China's Trust Law Is Failing Investment Funds, Says McKenna Lawyer

by Mary Swire, for LawAndTax-News.com, Hong Kong

18 February 2003

Following scandals in 2000 in which mainland Chinese fund managers artificially inflated trading volumes by self-dealing, the government introduced a forward-looking trust law in October, 2001, requiring the separation of legal and beneficial ownership, in an attempt to establish professional asset management and safeguard pension assets and state property from embezzlement.

According to CMS Cameron McKenna partner Iain Batty, however, implementation of the law has been weak, and has revealed flaws in the law itself. Mr Batty says that a major programme of education is needed to bring the judiciary and state officials up to speed. It's not uncommon of course for civil law jurisdictions to have problems integrating common law concepts of trust law into their systems.

"Even in senior government circles, there is not really an understanding of how trusts operate," Mr Batty says in the South China Morning Post. "There needs to be radical programmes of education to really help develop understanding in this area."

The law allows funds to be structured unit trust schemes, with an independent trustee being appointed to hold the assets for the trust's beneficiaries, as well as to supervise execution of the fund's investment policies. Normally, Chinese investment funds, of which there are about 70, are structured as corporations, with no external supervisory role.

Mr Batty is particularly concerned about the offshore subsidiaries of mainland investment funds, which are often run by managers out of view of senior management. "Without a trust mechanism . . . the company is going to be relying on the honesty of the managers not to abscond with the money," he says.

Other problems with the law are that trustees are appointed without their consent being needed, and the absence of any ban on slf-dealing with affiliates or relatives for personal gain. In addition, the fiduciary requirement in the law is weak, demanding only that trustees 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."

Finally, he points out that a ban on trustees being beneficiaries makes the law unsuitable as a basis for pension schemes, where it is beneficial for scheme members to be appointed as trustees. "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," said Mr Batty.

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