The impact of technology on the private trust industry

Partner, Tax & Legal Support Services, PricewaterhouseCoopers, discusses the possible impact of IT on the private trust industry in Asia.

The purpose of this article is to speculate as to the possible impact of new information technology on the private trust industry in Asia and in particular, Hong Kong. It is quite clear that new technology will obviously present a number of challenges to the global trust industry, not just the industry in Asia, and at one extreme there is the view that the internet revolution could in fact pose a serious threat to the industry. This view and other likely issues are outlined below.

The costs of new technology

Christian StewartFor a trustee company, the first issue with new technology must be the issue of cost and having the technical staff to implement changes. This may not be an issue for a trust company supported by a global financial institution. But it might be for the smaller local stand-alone trustee company, if it does not have an IT department and the resources to pay for new systems and new technologies.

The need to obtain sufficient critical mass to be able to afford an IT department and/or investment in new technologies might be a driver towards merger and acquisition activities amongst small local trust operations. When it comes to consideration of a merger or acquisition, trustee companies will need to look at the risk profile of the business they have on their own books - and the risk profile of any potential partner or target - in order to arrive at a sensible valuation for the respective businesses.

Due diligence will have to be carried out on the standard work practices and procedures of any potential target trustee company. The other alternative would be to try to outsource certain IT or business functions to another company that has already developed the relevant systems and/or has the resources to provide such services.

The potential for increased competition

The internet brings new ways of doing business, new opportunities and new ways to contact the ôclientö. A web site for a trustee company can obviously be used as a platform for the companyÆs marketing material, or to provide a convenient interface between the trustee (or private bank) and the beneficiary/client. For example, the trustee of a trust might decide that it will allow the beneficiary of the trust to access the trust accounts online. A trustee company might decide to provide an advisory service to respond to questions sent in by beneficiaries by email or posted in a secure chat room.

This means that Asian-based financial institutions may shortly find themselves facing competition for high net worth client business from companies which do not even need to have a physical presence in Asia, other than perhaps some relationship or marketing officers. Upon reflection, maybe there is nothing new in that.

New secure electronic payment systems

We are starting to hear of smart cards, digital money, megabyte money and e-cash. There are new ways of making payments through the medium of the internet, and which seem to offer money payment systems outside the scope of the traditional banking system.

Hence, chief among the challenges to come for the trust and private banking industry (and for the Financial Action Task Force (FATF)) will be how to prevent these new electronic payment methods from being used for money laundering purposes.

This is a topic in its own right and readers are referred to the paper ôCyberlaundering of Megabyte Moneyö presented by Graeme WP Aarons, FM Trust SA, Switzerland, at the Offshore Investment Conference, Vienna, Austria, October 2000.

YouÆve got mail

Even the humble email must present challenges to a trustee company. It has been said that communicating by email is like writing a message on a postcard which is then placed into the general postal system. Nevertheless, it is foreseeable that trustees will find that more and more of their settlors and beneficiaries will be communicating with them through email.

Trustees would probably also find that their own advisers and the beneficiariesÆ advisers will all be communicating by email, and this may include enclosing drafts of trust documentation.

The trustee who is under a duty of confidentiality towards the beneficiaries obviously needs to give serious consideration to the implications of the trustee sending an email containing information concerning a trust out into the public domain.

Email my be quick and convenient, but the other obvious danger for a trustee is verification of the sender. How does the trustee check that the email it has purportedly received from a beneficiary was not in fact sent by the beneficiaryÆs spouse or some other member of the beneficiaryÆs family who happened to gain access to the beneficiaryÆs computer? We all know that bearer share companies present a nightmare in terms of combating money laundering and in terms of trying to comply with  Know Your Client (KYC) rules. Perhaps we are now seeing the demise of the bearer share company under international pressure only to have it replaced by the ôbearer laptopö.

Online broking services

It seems to be possible to broadly characterize trustee companies into one of two different types. The first is a trustee that looks to make its main revenue through trustee fees. It is a stand-alone trustee operation. Such a trustee may not be affiliated to any particular financial institution or, even if it is a subsidiary or affiliate of one financial institution, it may still be very happy to see trust funds invested with or managed by other financial institutions. For this kind of trustee company, perhaps the revenue from asset management is not critical.

The second type is a trustee which is established, perhaps as part of the private banking operations of a particular financial institution. Such a trustee may be established to provide a service to the private banking clients of that institution and may be reluctant to take on business from non-private banking clients.

This second kind of trustee company may also be willing to charge very low trustee fees. It may even act as a loss leader, with the financial institution aiming to gain the revenue from the asset management services it can provide to the trust fund. The institution may also view a trust as a strategy for locking in the wealth from a particular high net worth individual for a longer period of time than may have been the case if the individual had opened a private bank account or established a personal investment company with the institution.

Where trustee operations have been established with the aim of securing long-term asset management business (i.e. the second type of trustee company mentioned above), the advent of cut-price internet broking services must be perceived as a very real threat. With access to real-time or close to real-time stock and financial data, trustees and private bankers may find that they are facing a harder time convincing clients that a professional is needed to manage the family wealth.

A trustee company which, in contravention of its prima facie fiduciary duty not to profit from the trust fund and not to put itself in a position of conflict between its own interests (or the interests of its affiliated companies) and the interests of the beneficiaries, would also have to be very careful to ensure that they are managing the trust fund better than the beneficiaries could with their internet trading accounts.

The professional trustee may, therefore, find an increase in challenges in relation to the investments of the trust fund, i.e. the beneficiary with a laptop computer may become a more demanding client than the trustee has experienced in the past.

Trustees should give more thought to their duties of diversification and to ensuring that there is proper documentation and disclosure made (and independent advice) if they want to place all or a substantial portion of the trust fund with an affiliated institution or asset manager.

Keeping control over the trust fund

Trustees who have a duty to get in and keep control over the assets comprised in the trust fund are also going to face a dilemma as they see more and more settlors and beneficiaries who want to establish a trust, but have asked if they can have the trustee open an internet trading account which the settlor or beneficiary then controls with their laptop computer. We are already seeing settlors asking about this kind of arrangement.

The question arises whether careful wording might be included in the trust documentation to expressly allow the trustee to delegate asset management of the trust fund back to the settlor and for the settlor to invest all of the trust fund with an internet trading account.

When thinking about this type of approach it would be prudent to bear in mind, as many of you would already be aware, that in Jersey an action has apparently been commenced against one of the institutional trustee companies by the beneficiaries named under a trust the documentation for which included investment direction provisions. The complaint of the beneficiaries (the wife and children of the settlor) was that the trustee should not have followed the settlorÆs written investment directions, notwithstanding the express provisions of the trust document.

Nevertheless, the challenge for the trustee industry is going to be to see if it can provide ways of accommodating this kind of request or otherwise explaining to settlors and beneficiaries why, where they have established a trust, it is not acceptable for them to be investing the trust fund in such a fashion.

Avoiding probate?

Where a trustee operation has been established to help support the private banking business of a financial institution, the private bankers need to find some reason for encouraging the high net worth customers of the bank to establish a trust with them. One obvious selling point of a trust is that it is a means of avoiding probate and disruption on death. However, another issue is whether clients will start to think that internet trading accounts will mean there is no longer any need to worry about probate.

The idea is that the high net worth individual invests funds through an internet broking account. The high net worth individual has a laptop and a password or security code for the trading account. Their succession plan involves writing the password down on a piece of paper which is placed in an envelope and left with their children. As far as their online broker is concerned, how would they ever know whether the individual they are receiving instructions from has passed away or not, so long as the user has the correct password?

Obviously these online brokers have KYC problems similar to those which trustees are going to be faced with. So with a laptop and a password who needs a trust to avoid probate?

Again, this is just like the bearer share company and the challenge for the industry is to be able to educate private clients that these mechanisms are not legally effective. If the trust industry is lucky, the cost of personalized security devices such as retinal scanning, will continue to drop or will become widespread in use such that death of an account holder cannot go unnoticed by the brokerage company. Clearly techniques must be developed so that customer identity can be properly verified.

Younger entrepreneurs

The ônew economyö (or what is now left of it) has also brought with it another challenge for the Asian trust industry. This is the trend of the younger entrepreneur, who probably has a very different profile from the high net worth individual that trustee companies and private bankers are traditionally used to servicing.

A younger entrepreneur is, by definition, going to be a risk taker and they would probably not be at that stage of life where they see it as being important to preserve assets. Certainly the younger entrepreneur is not going to be very concerned with estate duties or succession planning for their death. Possibly, asset protection might be an issue for them as might income taxes, withholding taxes and capital gains taxes (a charge on disposal of their shares). While asset management services may not be of that much interest, credit facilities and corporate finance services will be. If there is any trust business to be had, this type of profile must tend to favour the trustee company that is affiliated with a financial institution as opposed to a standalone trustee company.

Another feature of the new economy was the entrepreneur with an idea for a start-up business who was looking towards a listing, which, if successful, promised (at the time) to produce great wealth. However, until the listing, the entrepreneur tended to have no spare cash to spend on professional fees let alone on trustee fees.

Lawyers and accountants and other advisers generally took the approach that they would themselves invest professional time in such start-up companies, perhaps taking stock or entering into deferred payment arrangements in the hope that at least one of these start-up clients would be successful (but in the knowledge that many would fail).

Maybe we will not be seeing the same degree of this kind of activity as we saw in the (not too distant) past, but the issue will still present itself from time to time as to whether a financial institution and/or its trustee company should make an investment in a ôpoorö entrepreneur who has the chance of making good.

The obvious concern is that the financial institution and/or trustee company that spurns the entrepreneur when he or she is just starting out will have no chance of forming a relationship with them once they have made good.

Employee Benefit Trusts & ESOPs

The dotcom craze did present a new source of trust and structuring work. The founders of the dotcom companies, keen for an IPO, were willing to establish trust structures to hold their shares in the to-be-listed vehicle. For trustees, this represented opportunities to act as escrow agents (for Hong Kong GEM listings) and to act as trustees of trusts established for the major or founding shareholders in the to-be-listed companies. The new economy, and hopefully this is here to stay, also brought with it a much-increased interest in the use of stock option plans for employees, executive directors and others.

Most share option schemes take the form of an option issued by the company, i.e. it is an option to subscribe for new capital in the company. A share option scheme of this nature is really only attractive if there is a clear prospect of the company listing. While it does not seem to be that popular in Hong Kong, logically an Employee Shares Option/Ownership Plan (ESOP) arrangement or having a trust as part of the share option scheme seems to have advantages.

A trust as part of a share option scheme might help to provide a market in shares for a private company, making a share option scheme a possibility for the private company that has no immediate prospect of listing. A trust as part of a share option scheme also prevents the company from giving away its stock at a cheap strike price which is significantly lower than the market value at the time of exercise.

An ESOP trust is essentially just a discretionary trust for the employees and directors of a company and their dependents, with the trustees being given power to grant options over, or to give away the companyÆs stock, to the beneficiaries. Trustees looking for new ways in which to expand the revenue base should consider whether they have the ability to become involved in employee benefit trust structures of various kinds.

Christian Stewart is partner, Tax & Legal Support Services, PricewaterhouseCoopers. Email: [email protected].

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