Rise of the midshores

As the Unites States, European and other regulatory authorities like the OECD push to increase transparency and end tax evasion, “midshore” jurisdictions like Singapore, Hong Kong and Ireland, which incorporate elements of both onshore and offshore jurisdictions, are becoming increasingly popular among investors. Ranajit Dam investigates the trend, and what it means for traditional offshore jurisdictions

Among the number of significant effects of the 2008 global financial crisis has been a push for greater transparency as countries look to end tax evasion. The U.S., European and other regulatory authorities – particularly the OECD – are beginning to place an increasing emphasis on substance as a means of qualifying for tax treaty benefits. And to meet this demand for tax transparency, the term “midshore,” to describe jurisdictions that provide a halfway house between onshore and offshore has emerged almost from oblivion in the past 12 months.

Alan Dickson, director and head of the Singapore office at Conyers Dill & Pearman, says the term “midshore” refers to jurisdictions that have characteristics of a larger country or financial centre – that has an established financial industry, double tax treaty networks, and economic and political stability – while at the same time, proactively legislating to offer low-tax structures to the international financial community.  “Most onshore jurisdictions are poor hosts for complex cross-border financial transactions as their domestic tax and business laws often act as an obstacle to the efficient combination of capital from other jurisdictions and the outflow of that capital for deployment in investments in multiple countries worldwide,” he says. “A midshore jurisdiction acts as a host for such transactions, while also having sophisticated economic and political infrastructure typical of most onshore jurisdictions.”

Marcus Hinkley, group partner and head of the Singapore office at Collas Crill, cites five places as up-and-coming midshore jurisdictions – Singapore, Hong Kong, Ireland, Luxembourg, and New Zealand – and says that one of the reasons behind the increase in prominence of these midshores is the global shift towards  tax transparency. “Onshore jurisdictions, particularly in the West, have sought to clamp down on their citizens trying to evade income tax. We are seeing an unprecedented move by the G20, OECD and FATF to require its citizens to demonstrate that if they do go into offshore jurisdictions, they’re doing so for tax-compliant reasons,” he says.  "There is simply nowhere to hide any longer.”

Onshore initiatives are a strong catalyst for using a midshore jurisdiction like Singapore, because what the midshore offers is solid reputation and tax substance. "There isn't a  red flag for using a jurisdiction like Singapore, says Hinkley, adding that one can come to Singapore and start up a business that’s both tax compliant and tax efficient, whereas in offshore jurisdictions, it is extremely difficult to achieve this. “The typical international financial centre (IFC) is typically a small island state, and while is extremely good at creating a tax neutral platform for the movement of capital, it is unlikely to be the jurisdiction where one would set up a hub of one’s business,” he says.

Singapore is the perfect example of having a pre-determined plan, starting in 2002, of becoming a banking centre, says Hinkley. “It did that because it clearly wanted to diversify its economy, and it’s been very successful in achieving this objective. It didn’t take a lot for Singapore to then model offshore styled mutual funds and private trust legislation and in so doing compete against the offshore IFCs,” he adds. 

Midshore attractions

Dickson says that the main attraction of midshore jurisdictions is that they offer many of the advantages of traditional offshore jurisdictions, for example flexible low-tax structures for holding or financing international operations or assets – like airplanes, ships or investments in a myriad of countries – along with added government and/or economic infrastructure, sophistication and consequent greater respectability in the eyes of international organisations such as the OECD or G8/G20. “A midshore jurisdiction will often not have the stigma that traditional offshore jurisdictions suffer owing to the fact that the midshore jurisdictions have well-developed economies that are not otherwise dependent on providing the kind of tax-efficient structures and services traditionally provided by offshore jurisdictions,” he says. “Instead, a midshore jurisdiction will make a conscious policy choice to compete with offshore jurisdictions, with a view to getting a share of the lucrative market for such tax-efficient structures and services.”

Hinkley says that the essential feature of a midshore jurisdiction is that it is a dynamic economy beyond being just a financial or tourism centre. “Because of this, it’s very difficult to point a finger at Singapore as a jurisdiction,” he says, and use it as the political scapegoat which IFCs often become. “The OECD or the G20 can apply an enormous amount of pressure on places like Cayman or Jersey, because the argument is that these places are tax havens. You probably can’t get away with the same argument in Singapore,” he says.

He believes that midshore jurisdictions are here to stay, and because the campaign against tax evasion is getting stronger, they will continue to grow in significance. “In my industry, that of trusts, by far the most popular jurisdiction currently for setting up trusts is Singapore,” says Hinkley. “If you go around a table of the leading banks and trust companies in the trusts business with a presence in Singapore, I'm confident their strongest new wealth planning tool of the last two years will have been Singapore trust work, and if you’d asked them probably five years ago, they would be setting up offshore trusts instead, in places like the Channel Islands, Cayman Islands and the British Virgin Islands.” Similarly, he says, midshore jurisdictions are also becoming popular in the funds space. “It’s quite expensive to set up a fund in Singapore, and there are regulatoiry hurdles to overcome that are not present in an offshore IFC, but because it is such a sought-after jurisdiction, it can pick and choose as to who it wants to set up a business here, and it can also impose the controls and rules that it wants to,” notes Hinkley.

However, other lawyers interviewed suggest that the popularity of midshore centres might be overblown. “In Asia, we have not seen a particularly significant increase in business for midshore centres, such as Singapore, at the expense of the traditional offshore jurisdictions such as the Cayman Islands and British Virgin Islands. Furthermore, we do not see that the overall market for tax neutral work involving these jurisdictions as shrinking,” says Thomas Granger, a partner with Walkers in Singapore. “What we have seen is that different players such as Singapore have attempted to make inroads into the Double Tax Treaty-related business that would have typically gone to Mauritius, for example, for foreign direct investment into India, and Mauritius' position has certainly been eroded by Singapore to some extent.”

Granger adds that for the funds business in Europe, both Ireland and Luxembourg have also emerged as options for clients looking to take advantage of Double Taxation Treaty-driven deals. “However, given the severe problems with the economic climate in Cyprus, which has traditionally been used to structure foreign direct investment into Russia, due to the double taxation treaty, it will be interesting to see which jurisdiction can step up and meet that challenge,” he says. “We do not expect, however, to see any significant slowdown in the use of BVI corporate vehicles lower down the corporate structure when investing into Russia due to the numerous advantages they provide including the simple and competitive tax system, a reliable and time-tested legal system, and a sophisticated infrastructure of top-notch professionals.”

Offshore retains allure

Hinkley of Collas Crill notes that the traditional offshore jurisdictions still maintain their allure despite the emergence of the midshore up-and-comers. “There are a number of benefits that come with a pure offshore centre: It’s a tax-neutral platform, and it’s an easy place to do business and set up structures and so on – for example, it is easier to set up a Cayman fund than a Singapore fund,” he says. “Offshore centres are best placed to facilitate movements of global capital, if you like, and they’re very efficient at doing that. If you were to have a pure Singapore structure, then you still are laboured with additional regulations which you’re generally not going to suffer in the offshore centres. In the trusts space, one of the differences is that Singapore, just like Hong Kong, has implemented offshore-style trusts legislation. But they’re generally not willing to go as far as some of the innovations you see in the offshore world. So Singapore and HK are still going to be a little more conservative than some of the changes you see offshore, and so offshore will still probably drive innovation.” He also suspects that the IFCs will be able to respond to change more quickly than Hong Kong and Singapore, which will he thinks will be comparatively slower to implement amendments to its laws.

According to Dickson, while it’s clear that midshore jurisdictions would like to capture some of the offshore market – and by enacting legislation targeting the needs of that market, they position themselves to become active participants – offshore financial centres are used extensively by the legitimate financial industry for a variety of purposes and many are well established in their targeted markets. “Cayman, for example, hosts thousands, or tens of thousands, of offshore investment funds and private equity funds that invest worldwide as well as branches of international banks who use the jurisdiction as an easy and flexible conduit to participate in legitimate international financial transactions,” he says. “Bermuda hosts the insurance and reinsurance industry, and is known as one of the world capitals of insurance and reinsurance. Bermuda also has a known and trusted reputation with global stock exchanges and securities regulators  offering solid corporate governance for international companies seeking to access financial markets by way of IPOs/listings. The British Virgin Islands offers quick, flexible and branded incorporation services that make it very similar to Delaware as an incorporation jurisdiction. And Mauritius has developed a unique double tax treaty network virtually unknown in the offshore world that carves out a particular niche for its involvement in international transactions featuring India and Africa. Each of these jurisdictions has a well-defined place in the global marketplace for international financial centres.”

And following pressure from the OECD and G20 to be transparent, says Dickson, offshore centres have also “defended their positions by being proactive ... and are now all OECD white-listed countries that offer the same standards of economic and political stability sought out by those planning international financial transactions.” Says John Rogers, Singapore managing partner of Walkers: “It’s important to recognise that small International Financial Centres (IFCs), such as Cayman Islands and BVI, have been enhancing transparency for many years. For example, Cayman's first tax information exchange agreement with the U.S. was signed back in 2001 and another 30 agreements have been signed since then.” He adds that a recent report by the OECD Secretary General to the G20 leaders highlights how far certain IFCs have come in terms of transparency, in particular when compared with many onshore jurisdictions.  “Ratings were given for 98 jurisdictions judged on nine transparency criteria, with green the highest, followed by amber and then red. Cayman received the highest rating, with green across all measures, while the U.S. had two amber ratings, Russia had seven and Canada, Germany, Spain and the UK each had one amber rating,” says Rogers.

Competing or complementary?

According to Rogers, it’s important to recognise that competition among jurisdictions is not a zero sum game. “While midshores such as Hong Kong and Singapore will likely experience strong gains, we don’t believe this growth will come at the expense of small IFCs such as Cayman Islands, which provide a number of important enduring advantages,” he says. “In many cases, our clients based in Asia will communicate regularly with our lawyers based in our offices in that region, but they are still using Cayman Islands or BVI structures and vehicles in order to meet their objectives.”

Dickson at Conyers Dill & Pearman notes that competition already exists between the established offshore financial centres; indeed, competition has been a reality for each of these centres for a long time.  “The entry of midshore jurisdictions means there will be more of it going forward, but the established offshore jurisdictions are successful for a reason – they are good at what they do,” he says. “Midshores have an advantage as they have not been stigmatised by the press and international politicians; they may offer the same tax-efficient or tax-free structures as offshore jurisdictions, so their aura of respectability gives them somewhat of an advantage for businesses that are trying to avoid any negative press. Ultimately, they will also have to be as good, as efficient, and as stable as the established offshore jurisdictions to capture market share. Customer loyalty will play a part, and the established infrastructure in the offshore centres cannot be quickly and easily built in a midshore; so there are barriers to entry.”

Ultimately, says Dickson, if the model of the existing players is followed, it is more likely that the offshore jurisdictions will be complemented by midshores. “There is no reason for industry to flee offshore jurisdictions,” he says. “The IMF has stated that the main offshore jurisdictions, including Cayman, BVI and Bermuda, now comply with international standards for regulatory quality and tax information exchange. Each of these jurisdictions has vigorously acted to ensure its regulatory environment was up to the standards expected of the international community so as to ensure that there would be no reason for business to flee.”

He provides the example of Singapore filling a growing need in Southeast Asia for wealth management services for newly created wealth in that region. “This is a market that might have gone to offshore, but for Singapore’s targeted effort at attracting the market. Smart midshores will adopt a similar strategy, rather than trying to ‘steal’ work from offshore,” says Dickson.

Dickson adds that in the end, however, the most successful offshore jurisdictions have carved out a place for themselves by concentrating on a specific industry, product or service. It is very difficult for a new entrant to the market to supplant established market players. “We are seeing new company incorporations in our offshore jurisdictions in the last two years generally on the increase, notwithstanding midshore jurisdictions having ‘made a play’ for offshore work,” he says. “I predict one or two midshores will be successful in competing for traditional offshore work by following the same strategy as many of the premier offshore centres followed – that is, they will similarly identify and carve out their own particular niches.”

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AIFMD’s collateral damage

Structured products risk getting caught by a regulation designed for hedge funds

By Owen Sanderson of IFR

Structured products are at risk of being caught by European regulations designed for hedge funds, unless the main fund jurisdictions of Ireland, Luxembourg and the Netherlands fill in the regulatory gaps.

The regulation, called the Alternative Investment Fund Management Directive (AIFMD), came into force this summer across Europe, and is aimed at tightening up disclosure and marketing in the hedge fund industry, as well as restricting the scope of possible hedge fund investments. Worst of all, it requires formal remuneration policies.

It brings the largely unregulated world of hedge funds and private equity into the regulated sphere and has caused consternation across Mayfair, as intensely private institutions have had to adapt to the new regime.

The problem for structured products SPVs is that legally, they look an awful lot like funds. They undertake investments in accordance with defined guidelines, and they pool investor capital for a common purpose. Narrower definitions would exclude some hedge funds - for example, those that are privately marketed.

"Many of the provisions of AIFMD were designed with the investment fund industry in mind and, therefore, would not be a ready fit for the structured finance world," says Shay Lydon, funds partner at Matheson, a law firm in Dublin.

To deal with this issue, AIFMD has a carveout for securitisations. Unfortunately, this too is hard to define.

The European Securities and Markets Authority (ESMA), responsible for implementing AIFMD, has used a definition first penned by the ECB in 2009 when it was trying to collect statistics on "Financial Vehicle Corporations.”

Fans of regulatory consistency will note this is a different definition to that employed in bank regulation defined in the Capital Requirements Directive/Regulation and implemented by the European Banking Authority (EBA).

Issuers of structured notes have been trying to argue since 2009 that they should not be caught by the FVC definition. However, structures that are not "financial vehicle corporations" might end up being "alternative investment funds.”

Germany and the UK have anticipated the issue, with BaFin and the FCA issuing guidance to give securitisation issuers confidence. For Germany, the ambiguity of AIFMD and the chance that SPV sponsors could be criminalised through an accident of drafting, makes the legislation unconstitutional without further guidance.

"We don't think the Central Bank of Ireland, or for that matter, regulators in the other big SPV jurisdictions, such as Luxembourg and The Netherlands, actually want to bring SPVs and their managers into AIFMD," says Christian Donagh, structured finance partner at Matheson in Dublin.

"But if they don't want to regulate SPVs and their managers, they will need to provide clear exemptions as the UK and Germany have done."

Diligence and disclosure

AIFMD affects buyers, as well as sellers, of structured finance. Institutions that have become Alternative Investment Funds will no longer be able to buy structured finance that does not meet "skin-in-the-game" rules, which require issuers to keep 5 percent of their securitisations.

This matches up with rules for banks, though the punishment for getting it wrong is less severe.

"The biggest difference between 122A [risk retention in bank regulation] and AIFMD risk retention is the consequences," says Jim Waddington, structured finance partner at Dechert in London. "Banks get hit with punitive capital charges, but this doesn't really make sense in a fund context, and forcing a fund to sell will only hurt the investors in that fund. So there's some general language about getting compliant.”

The regulation says that the AIFM should "consider taking some corrective action, such as hedging, selling or reducing the exposure or approaching the party in breach. Such corrective action should always be in the interest of the investors, and should not involve any direct obligation to sell the assets immediately."

Most new deals in Europe meet these risk retention requirements, but they are expected to squash new issue CLO supply by restricting the market to managers that can put up 5 percent of the deal from their own funds, rather than client funds. One CLO manager, GoldenTree Asset Management, has already done a euro-denominated CLO which sources say it placed to U.S. and Korean investors, avoiding the need to comply with the rules.

Industry of AIFMD

Preparation for the AIFMD deadline has been inconvenient for hedge fund managers, but some believe there has been too much fuss about it.

"It's the millennium bug," says one, speaking on condition of anonymity. "There is a whole industry of consultants, lawyers and so on pushing this, while at the big money managers, the BlackRocks and Fidelitys of this world, there are whole teams of people pushing through AIFMD compliance."

Shortly after the conversation, he went on to call a law firm about his own firm's AIFMD effort.

The regulation has been criticised by numerous investment professionals. BNY Mellon surveyed 70 respondents worldwide from companies with more than $5 trillion of assets under management.

It found that half of the respondents said uncertainty remained in their firms, while a third were fearful of not complying on time and negative financial implications.

Half of the respondents believed their firm would be disadvantaged in some way over the medium term, and just 18 percent believed there would be a benefit. And while 58 percent have a project team in place, 73 percent did not expect to apply for authorisation before 2014.

The survey revealed an estimated one-off cost of compliance ranging from $300,000 to $1 million, although respondents were unsure about the cost of depository services.

In addition, 67 percent said AIFMD would lead to a reduction in the number of alternative funds, while 39 percent believed their organisation would close some funds, move funds out of the EU, or merge funds. And two-thirds believed the cost and complexity of compliance would lead to reduced investor choice.

AIFMD: A primer

Michelle Lloyd and Barry McGrath of Maples and Calder explain the regulation, and how it will affect Asian fund managers, to Ranajit Dam

What is AIFMD?

The EU Alternative Investment Fund Managers Directive, or AIFMD, came into effect on July 22, 2013 and introduces a harmonised EU regulatory regime for alternative fund managers.

Who in Asia will be affected, and how?

The wide definitions of alternative investment funds (AIF) and alternative investment fund managers (AIFM) and the broad provisions around marketing extend the scope of the AIFMD significantly to Asian AIFMs. AIFMD affects EU AIFMs which manage AIFs, regardless of the AIF domicile (for example, the London manager of a Cayman fund); non-EU AIFMs which manage EU AIFs (for example, the Hong Kong manager of an Irish fund); and non-EU AIFMs which market AIFs to EU investors, regardless of the AIF domicile (for example, the Hong Kong manager of a Cayman fund).

What steps should fund managers take to comply with AIFMD?

For non-EU AIFMs which manage EU AIFs: There is a transition period for the implementation of AIFMD and Asian managers managing Irish funds have until July 22, 2015 to comply with AIFMD on the basis that the manager will be capable of carrying out all the tasks of an authorised AIFM by that date.

Asian managers of EU funds should now adopt an AIFMD project plan. This should identify which entity (or entities) in their structures constitute an AIF and for each one, establish which entity or entities manage them so as to be considered an AIFM. It should document how the Asian manager will take all necessary steps to adhere to its AIFMD obligations and address the timing of such steps in the context of the transition period.

For non-EU AIFMs which market non-EU AIFs to EU investors: Asian managers of non-EU funds that market those funds into the EU (e.g. a Hong Kong manager of a Cayman fund that markets that fund to EU investors) need to carry out a full review of their marketing activities in the EU to see what is now permitted.

AIFMD did not introduce harmonised rules in relation to marketing in the EU and, therefore, such marketing analysis needs to be carried out on a country-by-country basis to determine what is permissible under the relevant national private placement rules.

Certain EU countries have introduced transitional periods of one year whereby marketing of non-EU funds is permitted to take place up until July 2014, provided that marketing activities were carried out prior to July 2013. Asian managers should, therefore, be considering whether they may avail of these transitional periods and, if not, what private placement registrations in their target EU countries would be required in order to permit marketing there. In 2015, ESMA might permit non-EU managers to adapt their non-EU funds to become AIFMD compliant and then avail of the EU passport, but until then, marketing requirements need to be assessed in each country where marketing is proposed to take place and the various AIFMD and country specific marketing requirements complied with.

What are the major concerns funds in Asia have in relation to AIFMD?

Cayman funds are still the vehicle of choice for Asian managers and the principal concern that most managers have is that they do not want all of their funds to come within the scope of AIFMD. Managers should consider only marketing such funds under relevant private placement rules or (after careful review) permitting reverse solicitation enquiries from EU investors in their Cayman funds or if that is not possible, establishing an AIFMD fund in the EU to avail of the EU marketing passport and ring-fencing all AIFMD compliance in a separate EU structure (such as an Irish fund). The additional cost burden of investing in an AIFMD fund will be transferred onto the EU investors and any Asian/U.S. investors coming into the Cayman vehicle will avoid this. The use of a Cayman fund also avoids having to comply with many aspects of the AIFMD, including for example the depository and remuneration disclosure, which will only apply to an EU AIF being marketed in the EU.

A cost-benefit analysis of such a proposal would need to be carried out by managers, and managers should also take advice on the concept of reverse solicitation to determine how this will operate in practice.

What do managers in Asia need to do now?

Businesses should be contemplating their moves towards AIFMD compliance now. Asian managers need to determine whether they come within the scope of AIFMD and take legal advice on this point. If Asian managers want to market their funds in the EU, they will need to take steps now in order to comply with the AIFMD and the importance of EU investors to the business model should be evaluated. Registration with local regulators and on-going compliance will be required if marketing is to continue and if the passport is sufficiently important, consider establishing an AIMFD fund that can avail of the passport and ring-fences all of your AIFMD obligations in a separate EU structure.

In Hong Kong we trust

Hong Kong's new trust law, set to take effect in December, looks to boost the competitiveness of the territory’s trust services industry, attract settlors to set up trusts there, and enhance the SAR’s image as an international asset management centre, finds Ranajit Dam

After years of planning, discussion and consultation, Hong Kong’s lawmakers earlier this year finally passed an amendment to the territory’s antiquated trust law. The significant amendments include an expansion to the default powers of trustees, which is expected to allow the industry to better exploit new business opportunities in retail funds and private trusts arising from growing wealth.

The amendment bill also abolishes the rules against perpetuities and against excessive accumulations. The result is that new non-charitable trusts - such as private trusts for wealth and estate planning - are no longer limited in duration. Perpetual trusts may now be set up with beneficiaries hundreds of years into the future.

“A very important aspect of the amendments is perhaps not simply the changes to the legislation per se, but rather, the fundamental fact that the legislature has looked at the legislation, considered it, and updated it, and shown that the trust law is important to Hong Kong,” says Marcus Leese, a partner at Ogier in Hong Kong. “By making it a topic of conversation within the legal and advisory community, Hong Kong has reinforced the fact that trusts (and by extension, private wealth planning and structuring) are an important part of the legal landscape, and that itself is greatly significant.”

The new law is also aimed at enhancing the protection for beneficiaries by imposing statutory control on clauses in trust deeds which seek to limit trustees' liability. The statutory control on trustees' exemption clauses will take effect on Dec. 1 for new trusts established on or after that date. For pre-existing trusts, the statutory control will take effect one year after, on Dec. 1, 2014, to allow time for the relevant trusts to make transitional arrangements.

“The amendments come into effect on Dec. 1, but some of them do have a retrospective application, in that they do affect existing trusts,” says Philip Munro, a partner at Withers in Singapore. “One of the key ones is in relation to exculpation provisions in respect of which trustees of Hong Kong trusts will be specifically unable to limit liability for breach of trust resulting from fraud, wilful misconduct or gross negligence. Trustees of existing Hong Kong trusts are affected by these changes notwithstanding that case law presently suggest that a trustee can limit their liability more widely; it’s not just in respect of new trusts that these changes are relevant.”

In perpetuity

Munro says that the amendments can be split into two categories: some are changes to modernise the administrative aspects of the trust law – for example the amendment to the default powers of trustees – which bring Hong Kong’s trust law up to the norm, as in practice, most trust law jurisdictions made these changes quite some time ago.

“There are, however, a number of more exciting changes that will be relevant to international families considering Hong Kong as a governing law for trusts.  One of these is the abolition of the rule against perpetuities, which means that going forward, a HK trust can be created that will endure perpetually,” he says. “That’s quite a big thing if you’re looking at families with very considerable assets, in which case, an 80-year or fixed perpetuity period isn’t effective, and also families where there’s dynastic sort of vision in terms of their succession planning.” The removal of this duration limit puts Hong Kong ahead of, say, Singapore, which has imposed a cap of 100 years and England which has 125 year fixed period.
Also making Hong Kong more attractive as a trust domicile to settlors, particularly those from civil law jurisdictions, is its recently introduced anti-forced heirship provision. For those setting up trusts in Hong Kong, the allocation of their trust assets in future cannot be influenced by relevant forced heirship rules in their home jurisdictions against their wishes.

“This will make Hong Kong an attractive place for settlors whose domestic law may have forced heirship features.  Hong Kong can for be used by such settlors for lifetime trust planning with less concern as to whether the planning might be vulnerable to challenge in the future,” says Munro.

Back on track

When the new law was submitted for hearing to the Legislative Council earlier this year, it was intended to breathe fresh life into a sector that had been left alone for many years. The new ordinance was intended to amend the Trustee Ordinance (1934) and the Perpetuities & Accumulations Ordinance (1970), by enhancing trustees' default powers, while providing for appropriate checks and balances to make trust administration more effective.

Current Hong Kong trust law is based mainly on common law and the English Trustee Act (1925), and is supplemented by the local Trustee Ordinance and the Perpetuities & Accumulations Ordinance, which have not been substantially reviewed or modified since they were enacted decades ago. As such, some of their provisions are outdated and do not meet modern trust requirements. Accordingly, even though Hong Kong banks serve as trustees, they do not use local trusts.

Munro adds that the amendments have brought Hong Kong in line with a number of comparable trust jurisdictions. “I think the amendments have gone a long way. They’ve plugged some serious deficiencies in the trust law,” he says. “It was unclear, for example, to what extent trustees of HK trusts could delegate functions - there was no automatic ability for trustees of HK trusts to charge if a trust instrument didn’t provide for one, there was only a limited ability for trustees of HK trusts to insure trust property, and so on. These were serious deficiencies, particularly in the international context.”

Versus Singapore

One of the other key features of the new Hong Kong trust law that brings it in line with its nearest Asian rival Singapore, says Munro, is that it has a feature expressly protecting trusts where there are powers reserved by the settlor. “To create a valid trust under HK law, there needs to be an actual disposition of property to the trustee. So a concern has been if the settlor retains too many powers that you may not create a valid trust,” he says. “One of the things Singapore’s done very successfully is that in its trust law, it expressly recognised and protected investment powers that were reserved for the settlor. This is quite an attractive model from the perspective of settlors who are keen to continue to manage trust assets during their lifetime. And it’s quite attractive to trustees because where the settlor is managing investments rather than them, there’s a feeling they should not be within the scope of liabilities in terms of investment performance. So that’s a very common model of trust in Singapore because of this provision.

Offshore competition?

Munro of Withers says that with its new trust law, Hong Kong should certainly be able to compete with offshore jurisdictions for international trust business. “In some ways and for some families, Hong Kong will be more attractive than a traditional offshore jurisdiction because it has a trust law that has the key features you would often be looking for, but at the same time, it’s a jurisdiction with substance and with double tax treaties” he says. “Hong Kong could have gone further – many offshore jurisdictions have what are called non-charitable purpose trusts, which are trusts that exist for a purpose or purposes instead of a beneficiary  – Hong Kong hasn’t legislated to bring those in.”

According to Colin Riegels, partner at Harneys in Hong Kong, while the modernisation of Hong Kong’s trust law is welcome, “the elephant in the room is the geopolitical fact that in 35 years, Hong Kong’s legal system will be subsumed by the PRC. In estate planning terms, with trusts often used as multigenerational or dynastic succession vehicles, 35 years is a very short time horizon, and that will operate as a block for a large section of the potential market.”

“Similarly, whilst the new regime in Hong Kong is much more flexible than the former position, it is still considerably less radical in terms of flexibility than either BVI or Cayman trusts,” Riegels adds. “In areas such as purpose trusts, reserved powers and trusts to retain, as well as the ability to establish private trust companies in BVI and the Caymans, Hong Kong trusts still look very conservative compared to their offshore counterparts. And there is no equivalent in Hong Kong to the more exotic offshore trust products like BVI VISTA trusts and Cayman STAR trusts.” Given that it took about eight years to have these amendments passed into law in Hong Kong, when one considers how regularly the offshore jurisdictions such as BVI and Cayman look to update and fine tune their trust legislations to remain current, innovative and user friendly to high net worth clients around the globe, it does seem likely that BVI and Cayman will remain at the cutting edge of international trust planning and thereby, the jurisdictions of choice for the vast majority of clients, he says.

However, it’s not that Hong Kong is looking to compete directly, at least not yet. “My understanding is that at a policy level, the Hong Kong administration does not wish to see Hong Kong as an offshore centre (at least in the traditional sense), and does not wish to see itself, strictly speaking, competing with offshore centres. So during the process as I understand it, the draftsmen were not focusing their benchmarking against what would be the traditional offshore centres such Jersey, Guernsey, the Cayman Islands and BVI,” says Leese of Ogier.

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