It is generally used in the context of compliance, and involves obtaining sufficient knowledge and supporting documentation to ensure that individuals and companies are who they say they are, and transacting for legitimate purposes. It is also a key concept in marketing. It is vital to collect information about the prevailing customs, regulations and preferences in a specific location before trying to sell products there.
By extension, if the British Virgin Islands (BVI), and its service providers, are to be successful in promoting trust services and products in China, they must be familiar with the local market. And given the client scale and scope in that country, this means understanding the needs of high net worth individuals (HNWIs).
The prototype Chinese HNWI is first-generation wealthy - an entrepreneur who has built his fortune in recent years. He is also likely to be concerned about threats to his wealth, and for good reason.
The upheaval created by the Cultural Revolution, though more than 40 years ago, lives long in the memory of even the most privileged. Chinese President Xi Jinping is a prime example of somebody whose family fortunes were significantly altered during this period. With a father who occupied a senior position in the Communist Party, Xi enjoyed a "princeling" upbringing in Beijing. However, his father was subsequently deposed and the son was one of 30 million "sent-down youth," who were forced to leave the cities for the countryside between 1969 and 1975.
China has, of course, changed significantly since the Cultural Revolution, but parents and grandparents have not forgotten the hard times and are keen to plan for the future, and for worst case scenarios. Safe, secure and certain succession planning are, therefore, likely to be important.
Control is another key issue. China's trust legislation came out in 2001, but the legal and regulatory apparatus is not well developed, and there is little concept, in the private client arena especially, of handing over the beneficial ownership of assets to a professional trustee.
Indeed, Chinese trust law and the limited litigation in the courts, appear to indicate an understanding of trusts as essentially a special type of contractual arrangement. Article Two of the statute defines a trust as an arrangement whereby the settlor "entrusts" his property rights to the trustee who manages them in his own name. Significantly, this does not mandate or prohibit the transfer of ownership of the trust property to the trustee. It is therefore possible for the settlor to retain ownership of the trust property, and create a trust by simply entering into a contract with the trustee.
As a result of local laws and custom, the "traditional" Anglo-Saxon discretionary trust may not always be understood fully in China. But the potential uses of these structures to entrepreneurs stretch well beyond asset protection. Pre-IPO and employee benefit trusts, for example, are well-suited to the fast-growing companies from which their wealth ultimately derives.
A pre-IPO trust involves settling the shares of a company to be listed into a trust. Using an independent, professional trustee, provides a continuity of shareholding, which can be important ahead of an IPO as sudden changes at the last moment would be undesirable.
The shares are consolidated in one trustee, preventing them from being frozen due to the incapacitation or death of the founder. This ensures that controlling voting rights of shares are not split amongst several beneficiaries on the founder's demise. The same beneficiaries may also enjoy the economic benefits without dilution of the majority controlling interest.
Appropriate succession planning, such as establishing a pre-IPO trust, may avoid probate or inheritance tax (depending on circumstances) on the death of the founder. It can also provide protection in the case of matrimonial disputes, by preventing shares from being frozen or controlling powers being split up in the event of a beneficiary getting divorced.
A further advantage of pre-IPO trusts is minimal post-listing regulatory reporting and attention. Transferring shares into a trust after the IPO may trigger reporting to the relevant stock exchange and other authorities, which could lead to media coverage that negatively affects the share price.
The same successful entrepreneur could also consider establishing an employee stock option plan - this is because the company's performance in the months leading up to the listing is critical. Retention of the senior management team will be vital to such efforts, and will build loyalty.
Placing such options, in an employee benefit trust, held by an independent third party trustee, provides assurance to the relevant managers. Shares that are not held in the name of the founder or the company provide much greater protection against bankruptcy or insolvency. In addition, employees may benefit from the listed shares without having to separately open brokerage accounts individually.
As individual wealth grows in China, entrepreneurs will increasingly look at their assets in terms of what is held onshore and what could be moved overseas, and trusts are part of this broad trend. It is driven by historical and political issues but also by a basic desire for diversification. This can be as straightforward and close to home as establishing a bank account or purchasing property in Hong Kong, to educating a child in the UK or the US, or as substantive as obtaining a passport in another country.
The onus is therefore on service providers to be proficient in a variety of areas and on jurisdictions to ensure the legal and regulatory systems that underpin their products are sound. The BVI has a modern, effective suite of trust legislation, encapsulating, among others, discretionary trusts, the Virgin Islands Special Trusts Act (VISTA) and private trust companies (PTCs).
VISTA is particularly useful in a pre-IPO context. There are three reasons for this: trustees must retain the shares of the BVI company, and cannot look to sell them; the trust deed can make provision for successive directors of an underlying company, ensuring smooth transition; and the founder, or his designated person, can be appointed as the director of the underlying company to manage its assets, including the listed company shares.
There is considerable scope for the use of PTCs in China. Under a PTC structure, the founder - or family members or professional advisors - may serve as a director on their own trust company established to act as trustee for the family trust. This arrangement provides a different set of advantages to those in the VISTA trust: less involvement from professionals, and therefore lower costs; and an ability to act more quickly by virtue of keeping matters within a trust family circle rather than involving third-party professionals.
All structures require appropriate thought and planning. The problem in China is that many HNWIs don't want to discuss - or even consider - their own demise and families tend to be small, as a result of the one-child policy. Octogenarian entrepreneurs still in firm control of the family business, with no succession plan, and a limited number of possible successors, are not uncommon.
It is up to the well-informed and resourced service provider to advise such prospective clients of the advantages of succession planning, and the services and products that the BVI can contribute in that regard.
