Judiciary and regulators need to be educated on trust law, lawyer says

PUBLISHED : Monday, 17 February, 2003, 12:00am
UPDATED : Monday, 17 February, 2003, 12:00am

Radical programmes are needed to educate the mainland's judiciary and regulators about China's new trust law and inform trustees of their obligations, according to a Western lawyer.

China's trust law segregated legal and beneficial ownership of assets but its implementation had been weak, said Iain Batty, a partner at international law firm CMS Cameron McKenna.

Separating ownership and control of assets has been hailed as a big step forward in establishing professional asset management and safeguarding state property from embezzlement.

Yet little hard progress has been achieved since its October 2001 implementation due to lack of public understanding, together with the law's intrinsic flaws.

'Even in senior government circles, there is not really an understanding of how trusts operate,' Mr Batty said. 'There needs to be radical programmes of education to really help develop understanding in this area.'

An efficient trust system is seen as a vital piece of legal infrastructure important to fostering public support for pension reforms, with a shift in emphasis towards individual accounts and employer-sponsored plans. .

In Central and Eastern Europe, which similarly lacked a history of trust law, pension funds were created as foundations for mutual insurers.

Such institutional arrangements, which bundle the funds of founders and members into a common pool of cash, were out of favour as they lack transparency and were open to abuse, Mr Batty said.

The trust law, properly applied, also had the potential to improve accountability and independent supervision - and hence investor confidence - in China's young and scandal-hit fund management industry.

The law allows funds to be structured in unit trust schemes.

An independent trustee, often a custodian, is appointed to hold the assets for the trust's beneficiaries, as well as to supervise execution of the fund's investment policies.

To date, China's 71 investment funds are structured as corporate vehicles, with custodian banks performing no monitoring role over the investment managers.

In 2000, the sector was rocked by revelations of widespread illegal self-dealings within and between equity funds run by the same fund management firms to inflate trading volumes and create a false impression of liquidity.

Mr Batty sees application of China's trust law being further applied to mainland corporations' ubiquitous offshore window companies.

The trust law allows the parent companies to appoint senior managers-shareholders sent to the overseas offshoots as trustees of the offshore assets.

'Without a trust mechanism . . . the company is going to be relying on the honesty of the managers not to abscond with the money,' Mr Batty said.

Despite its promised benefits, trust ownership has remained a novel idea in civil law countries such as China.

With no trust tradition, whether regulatory authorities and the judiciary in far-flung provinces would appreciate the new idea was of particular concern, Mr Batty said.

Beijing's recent abandonment of an earlier idea to operate as a trust the National Social Security Fund, because of difficulties in identifying the settlor and the beneficiaries, was a disappointment.

One of the new law's main weaknesses was its requirement that trustees only treat property in their custody with the same care as their own.

'This really is not a good enough standard,' Mr Batty said.

'The current common law standard is for the trustee to act with the care, skill, prudence and diligence that would be exercised by a prudent man familiar with the matter and acting under similar circumstances, dealing with the property of another.'

Also missing from the law was an explicit ban on trustees self-dealing with affiliates or relatives for personal gain, Mr Batty noted.

Meanwhile, China's law had insufficient curbs on exculpatory clauses, and enabled abusive or incompetent trustees to negotiate too many exemptions from liabilities, he said.

That had been compounded by a shortage of provisions on actions that could be taken against wayward trustees.

Another oddity of the law was that it allowed people to be forced into becoming trustees, contrary to Western thinking that trustees should be volunteers, Mr Batty said.

Contradicting the trust principle, the law further gives a settlor rights to interfere with a trust's operations.

In an apparent attempt to prevent conflicts of interest, the law states that trustees cannot at the same time be the trust's beneficiaries.

That contradicts the increasingly common international practice allowing pension scheme members to nominate fellow beneficiaries as trustees.

'People who are actual members of a pension arrangement will have the best interests of the pension arrangement at heart,' Mr Batty said.

'In many countries, there are legal requirements for trustees or a proportion of trustees to be drawn from among the members and nominated by the members.'