. The general rule is subject to certain exceptions. However, it is felt that, given the complex nature of administering a modern-day trust, professional trustees (whether non-charitable or charitable trusts) should have a right to receive remuneration for services rendered, even if they are services which are capable of being provided by lay trustees, subject to reasonable safeguards. The government is therefore proposing that professional trustees have the right to receive remuneration, again along similar lines as provided for in UK trust law.
There is no express provision in the TO giving beneficiaries the right to remove trustees. However, beneficiaries may remove a trustee if they are authorised by the trust instrument, or by the court, or when all the beneficiaries (all of full age and legal capacity and are absolutely entitled to the trust property) act together to terminate a trust and re-settle the trust property.
The government is proposing that beneficiaries are given the right to remove or retire trustees using a simple court-free process following the UK approach. The pre-conditions for exercising such power are that all the beneficiaries under a trust should be of full age and legal capacity, and are absolutely entitled to the trust property.
In Hong Kong, the question of whether a settlor’s reserved powers will affect the validity of a trust instrument remains to be governed by case law. In the interests of clarity, the government is recommending that a statutory provision be put in place to n to the effect that a trust is not invalid by reason only of the settlor reserving to himself powers of investment or asset management functions. This will mean that a trust would not be invalidated by virtue of the mere fact that the settlor has kept to himself certain investment powers. It is also proposed that where an investment power or asset management function has been reserved by the settlor, a trustee who has acted in accordance with the exercise of the power is exempted from liability.
The rule against perpetuities (RAP) puts a time limit within which trust properties must vest in the beneficiaries. However, the RAP is considered by the government as complicated and difficult to apply in practice. The principal defect, the consultation paper notes, is the reliance on the concept of lives in being as a means to determine the perpetuity period. The statutory “wait and see” rule creates uncertainty for trustees administrating the trust property. Non-observance of RAP may render a disposition void, which is a result not expected by settlors. In Hong Kong, the importance of RAP in ensuring that land would not be tied up for a certain outdated purpose has been reduced because almost all private land is leasehold land held from the Government with a fixed lease term and there are several Ordinances that govern resumption and compulsory sale of land.
Separately, a trust instrument may direct that the income of the trust be accumulated for a certain period of time and be distributed at the end of that period. Under the common law, the accumulation period must be confined within the perpetuity period, i.e. rule against excessive accumulations of income (REA), to disallow settlors from preventing the enjoyment of income of the trust property by the beneficiaries. The common law position was modified by the PAO, which provides that settlors may choose one of the six statutory accumulation periods for which the income of a trust may be accumulated. However, the REA is said to be archaic and overly complicated, and would also frustrate the wishes of a settlor to accumulate income.
The government therefore proposes abolishing the RAP and REA (except for charitable trusts) in respect of trust instruments taking effect on or after commencement of the amendment bill. A trust may continue in existence for an unlimited period unless the terms of the instrument creating the trust provide for the contrary. The RAP and REA will not apply in relation to an instrument that takes effect on or after the commencement date of the amendment bill.
After considering the views and comments received during the consultation period, which concludes on May 21, 2012, the government intends to introduce the relevant amendment bill into the Legislative Council in the coming year.
"The consultation we launched today (March 22) marks another milestone in taking forward the trust law reform,” commented Secretary for Financial Services and the Treasury, Professor K C Chan, upon the release of the consultation document. “We look forward to receiving further views on the draft legislation so that we can finalise the amendment bill for introduction into the Legislative Council in the 2012-13 legislative year."
The government says that the feedback it received from the first consultation suggested that practitioners and other interested parties felt an overhaul of the legislation was long overdue, and that this could only be a good thing for the territory’s trust industry. Others, like the British Chamber of Commerce in Hong Kong, are of the view, however, that contrary to the widely held belief that Hong Kong is an insignificant trust jurisdiction, the level of trustee activity in the territory is actually very high. “In fact we believe Hong Kong is the main trust centre in Asia, although this assertion is mainly supported by anecdotal evidence and perceived activity rates as there are no comprehensive statistics available,” the BCC stated in its consultation response. “We would not wish to see many of these activities curtailed in Hong Kong. Indeed we believe we do not need many of the provisions introduced, for example, recently into Singapore trust law, as these were aimed at improving the Trustee activities relating to the Private Banking sector. Since that is only a specific sector and it should not dominate the whole.”
It is hard to judge at this stage what impact the proposed reforms will have on the trust sector in Hong Kong. But what does seem certain is that change is on the way, and that Hong Kong no longer wants to be seen as something of a forgotten backwater in a world where the trust is a key wealth management and asset protection tool for Asia’s growing class of wealthy investors.