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Opportunities and Impediments for Domestic Family Trusts in the Era of the New Asset Management Rules

2018.11.29 SHAO, Chunyang、HUANG, Weijia

Recent years have witnessed marked growth in the number of high net worth individuals[1] (HNWIs) in China and an associated increase in demand for advice on the management, inheritance and security of family wealth. The use of family trusts, a solution for intra-family wealth transfer that originated overseas and that has been widely adopted throughout much of the western world, is receiving increasing attention in mainland China, and the domestic family trust business has started to take off.


On April 27, 2018, the People’s Bank of China (PBOC), the China Banking and Insurance Regulatory Commission (CBIRC), the China Security Regulatory Commission (CSRC) and the State Administration of Foreign Exchange (SAFE) jointly released the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (Yin Fa [2018] No.106) (the “New Asset Management Rules”), which provide tighter supervision requirements and higher access standards for the asset management activities (including trusts) of financial institutions, and in so doing present both opportunities and challenges in the development of trusts. Subsequently on August 17, 2018, the Trust Companies Supervision Department of the CBIRC issued the Notice of the Trust Companies Supervision Department on the Enhancement of Regulating Supervision on the Trust Business during the Period for the Transition of Asset Management Business (Xin Tuo Han [2018] No. 37, CBIRC Notice 37) (“Notice 37”) to the relevant trust supervision offices within the lower level banking regulatory authorities. For the first time in mainland China, Notice 37 officially defines a family trust, provides the criteria for setting up a family trust and specifies the activities that fall outside the statutory forms of family trust. Most significantly, Notice 37 clarifies that the New Asset Management Rules do not apply to family trusts and charitable trusts. In doing so, a clear line is drawn between family trusts and the types of asset management plans and products that are governed by the New Asset Management Rules, indicating the special conditions that apply to family trusts.


Domestic family trusts, as a “Blue Ocean Business”, present a business development opportunity for trust companies. To better understand the formation and operation of family trusts and the relevant legal issues, we have undertaken research on the current trust law framework, examined several practical issues from a policy and business perspective and prepared a brief analysis here for our clients’ general reference.


 I   What is a Family Trust?


While a popular mechanism in mainland China for several years, and a term commonly referenced by trust institutions, banks and insurance companies, prior to the promulgation of Notice 37, “family trusts” have never actually been officially defined by any laws, regulations or other normative documents of the People’s Republic of China (the PRC)[2]. For example in April 2014, the then China Banking Regulatory Commission issued its Guiding Opinions on the Risk Management of the Trust Companies (Yin Jian Ban Fa [2014] No.99) in which it encouraged the trust business sector to “explore management practice and provide customized asset management solutions”, but it did not include a legal definition of a family trust.


In Notice 37, a “family trust” is defined as a “trust business carried out by a trust institute that is entrusted by an individual or a family to provide customized management and the financial services of estate planning, risk isolation, asset allocation, children’s education, family governance, charitable undertakings, etc., with the trust purpose of the protection, inheritance and administration of family wealth.


Notice 37 further provides that a family trust shall: (i) Have trust property of more than RMB 10 million in amount or in value; and (ii) Designate family member/s including the settlor, as the beneficiary/beneficiaries (though the settlor shall not be the sole beneficiary).


Notice 37 emphasizes that a trust that has the sole purpose of preserving or increasing the value of the trust property and that possesses the characteristics of separately managed account or asset management shall not be deemed as a family trust.


In summary, any trust with a trust property value lower than the minimum requirement, or that is established for self-benefit or value-preservation falls outside the scope of the definition of a family trust under Notice 37, even if the beneficiaries of such trust are family members. However, until the CBIRC further clarifies on this issue, it remains uncertain whether a trust that is excluded from the definition of family trust will then be subject to the jurisdiction of the New Asset Management Rules.


 II  Advantages of Family Trusts in the Era of the New Asset Management Rules


Notwithstanding such uncertainties, Notice 37 has liberated family trusts from the jurisdiction of the New Asset Management Rules. Compared with other asset management products governed by the New Asset Management Rules, a family trust has the following advantages.


1. No restriction on investment target or investment proportion


According to the New Asset Management Rules, on the basis of their features, asset management products, can be classified into fixed-income products, equity products, commercial and financial derivative products, and comprehensive products. There are specific requirements on the investment targets or investment proportions for each product category. A financial institution cannot arbitrarily change the type of product during the term of the product without prior written consent from the investor(s) and registration or record-filing or any other formalities as required by laws, regulations or financial supervision, and by regulatory departments shall be performed afterwards, unless such change applies to a high-risk product where the manager invests in low-risk assets in excess of the original designated proportion.


Given their varying capital accumulation modes, the composition of beneficiaries and risk preferences, family trusts may be both unique and complex, and are likely to require a degree of flexibility to make timely adjustments or modifications, and to respond to any changes to internal and external factors. When setting up a family trust, the settlor may wish to shift course at various points, in respect of matters including the structural design, investment purpose and target, investment proportion, etc.


As family trusts are not bound by the restrictions on investment target and investment proportion of the New Asset Management Rules, they have more leeway to unilaterally change investment targets and to adjust their investment proportions without becoming entangled with the statutory formalities demanded by the various administrative authorities. In this way, family trusts can customize their investment portfolios to satisfy the settlor’s needs and to maximize investment efficiency.


2. No restriction on investment layers


According to the New Asset Management Rules, an asset management product can invest in only one additional layer of asset management product and the target asset management product may not participate in further investment other than investing in publicly-offered securities investment funds.


By contrast, a family trust, with its dual purposes of security and wealth preservation, is more likely to adopt a long-term investment approach and to build a portfolio offering low-risk, stable returns. To this end, the settlor will often select a diversified asset allocation structure, including a multi-layer investment structure, to minimize and spread any non-systemic risks.


Since, under Notice 37, they are not bound by the New Asset Management Rules restrictions on investment layering, family trusts can nest layers of asset management products into an integrated investment portfolio. That being said, if one of the layers in the family trust investment structure is an asset management product governed by the New Asset Management Rules, such product is still likely to be subject to relevant asset management rules above.


In summary, within the era of the New Asset Management Rules, the publication of Notice 37 has meant that domestic family trusts are subject to a comparatively relaxed set of rules.


 III  Some Problems in the Practice of Family Trust


While Notice 37 enables the development of family trusts, the absence of certain clear legal guidance on family trusts under the current trust law framework may impede the further development of family trust. Here are some particular aspects of such impediments.


1. Absence of trust property registration for non-monetary trust property


It is common practice for HNWI settlors to fund family trusts with various non-monetary properties or property rights, including but not limited to real estate, vehicles, antiques, jewelry, precious metals, equity rights, legal titles in property, stocks, bonds, negotiable instruments, derivatives, and shares of various different kinds of asset management products.


Article 10 of the Trust Law of the People’s Republic of China (the “Trust Law”) stipulates that when establishing a trust, if trust property is required by laws and administrative regulations to undergo registration procedures, it shall do so according to the applicable laws and regulations; if a trustee fails to complete the trust property registration, then it shall complete supplementary registration procedures, and if not, the trust, even if established, shall not take legal effect. Such provision is based upon the principle of “strict registration effectiveness”, i.e., the effectiveness of the trust rests in the due registration thereof. In addition to the requirement to register trust property, under current laws, regulations, and industry standards, there is also a requirement to register trust products and trust beneficiaries, though this is mainly for the purposes of public access and public announcement, and the principle of strict registration effectiveness does not apply. This section will therefore focus primarily on the registration of trust property, and not on the registration of trust products and trust beneficiaries.


With regard to the registration of trust property, there are as yet no explicit or detailed rules on the authority, formality, measure, and process of the registration of trust property. In practice, registration authorities often refuse to register trust property because such registration application lacks a statutory basis. Hence, if the holder of any equity interests or real estate applies to the industrial and commercial administrative authority or real property registration authority to register such equity interests or real property right as trust property, the related administrative authorities will refuse to process the applications due to a lack of legal basis for such registration applications. However, as stipulated in the Trust Law, a trust cannot be legally effective if the relevant registration procedures for any trust property are not completed. Such legislative design has inevitably resulted in trust companies tending towards monetary-type investments and has created a degree of uncertainty in the formation, investment, operation and administration of family trusts. Given that ownership registration is not currently available for the registration of rights-based trust property, the registration for non-monetary trust property in the form of real estate, equity interests, stocks and bonds is only available after the settlor has transferred such property to the trustee/trust vehicle.


Consequently, in practice, a settlor will typically first establish a monetary trust which will then purchase the non-monetary assets using trust property to overcome the obstacle that non-monetary assets cannot be registered as trust property. However, the process of property transfer that is required to satisfy the registration requirement will incur tax liabilities. The PRC tax law system currently fails to clarify the tax implications of trust-related transactions and there is no explicit tax exemption or preferential treatment for any nominal transfers incurred to fund a trust. Under these circumstances, local tax authorities tend to levy taxes on all such nominal transfers to shield themselves from potential responsibilities but in doing so cause double taxation.


To sum up, the lack of a clear process to register trust property, the potential tax burden and other legal ambiguities all constitute impediments to the development of family trusts.


2. Non-recognition of listed securities as trust property


To fund a family trust with listed securities, the settlor holding shares of listed companies is required to transfer such securities to the trustee/trust vehicle. Such transfers may impact upon the listed companies in various ways and the settlor, before any share transfer, should consider factors such as his or her role in the company, the nature of such shares, the proportion of the shares that will transfer to the trust, and the time of the transfer as well as any relevant legal restrictions. Some specific restrictions are as follows:


(1) Restrictions on sale of securities based on the settlor’s role in the listed company


The settlor, based on his or her role in the listed company (such as promoter, actual controller, controlling shareholder, shareholder holding more than 5% shares, other shareholder, or the director, supervisor, or senior management officer), is subject to restrictions on the sale of securities under the Company Law, the Security Law, Several Provisions on Reduction in Shareholding by Shareholders, Directors, Supervisors and Senior Management Personnel of Listed Companies, and other applicable laws and regulations. Such laws and regulations impose various restrictions and requirements with respect to the settlor’s shareholding period, shareholding ratio, method of share transfer, and type of transferrable shares. For example, controlling shareholders or the actual controller of a listed company shall not sell their shares during a thirty six-month lock-up period (the “Lock-up Period”); shareholders who subscribed for shares in a listed company through private placement within twelve (12) months before the publication of the prospectus shall not sell their shares until the Lock-up Period expires.


Subject to the restrictions above, in order to comply with legal requirements, settlors should meticulously plan the transfer of any listed securities to the family trust, which may thereby affect the timeframe for the formation, the scale of trust property, the investment strategy and ultimately the fulfillment of beneficiary rights of the family trust. Accordingly, when setting up a family trust that involves any transfer of shares of listed companies, it is suggested that the settlors should consult with attorneys, financial advisors and other counsel regarding the background, trust purpose, and so on, to plan the formation of the trust and any transfer of listed securities (including timing, proportion and method), as well as the overall structuring of the family trust, in order to minimize the impact on the listed companies, while protecting the beneficiaries’ interests.


(2) Regulatory concerns in the change of actual controllers of listed companies


If the settlor of a family trust is the actual controller of a listed company, when the shares of the listed company transferred into that family trust reach a certain proportion, the regulatory authorities will need to confirm whether the actual controller of the listed company has changed accordingly.


Therefore, when setting up a family trust, the settlor should take various measures to maintain his or her role as the actual controller of the listed company, including but not limited to:


a) When the settlor transfers his or her shares in the listed company into the family trust, it shall be expressly stated in the Equity Transfer Agreement that the designated trust property is purely the right to earnings, while the voting rights and any other shareholder rights of equity interests in the listed company are still held and exercised by the settlor;[3] and/or

b) The trustee, the beneficiary and the settlor of the family trust shall all sign an Agreement of Persons Acting in Concert so that the family trust may act consistently with the intention of the settlor in matters concerning the listed company’s operation, management and decision-making.


Be that as it may, the demands of the settlors and the family members and the corresponding solutions are often complicated. Documents addressing the aforementioned measures should be drafted with a forward-looking perspective, the rights and obligations of relevant parties therein shall be explicitly stated and corresponding precautionary measures shall be included to address potential risks.


(3) Potential disclosure obligations of the settlor in funding the family trust with listed securities


If the settlor funds a family trust with shares of a listed company held by him or her and if, following the transfer, the family trust subsequently after the transfer holds a certain proportion of the shares of the listed company, the settlor will be obliged to disclose such information. Pursuant to the Measures for the Administration of the Takeover of Listed Companies (2014 Revision), if a family trust holds or intends to hold such shares of a listed company that reaches or exceeds a certain proportion of the issued shares of the listed company, an equity change report (the “Equity Change Report”) shall be prepared in the required format and submitted to both the CSRC and the relevant stock exchange, the listed company shall be notified and an announcement shall be published within a certain time limit as required; if the proportion of the equity shares of the listed company held by the family trust subsequently increases or reduces by a certain percentage, the aforementioned reporting and announcement obligations shall also be fulfilled.


The content of the Equity Change Report shall include but is not limited to:

  1. Basic information of the family trust;

  2. Purpose of shareholding, and whether the family trust intends to continue to increase its shares of the listed company within the next 12 months;

  3. Name, type of shares, quantity and proportion of the listed company;

  4. Timeframe and method for the shareholding in the listed company by the family trust holding the interests in shares to reach or exceed a certain proportion, or subsequent increase or decrease of the certain proportion of the shares held by the family trust, and the method for the aforementioned alteration;

  5. Brief information on the purchase and sale of the shares of the listed company through the securities transactions at the stock exchange by the family trust within six months prior to the alteration of shareholding in the listed company in item iv above; and

  6. Other content to be disclosed as required by the CSRC or the stock exchange.


Furthermore, if the family trust is has the largest shareholding or is actual controller of the listed company, the family trust is required to further disclose the following information:

  1. Structure of the family trust;

  2. The price, capital, sources of capital or other payment arrangements for the family trust to acquire the relevant shares of the listed company;

  3. Whether there is any horizontal competition or potential horizontal competition, or whether there are any ongoing affiliated transaction between the family trust and the listed company; if so, whether corresponding arrangements have been made to avoid horizontal competition and maintain the independence of the listed company;

  4. Subsequent plans for adjustment of the assets, businesses, personnel, organizational structure or articles of association of the listed company in the next 12 months;

  5. Major transactions between the family trust and the listed company in the preceding 24 months;

  6. Whether there are any circumstances that may harm the lawful rights and interests of a target company or its shareholders by benefitting from the takeover of the listed company, or violation of the laws, administrative regulations or requirements of the CSRC to take over the listed company; and

  7. Other documents relevant to the alteration of shareholding as required by the laws and regulations for inspection.


In addition, according to the Standards for the Contents and Formats of Information Disclosure by Companies Offering Securities to the Public No. 2 - Contents and Formats of Annual Reports (2017 Revision), the listed company shall disclose its actual controller, the ownership and control relationships between itself and the actual controller, as well as information about the de facto control relationship formed by way of trusteeship. If the actual controller controls the listed company by way of trusteeship or any other means of asset management, the listed company shall disclose the main contents of such trust contract or asset management agreement, including the specific form of trusteeship or asset management, trustee’s authority (including the exercise of the company's voting rights, etc.), number of shares involved, the relevant shareholding ratio in the listed company by the trust, trust fee or asset management fee, trust asset disposal arrangement, the execution, duration, conditions for modification and termination of the relevant contracts and other special terms, etc.


A concern for privacy has always been one of the key reasons for HNWIs to choose a family trust over other wealth management vehicles. If a family trust is bound by the disclosure requirements described above, especially those with relating to listed companies under the current PRC laws and regulations, it may significantly restrict the funding of such family trust, and thus the overall development of family trusts as a wealth management vehicle.


 IV  Conclusions and Suggestions


Although the family trust is still in its infancy in mainland China, with the rapid increase in the number of HNWIs, it is important to build a sound and specialized legal system for family trust. The relevant legislative authorities have recognized the need, and are pressing ahead with a legislation agenda on a specialized family trust law. Meanwhile, with Notice 37 already noting certain concerns within the administrative authorities in relation to family trusts, it appears it will not be long before the family trust is brought into a systematic orbit rather than just allowing it to develop unfettered. In such context, we propose the following suggestions to improve the existing trust law system.


1. Separate legislation focused on civil trusts in addition to the existing Trust Law


Notice 37, by excluding family trusts from the regulatory scope of the Asset Management New Opinion, embodies to some extent the regulatory approach to gradually distinguish in practice between civil trusts and commercial trusts. Nevertheless, Notice 37 is only a departmental regulatory document. The applicable upper-level law governing civil trusts remains the Trust Law, which draws no distinction between civil trusts and commercial trusts. In addition, in terms of its structure and provisions, the Trust Law heavily leans towards commercial trusts. Founded as they are on a civil fiduciary relationship, family trusts should be subject to civil trust rules rather than the rules and regulations designed for commercial trust. However, the absence of the guidance from provisions specifically addressing the requirements for civil trusts has led to banks, trust companies, insurance companies and other institutions developing family trusts on the basis of the type of thinking and practices that are more appropriate for commercial trusts, and thereby causing family trusts to deviate from their original intention. Without an appropriate regulatory framework to serve the purposes and needs of family trusts, further development of family trust business will likely be hampered. It is therefore imperative to accelerate the introduction of relevant legislation on civil trusts.


2. Establish a comprehensive trust property registration system


Given that family trusts also function as a safeguard for family wealth, the trust property should be able to declare its independence from that of the settlor through trust property registration, which is in practice equally as important as the registration of equity interests and real rights. Appropriate regulations and rules are required to facilitate the registration of any trust-motivated asset transfer, so that a family trust can be funded according to the settlor’s intent.


3. Clear tax treatment for family trust


Currently, there is no special tax treatment for family trusts during the processes of trust formation, trust assets transfer, the appreciation of trust assets, distribution of trust income to beneficiaries, etc. Under Anglo-American common law, family trusts are a familiar and legal method to avoid costly inheritance taxes. While an inheritance tax has as yet to be imposed in China, the possibility of the introduction of such tax should be a paramount consideration for estate planning going forward. There is an inescapable tension between family trust taxes and an inheritance tax: if enforceable family trust taxes are much higher than an inheritance tax, they will significant harm the beneficiary’s interests, thereby defeating one of the basic purposes of the family trust as a vehicle for family wealth inheritance; conversely, if there is no family trust tax or the family trust tax is set at a nominal rate, it may lead to family trusts becoming a tax evasion tool, rendering null and void the legislative purpose of inheritance taxes. As such, in designing tax policy, there is a need to thoroughly consider both types of taxes and to develop integrated tax policies that preserve the positive role that family trusts can play while maintaining social fairness and stability. 


1. High net worth individuals generally refers people with assets such as financial investment and investment real properties worth more than RMB 6 million.

2. For the purposes of this report alone, the PRC refers solely to mainland China and does not include Hong Kong Special Administrative Region, Macau Special Administrative Region and Taiwan

3. Although there do not appear to be any published cases regarding the transfer of the right to earnings of shares for the purpose of establishing a family trust in China, there are market precedents in which controlling shareholder of a listed company transferred the right to earnings of its shares to the lender for the purpose of financing (e.g. the Announcement of Huayi Electric Co., Ltd Regarding its Controlling Shareholder Transferring Part of its Right to Yields of the Equity and Pledging of Shares). This would suggest that the CSRC does not prohibit the shareholders of a limited-liability company to transfer their right to earnings alone, but without transferring the voting rights and other equity rights of such shares.


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