Trusting the next Asian generation

With Asian wealth – estimated at $10,700bn (€8,026bn) by Cap Gemini – still largely in the hands of the  first generation of entrepreneurs, Asia Pacific is at the beginning of a bull market in succession planning.

Deutsche Bank expects 85 per cent of that wealth to move to the next generation over the coming 10 to 15 years. Hoping to capitalise on the opportunity, a growing number of providers have moved to Asia – today there are 50 trust companies in Singapore alone – and private banks have enhanced their offering in this area, particularly post financial crisis, when criticism about their product push and lack of a holistic approach reached its peak.

In the last few years major family disputes and unwelcome publicity around their estate situations,  especially in Hong Kong, contributed to increasing awareness of the need to set up proper planning structures.

“Asian clients are generally relying on old methods and are going through that cultural battle in their own minds between the way they used to do and are doing things today, which is pretty shambolic, and the way things should be done in wealth planning,” says Mark Smallwood, head of wealth management solutions Apac at Deutsche Bank.

As the major part of a family’s asset is tied to their operating business, typically Asian hands-on, wealthy entrepreneurs – often advised by their corporate CFO or COO or family lawyer – hold assets through an offshore company, often in the British Virgin Islands (BVI). They pre-sign share certificates of their holding company in the belief this is enough to ensure transfer of shares to designated heirs at their death. But many issues, including fraud, could arise and probate to release  those assets to intended beneficiaries can take years. With no will, the estate is transferred according to intestacy laws of the country where the client is domiciled.

“Around 70 per cent of high net worth clients I see don’t have a will, but they have arrangements around the shares, as the majority of their wealth is in their company,” says Mr Smallwood. If the first step is to have a will, this is just a flimsy document and there is the potential for “shenanigans” as beneficiaries dispute it, he says.

The time-consuming probate process for the will can be particularly tricky if it relates to a complex estate with assets in multiple jurisdictions. The estate is frozen until probate has been granted and, as this is a public exercise, can cause family squabbles and people trying to get their hands on assets.

Holding assets through a structure such as a trust or a foundation can help resolve such issues. It is confidential and the ‘settlor’ sets up the governance of the structure explaining how they want assets distributed to beneficiaries. In Asia trusts started to become more commonly used 20 years ago, as people were focused on trying to avoid estate inheritance taxes in Hong Kong and Singapore.

These tended to be irrevocable,  discretionary trusts, where the settlor of the trust had to give up any control, which was not appealing to entrepreneurs.

The lifting of estate tax both in Hong Kong and Singapore combined with the evolution of trust law in the last 10 to 15 years have given the opportunity to put in place structures where the wealthy can retain more control during their lifetime.

The settlor of the trust can reserve considerable powers, including revoking the trust, and appoint themselves succession planning as investment advisers to the underlying assets and make the appropriate investment decisions.

Unlike in the Western world, where trusts are typically driven by tax planning or, in the case of a living trust in the US, to avoid probate, in Asia clients are more control-driven.

The average Asian client is a “control freak”, as they built their business from zero and they do not trust anyone, says Mr Smallwood. Asking clients to transfer all their shares to a trustee is very challenging.

In the US, normally assets are transferred into US trusts and the trustee has full discretion over investments, as that allows a tax break. In Asia, as there is no tax benefit, the settlor of the trust is very keen to remain engaged in the investment process.

Global perspective

As the level of wealth increases and families become multinational, the reasons for setting up proper structures for wealth and succession planning become even more compelling, according to Paul James, global head of Citi Trust Services. Developed markets such as Hong Kong and Singapore have reached a “tipping point” in the transfer of wealth.

“Clients have accumulated huge amounts of wealth and if they were to leave it to the next generation through a will or probate, then all those assets would pass immediately to their heirs,” states Mr James. “So they are looking to use some form of fiduciary structures to slow down the passage of wealth, as they may not want a 20 year old student, maybe at Stanford University in the US, to receive $150m(€112m).” Often people misjudge many of the bigger trust companies, thinking they are on offshore islands simply to evade tax, he says.

Moreover, as now wealthy family members live in high tax jurisdictions, setting up the assets through a corporate trust becomes crucial for tax purposes too. “The trust can be structured in such a way that the money is left offshore outside of the high tax jurisdiction until it is required and taxes are paid when the funds are remitted onshore,” explains Mr James.

Client education remains an issue, says Kevin Tay, head wealth and tax planning, Bank Julius Baer in Singapore. “We really need to educate and let them understand the advantages to ensure a proper succession of the business without having to pay exorbitant taxes.”

The final solution for the client can include two or more tools. “Many of our clients own very successful businesses worth hundreds of millions of dollars, but what they lack is the liquidity,” he says. In a high tax jurisdiction they may need cash to pay for asset duty liabilities, and special life insurance products which have a minimum premium of S$1m (€600m). “Upon the demise of the patriarch, insurance policies pay cash to the beneficiaries, who are able to sustain themselves and are not forced to sell assets under value.” By laying down the governance of the structure, the patriarch or matriarch can make sure their family values are transmitted to the next generation. The trust will serve a number of  purposes, by giving precise guidelines on how, for example, assets should provide education for the next generation or should be allocated to philanthropic causes.

In the US, high profile philanthropists like Bill Gates or Warren Buffet have consciously decided that leaving all their wealth to their children would be bad for them. Mr Buffet famously said “he wanted to leave his children enough money so they could do something, but not so much that they could do nothing”.

“In Asia, when there is a strong patriarch, the children are already growing up in the shadow of a very powerful figure,” says Peter Triggs, head of international clients and wealth structuring at DBS Private Bank inSingapore. “If they are going to be left a huge amount of wealth that the father has created, it can be tremendously demotivating for them.”

A charitable trust or foundation can also provide roles for the next generation, a chance to prove and express themselves as well, still within the context of the founder’s vision.

Share of wallet

With advisers losing an estimated 49 per cent of assets under management during generational wealth transfer, according to the World Wealth Report, it is crucial for private banks to be able to offer a holistic approach and establish a deeper relationship with the next generation before the patriarch passes away. Succession planning plays a key role in this.

“By getting involved in these structures the bank increases the connection to not just the client, but to the client’s family and we can break through the generational gap,” says Mr Tay at Julius Baer. Wealth planners and trustees also represent an extra point of contact between the bank and the client, which helps create a “stickier relationship” with the client.

Also, while the average Asian wealthy family deals with about six private banks, they tend to only have one trustee. “If you can position yourself as the family trustee, you can change the whole relationship with that family. In addition to their investments, families are talking to you about some of their more personal issues, and you position yourself very quickly as their lead bank and the adviser to the next generation,” says DBS’s Mr Triggs. This leads to increasing the bank’s share of a client’s wallet. “By being a trustee, you do attract more assets and more family members become clients.”

As a consequence, programmes for the next generation of wealth holders have exploded in popularity, with many private banks running seminars ranging from financial literacy and management to wealth planning for their clients’ children.

These also help tackle a strong cultural barrier, in particular in Northern Asia, where there is a strong reluctance to talk about death. “In Europe or America, death and succession are discussed very openly because there is a tax impact and clients want to ensure the maximum amount of money goes to inheritors. But in Asia, mostly in North Asia, talking about death is still very difficult,” says Citi’s Mr James.

But this is changing. “The push is now coming as much from the children who live in high tax jurisdictions as it is from us explaining the service we are able to offer. From the beneficiaries’ perspective, it is a big difference if they are only going to receive 60 per cent or 90 per cent of the money,” he states.

What works best with clients is to haveconfidential conversations about their affairs, an appropriate structure for tax and estate planning and not directly about death.

Most clients do not necessarily want their children to know how much they are leaving them. Many change their minds during the course of their lives, primarily because their children may marry badly, may be bad in business, or may be spendthrifts or may not want to get involved in business.

“Getting in front of clients and talking to them about wealth transfer or death is not an easy topic, especially in Asia,” agrees Shayne Nelson, global head, high value client coverage and CEO of private banking at Standard Chartered. “But I think those conversations about structuring wealth correctly with the new generation are a lot easier than with the older generation.”

In Asia-Pacific, excluding Japan, where fast economic growth has created a whole new breed of  entrepreneurs, 41 per cent of HNWs are 45 or younger, versus 15 per cent in Europe and 8 per cent in the US, according to the World Wealth report.

Choosing a trust company

Wealthy clients may prefer bank affiliated trust companies as opposed to independents as they perceive banks offer higher protection or have “deep pockets”, in case something goes wrong. This is also why banks sometimes command a higher premium in terms of fees, says Julius Baer’s Mr Tay.

“Banks have a tendency to promote their trust companies because in effect it gives them control over the clients,” states Shelby du Pasquier, co-head of the Banking and Finance group of Lenz & Staehelin in Switzerland, who sits on the board of a large independent trust company Stonehage.

“Also, they tend to be able to offer very attractive pricing at the trust level, because they can get compensation at the bank level.”

In Switzerland of late, banks and wealth management institutions have focused on their core business and decided to spin off their trust companies, which is a healthy process, believes Mr du Pasquier.

“There is an inherent conflict of interest with bank affiliated trust companies, especially for large trusts, because the trustee will never monitor the work the bank is doing, will never challenge the performance of the assets under trust or the use of the bank’s own products.

Also, the bank’s interests will always prevail over those of the clients.” Independent trust companies – and those recommended have strong financial means and insurance and professional indemnity coverage – would instead choose the best financial institution for running the trust, closely monitor investments and not hesitate to change an institution if there is a problem.DBS’ Mr Triggs believes that a bank is a very good choice as a trustee, with advantages outweighing  disadvantages. “Clients can simply give investment power to somebody else, or keep it with themselves or state they want the bank to invest with a list of external product providers,” he explains.

“I always advise clients not to rush into setting up a trust,” says Hilary May, managing director at RBC Trust Company Singapore. “It is not an off-the-shelf product and careful thought needs to be given to all the pieces of the jigsaw.” It is important to consider the jurisdiction of the trustee, the law of the trust, what assets are put into the trust, tax advice and how beneficiaries might be affected going forward. A lot of Asian clients are cost driven, but this is not the best selection criterion for selecting a trust. In places like the Channel Islands some smaller trust companies have not had the capacity to deal with increased legislation, such as anti-money laundering and extra compliance burdens, she says.

“A trust is a long-term vehicle and you really want to be with somebody that is going to be in the trust business for the long term.” More stringent rules on private banking secrecy will lead to an increasing misuse of discretionary structures, be those trusts or foundations – which are perfectly legal vehicles – in order to avoid taxation, according to Mr du Pasquier of Lenz & Staehelin.

Typically, discretionary structures do not require disclosure of the structure’s beneficial owner, as indeed there is none, given the trustee or the foundation board is entitled to decide freely whether and to whom to distribute assets.

“Today there is an attempt to criminalise tax offences and to force financial institutions to report  suspicions of a tax crime to the tax authorities,” states Mr du Pasquier. “Therefore we are likely to see an increased misuse of discretionary structures by non tax compliant people, in order to hide the identity of the actual beneficial owner of the assets from the bank and avoid this type of reporting.”

Jurisdiction diversification

The surge in offshore trusts, which traditionally developed in Anglo-Saxon jurisdictions, meets clients’ demand to bank in the financial centres where they are based. Cost, confidentiality, robustness or duration of trust can vary across jurisdictions. BVIs are popular with Asians and Hong Kongers in particular because they are cheap. Also, they are language-friendly, as it is possible to draw up legal documents in Mandarin. “In Hong Kong, people do not talk about offshore companies, they talk about BVIs. When I came here in the 90s, it was a status symbol to say how many BVIs you had, because it would imply that if you had six BVIs, you had six assets worth holding separately in a BVI,” says Deutsche’s Mr Smallwood. When selecting a jurisdiction, it is important to understand what clients are trying to achieve and where the beneficiaries are. Tax implications and time zone convenience also need to be taken into account. “What works for clients is time zone convenience and then cost,” says Citi’s Mr James. However, the differences between jurisdictions have now reduced greatly compared to 10 years ago and today it is probably as important to pick the right trustees as it is to pick the right jurisdiction, he says.

A new noticeable trend is that the wealthy increasingly diversify their trust business across different jurisdictions. “We are seeing some of the very wealthy families wanting to set up three or four trusts in different jurisdictions, as they want jurisdictional diversification for their trustee assets and their  trustees,” says Ms May at RBC.

Definitions

• Trusts and foundations are both efficient vehicles for succession planning. People from common law jurisdictions, such as the majority of Asian countries, are more familiar with trusts. In civil law jurisdiction, such as Switzerland, there used to be a preference for foundations, for they allowed a higher degree of control. Over the years, trusts have gained traction and international recognition, in particular with The Hague convention which ensures that a trust structure is recognised by all the member states and more generally internationally. There is no such treaty for foundations.

• A trust is a private contractual arrangement between the settlor and the trustee. Trust services are typically offered by bank owned trust companies, independent trust companies, law or accounting firms. Generally a corporate trustee is a licensed trust company. Large clients, such as family offices, can also set up their own trust company. The trustees have fiduciary duties to the beneficiaries.

• For the trust business, the areas of growth are primarily Asia and the US, where baby boomers are reaching the age of 70-75. According to The Boston College Center on Wealth and Philanthropy, more than $40tn is expected to transition to younger generations in the US over the next several decades.

Asian wealth is estimated to be at $10,700bn (€8,026bn) according to Cap Gemini, and this is largely in the hands of the first generation of entrepreneurs. Deutsche Bank expects 85 per cent of that wealth to move to the next generation over the coming 10 to 15 years

See you in court

The court case in Hong Kong over property tycoon Nina Wang’s estimated several tens of billions of dollars fortune was a lawsuit that gripped local people for three years since her death in 2007. It ended with the judge ruling against her late feng shui master lover, dismissing the will he produced after Wang’s death as a forgery and her supposed signature as “a highly skilled simulation”