By Michael Liu
Evident pressures have driven high net-worth individuals in China to transfer from "underground" to offshore trusts.
Like many industries, after the economic crisis in 2008, the offshore finance industry faced new challenges, namely the pressure caused by the decline of traditional corporate business and the increasing regulations imposed by the economic giants against the offshore finance industry. These pressures appear to have come from two different sources, but there is only one underlying cause; lack of money. The decline of corporate business arises from a lack of private money and the tough line set against offshore finance arises from a lack of government money. Offshore financial institutions accustomed to effortless expansion had to find new sources of growth. After about a year of searching, they seemed to find a new growth source - rich Chinese who spend lavishly when purchasing luxuries and real estate. Although such people don't necessarily need offshore companies, they do need to rely on the expensive family trusts in the same manner as the rich in the West do. In response, various types of financial institutions have sprung up in China. This could also explain why many institutions received unusual inquiries about trusts from "potential customers" from 2010 to 2012. In fact, these inquiries came from industry insiders.
By 2013, the surge began to decline because an arena cannot last long with only performers and no audience. After two hours of informal discussions between a Western trust company and a group of potential customers, the customers suddenly raised the question; "what are the proceeds that you can guarantee, and are they rigid?" Immediately, our peers felt helpless. This is just like the popular Chinese saying, "being deeply attached to each other because of misunderstanding and parting because of understanding". Many large trust institutions now have far less enthusiasm about China, or at least, their enthusiasm has returned to a sensible level.
The market forces the offshore trust providers to focus on Asia, but such one-sided enthusiasm will be doomed to fail. Surely, the market will force them to calm down. After all, the selling point of offshore trust is the results of careful consideration rather than speculative income.
Birth of Trusts - More Policy Pressure
Since offshore trusts are unaccustomed to the Chinese climate, let's review how trusts developed overseas. Maybe we can learn something from the following comparison. A thousand years ago, in Britain, Franciscans were not allowed to own land in the name of church, so the church entrusted professionals to hold land under the name of “cestui que use” (i.e. beneficiary). Due to this separation of ownership and beneficial power, the king could not levy taxes on this land (since the beneficiary, which is a church in this case, doesn't die, there would be no transfer of property right happening on this land). Therefore, the practice of beneficiary became increasingly popular and gradually evolved into today's trusts after several twists and turns.
Thus it can be seen that trusts in Britain can be considered as a result of policy pressure, a way explored when there had been no ways at all. However, it was a good idea and it has been maintained in a legal form. Equity, which is parallel to British common law, takes trusts as its core. The trust under equity is deemed as a great contribution of the British Empire to human civilization. As a perfect tool to protect capitalism from power, the trust can carry on the wealth and continue to uphold the family in a civilized fashion. Just like other elements of Western civilization, trusts are now standing at the gate of this ancient oriental country. In such a place with innumerable laws but bad enforcement, it is impossible for an ordinary Chinese customer to consider somebody else as the owner of his huge wealth and make himself a so-called beneficiary. He would be sleepless all night wondering whether it were reliable!
Local Chinese Trusts Are A Monster
Chinese customers have reason to doubt trusts, because customers in China have never discovered the separation between ownership and beneficiary rights in a trust contract. Not long before, when I talked with the private banking managers of several large state-owned banks, they said the top level design of Chinese wealth management lacked available legal instrument. At present, on the one hand, the so-called trusts are only restricted to products within the private banking rather than the overall wealth of a family. On the other hand, the trustees are directly controlled by the founder and the trust remains in name only, because customers pay more attention to the rate of return instead of the trust itself.
This may be what Chinese private banking wealth management is really like. Keeping this in mind, how do trust companies deal with this problem in practice? I asked a senior manager of a large trust company, "Can your trust beneficiary appoint a third party? Can a category with non-specific members be appointed?" He answered that most trusts are self-benefit trusts (you buy the trust product with the beneficiary being yourself) and very few are other-benefit trusts; there is no suggestion of trusts with the beneficiary being some category with uncertain members. Furthermore, the trust you buy is your property. If the court has a problem with you, your trust assets can be pledged and executed. Although your beneficiary rights can be transferred, there is a lack of legal provisions on strong beneficial trust relationships and a greater lack of reference cases.
Therefore, the nature of Chinese trusts can be summarized as that when you invest in the purchase of a trust product, if the trust is irredeemable, the ownership and the beneficiary rights are separated and the trustee can carry out investment management; however, when creditor rights come into existence, the ownership of the assets becomes legal absolute ownership (this is based on the actual experiences of some trust companies and may not be supported by all lawyers). Such self-contradiction is a typical Chinese characteristic, but it doesn't mean that such an unreasonable fact should be kept and respected. In fact, China is now enacting more laws in an orderly fashion to adapt to such demands and changes. Perhaps the time has not yet come.
An Invisible Country
The verdict is that it is hard for local Chinese trusts to make a difference in the top-level structure of wealth management in a short time. There are no signs of change as yet. However, this doesn't mean that Chinese customers' wealth management doesn't do anything other than speculative money management with high yields and high risks. On the contrary, Chinese customers are a group of people with bare feet, while offshore trusts are a pair of flexible shoes. The only thing you need to do is to persuade them to wear such shoes. Why put it this way? It all starts with an invisible country. Now, it is easy to find Chinese in any corner of the world. From this perspective, the Chinese must be the descendants of Abraham, since God made a promise to Abraham that "I will cause your descendants to become as numerous as the stars in the sky and as the sand on the seashore". Today, only the Chinese fulfill this promise.
For 30 years since the reform and opening-up of China, people with the ability to create wealth have already sent more or less of their investment, children and relatives overseas or frequently travel to many different places around the world. They show up in many developed countries. Even so, Chinese people are more excluded from the mainstream culture than Indians, Russians and even Africans. They act prudently, come and go in haste, quietly make money without overpaying their taxes, and study hard. They may hold several passports, but they don't give up their Chinese identity under Chinese law or they are just unnaturalized green card holders. In China, they are local star entrepreneurs, but overseas, they disguise themselves as nobodies without attracting any public attention. They are overseas Chinese, or overseas Chinese with permanent residency in China. Their wealth and their spiritual pursuits fall between the cracks. They recognize and long for desired order and rules, but they cannot give this their full attention. They have to carry on their business in China, but they cannot believe their wealth will be peacefully and safely inherited. This partly-hidden, partly-visible group is probably the people who are able to change China and even the world. However, since they live in a world of fence-sitters, they need to find a way to bring both their wealth and their identities out into the open before they can sleep easily.
This special group is more eager to wear shoes than the purely local nouveau riche, because their special identities is forcing them to resorting to offshore trusts.
Increasingly clear pressure
People have been arguing about FATCA for many years, but they didn’t realize the severity of the problem until the name of China appeared on the website of U.S. Department of Treasury. People in the invisible countries as mentioned above have suddenly realized that in the near future, if they hold American Green Card and depositing money into ICBC without filling in a special form would cause a crime in U.S.. People are less likely to convince themselves of their wishful thoughts of the past.
FATCA is only part of the pressure. Many other problems have appeared in all forms: the popular BVI companies cannot open accounts in HSBC; the names of BVI companies can be looked up over the Internet; even new registration certificates now have QR codes; Canada has signed an agreement on jointly recovering confiscated assets with China; Hong Kong appears to be starting the rectification of overseas loans under domestic guarantees; some banks have suddenly ceased to carry out multinational transactions in US dollars; Chinese inheritance tax and property tax are still sharp swords hanging over people’s heads. All these things are telling us that the invisible trans-boundary residents need to verify their identity and even surrender themselves. However, traditional ways have become increasingly unreliable. For example, someone may let one of his Chinese relatives to hold his Australian real estate or the equity of a Chinese plant on his behalf, such as accumulating over $1 million US dollars cash in some offshore account, but he has no idea of how to deal with it; another example is a Hong Kong based company used for pricing transfers that has not declared dutiable goods for 10 years. These traditional ways may directly transform into serious problems, causing direct losses and separation of wealth. For example, if an informal trustee suddenly passes away, making his will public may incur heavy tax and even lead to the complete loss of wealth. High net-worth accounts without professional management may be expelled or publicized by the bank.
The FATCA-led pressure has rung alarm bells for invisible Chinese millionaires and also invisible global millionaires to settle and rectify top-level wealth structure. The prime time for effective planning has already been significantly decreased. The challenges faced by a Chinese high net-worth family include not only the pressure of compliance with local finance and taxation policies in China, but also the pressure coming from United States, Australia and EU countries. The wealth problem of a high net-worth Chinese customer is truly a global problem requiring a team with a global view, local wisdom and executive force on a world scale to integrate resources and take action immediately.
Under such circumstances with a storm around the corner, although Chinese people believe in control instead of trust (because it requires giving up legal ownership), and believe in power instead of laws, many internationalized groups have begun to act. The trust is not their optimal instrument, but it is indeed the only existing instrument that works. If you want to ensure the privacy, inheritance and safety of your wealth, find an overseas trust as soon as possible, even though it is a reluctant and barely satisfactory choice coming from external pressure. However, an instrument out of pressure is better than nothing.
Conclusion
"No man ever steps in the same river twice". The world is ever changing and the pressure tomorrow may be vastly different from the one today. The only thing that never changes is change itself. The world cannot offset the overdrafts drawn since 2008 within the next three to five years, there is no rapid comeback through normal technological advancement and micro-structural reform. It must be a time-consuming process, during which the risk of unrest and excessively harsh levies will surely become the main external risk to high net-worth groups. Therefore, people who are well prepared always have the last laugh. After all, what you worry about will always come to pass.
