In China we trust

A new law on trusts was passed by the People''s Republic of China (PRC) recently. It has raised many an eyebrow, not just in the legal field, but also in the pensions and fund management arena.

China's new law on trusts paves the way for trusts to be used as a legal vehicle for new pension funds. The path will not be smooth if other radical new pension reforms and further amendments to the law itself do not take place says Iain Batty, partner at international law firm, CMS Cameron McKenna.

"Trusts are likely to provide the underlying legal basis for certain types of pension funds and for certain investment funds, like unit trusts," says Batty, who has been advising the PRC government on pension reform. "Trusts have been popular vehicles primarily in common law countries, like Hong Kong and the UK. Now it is extending to civil law countries, and China has taken a bold, far reaching step in introducing a system of trusts."

Trusts are likely to play an important part in the radical pensions reform that the PRC government has embarked upon. Coined the "three pillar" pension system, the first pillar will be a "pay as you go" state social security system. The second pillar will be a funded mandatory account system. The last pillar will see the introduction of voluntary arrangements. According to Batty, it’s this third pillar of reform that trusts are likely to play the most significant role.

Although no pension fund legislation has yet been drafted, Batty says it is envisaged that private pension arrangements will be subject to the trust principle and it is also conceivable that open pension funds might be created in the same way. "Where you may have a pension arrangement sponsored by an employer for their employees, you would want to ensure that the employer cannot do as he likes with the money," says Batty. Trusts are a good way of ensuring the segregation of assets should the employer go into liquidation." Under the trust law, the employer would, as settlor, give contributions to trustees to hold for the benefit of its employees. Typically, the trustees will be drawn from the management and the workforce of the employer. An investment manager under the control of the trustees would then manage the contributions as a whole.

Batty points out that whilst it is generally understood that the trustees are to act in the best interest of the beneficiaries, there are rare cases of trustees using pension money for their own purpose. "Introducing a system of trusts isn't just about introducing law," says Batty. "It is about introducing a culture and an understanding about how trusts separate legal and beneficial ownership. Frankly, it is a difficult concept and unless it is properly understood by trustees and potential trustees, it could be a recipe for fraud."

The new PRC law on trusts has other faults. For example, the PRC law provides that where the trust property, the beneficiary or the scope of the beneficiaries cannot be ascertained the trust is void; but it is as yet unclear how general the descriptions in the trust document can be before this provision is activated. Particular problems are envisaged in relation to pension, mutual and investment funds, as the trust property cannot be exactly specified at the outset because contributions will be made over a period of time.

In addition, the law allows the settlor to instruct the trustee to manage the trust property differently where the present management is detrimental to fulfilling the aim of the trust; or if it is not in the interest of the beneficiary, due to special circumstances not foreseen at the time of the trust's establishment. Batty points out that this could be detrimental to the proper administration of trusts as the settlor will be able to criticize and even intervene in the trustees every move. This concept is contrary to the principles of trust law found in most other jurisdictions.

"The overall thrust for the law is right, but there are lots of points of detail that still need to be addressed. The structure can be useful if it is understood properly, if it is regulated and supervised properly," Batty points out. Furthermore, he says, trust law will only have an impact if other laws are also in place, such as a pensions law and an investment funds law.

Therefore, whilst the PRC can be applauded for its far-sighted approach in introducing trusts into its civil law system, much work on education and clarification on the PRC law of trusts needs to take place before trusts are a fully workable vehicle for pension and investment funds.

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