There have been many articles, papers and presentations analysing the uses of international trusts, and rightfully so, as the trust has been the most commonly used and impactful wealth preservation and succession vehicle for centuries. All trusts have trustees of course, but interestingly, very little has been written from their perspective, nor about the real role of the international trustee and the challenges they face.
Trusts are often designed to last for generations and that longevity is normally achieved when there is good understanding and communication through time between the parties to the trust. In this article, my aim is to shed more light on trusteeship through a trustee’s eyes to help further develop mutual understanding between settlors, beneficiaries, protectors and their trustees and thus help ensure wealth and dynastic objectives are actually achieved.
Six pillars of international trusteeship
To help discuss international trusteeship and put it into context, I find it helpful to consider and summarise the role under six key ‘pillars’, as outlined below. Please click to expand the sections to find out more about the themes through a trustee’s lens.
The law applicable to trusts is the primary and fundamental pillar, from which most of the other five pillars derive their meaning and application. Trustees must therefore have a solid understanding in this area. In simple terms, trust law derives its content from both legislation/statute and court decisions. Eventually, the prior is tested and further defined by the latter, which in turn gives the prior much more relevance, or in some cases, possible irrelevance.
At its core, the relationship that a trustee has to its beneficiaries is fiduciary in nature, requiring a very high duty of care, fidelity and loyalty. In other words, the trustee has an ongoing obligation to always act in the best interest of its beneficiaries. Breaching fiduciary duty can result in serious liability for trustees.
It is also important to take into consideration the regulations promulgated by branch agencies pursuant to a delegation of rule-making authority from a particular country’s legislature. These regulations govern minimum standards of trustee operation and set out codes of conduct that trustees must follow. Such regulations have been increasing materially around the world and although this is putting considerable extra pressure on trustees, it does provide settlors and beneficiaries with additional peace of mind, knowing that independent third parties are overseeing their trustee.
2. Accounting and reporting
Whilst one of the core duties of a trustee is to account to its beneficiaries and maintain accurate records, in practice, trustees are remarkably free from accounting-related regulatory constraints or parameters. There are few rules on the form and content of financial statements for trusts. However, such freedom can lead to problems. Accordingly, trustees must decide what type of financial reporting they wish to undertake for the various trusts and other entities under their care, taking legal, risk, tax and commercial factors into consideration.
How the trustee safely and securely maintains such records is also relevant, which these days normally involves digital document management. Moreover, trustees must not overlook the peace of mind provided to beneficiaries by accurate, timely and consolidated reporting, preferably digitally enabled. Demands for detailed, up-to-the-minute financial data has increased significantly in recent years, accelerated further by COVID-19 disruption and uncertainty.
The entire investment process for cash and public securities – from the appointment of investment managers/advisors to monitoring performance on an ongoing basis – is generally the responsibility of the trustee (in the case of discretionary trusts). This area of fiduciary duty has been accented by the recent market fluctuations caused by the COVID-19 pandemic, as discussed by my colleague Tom Hardman.
In addition, there are unique considerations, as well as specialised expertise and experience required, for holding operating companies and alternative assets (e.g. real estate and private equity investments), whether directly or via funds, as well as various luxury assets (e.g. yachts, aircraft, classic cars, artwork).
And, at the risk of overlapping with our fourth pillar, tax is an important consideration when making, maintaining or disposing of any investment. For example, there are a number of common US tax related implications, which many international/non-US trustees have been caught out by in the past.
Whilst trusts are often established in well regulated, tax-neutral jurisdictions, that certainly doesn’t remove the need to address tax considerations relating to the settlor, beneficiaries and/or assets. Rather, it simply provides a clear base from which to do so. With increased global tax harmonisation over the last couple of decades, this requirement has become more important than ever.
Dealing with US connections is again a good example. A prudent trustee that has, or would like to have, trust business with Americans (or others with US connections) requires at least a basic level of understanding of the relevant US landscape, including tax rules, both in terms of high-level understanding of the rules themselves as well as suitable planning structures and related reporting requirements. Of course, trustees are not expected to be US tax experts, but this high-level understanding combined with a solid network of reputable US tax advisors is key.
Whether a particular trust structure results in a tax benefit or not (keep in mind many trusts are fully taxable), tax reporting/compliance may still be required and the reputational and financial risks of not doing this correctly can be significant. Accordingly, trustees require good knowledge in this area and an ability to complete (or outsource to the right specialists) various forms of applicable US tax compliance or calculations. Requirements can go well beyond FATCA and include, for example: Form 3520A; appointment of US agents; Form 8832; 65-day election; QEF election; Foreign Non-Grantor Trust Beneficiary Statement; and distributable net income (DNI) / undistributed net income (UNI) calculations.
5. Risk management
The level of risk faced by trustees in today’s fiduciary world is arguably greater than ever, owing to various factors such as increased global tax transparency, family members residing in multiple jurisdictions, increased regulatory compliance obligations, increased reputational concerns, and a form of ‘blame culture’ resulting in increased litigation in many jurisdictions. Associated risks come in all shapes and forms – from operational and commercial issues to the risk of third party liabilities via underlying trusts.
One key type risk for trustees to keep in mind is fiduciary risk, which is associated with allegations made by beneficiaries regarding breach of fiduciary duty. Perhaps one of the best and simplest mitigation tools is for the trustee to ask themselves “Can I? Should I?” when facing a particular beneficiary request or decision. First, “can I” make that decision? As in, do I as trustee have the perquisite power under the trust deed and/or law? If not, then often the matter stops there. If indeed “I can”, then “should I”, considering all relevant circumstances and facts? In other words, is that undertaking in line with the trustee’s fiduciary obligations to operate in the best interest of the beneficiaries?
Regulatory risk is significant too. Although a trustee's primary fiduciary obligation is to its beneficiaries, trustees also have very specific and sometimes rather onerous regulatory obligations, intended to maintain the integrity and reputation of the trust industry and to protect its settlors and beneficiaries. This requires regulated trustee businesses to have, for example, proper operating procedures and policies and regular governance reporting.
Further, trustees must be thorough in their due diligence procedures when taking on and retaining clients, checking factors such as source of wealth, reputation, character and origin of assets. There is also often a requirement to report suspicious activity to the relevant regulator. Significant regulatory breaches may of course result in fines and/or a trust business licence to be suspended or revoked. The key is an effective risk framework and robust but proportionate internal controls.
6. “KYB” (Know Your Beneficiaries!)
Finally, in order to effectively address each of the previous pillars and overcome many of the hurdles mentioned throughout this article, trustees must keep in mind one simple but important objective: “know your beneficiaries”!
After all, how can a trustee truly act in its beneficiaries’ best interests if that trustee doesn’t have adequate knowledge and understanding of the beneficiaries it has been charged with protecting? This knowledge includes, for example, their lifestyle, family structure, liquidity needs, succession issues, family businesses, internal disputes, overall family circumstances as well as cultural traditions and/or religious beliefs. There are also more sophisticated methods to achieve solid KYB, including for example enhanced family governance through the use of family charters and family offices.
If a trustee gets its KYB approach right, not only does that pave the way for fulfilment of fiduciary obligations and mitigation of relevant risks, it also significantly increases likelihood of both a positive experience for the beneficiaries and long-term commercial success for the trustee.
In considering trusteeship through a trustee’s eyes, it is hopefully apparent the direction in which those eyes must be focused: resolutely towards the beneficiaries. This has been the case for centuries, but what has changed in more recent years is that the trustee’s gaze must also constantly monitor a range of other factors relating to the heightened regulatory, compliance and related enforcement environment in which trustees now operate – which, at the end of the day, has arguably evolved in accordance with the same goal: protection of beneficiaries.