Hong Kong Monetary Authority consults on proposed code to enhance regulation and supervision of trust business in banking sector

The Hong Kong Monetary Authority (HKMA) recently launched a consultation on proposals to enhance the regulation and supervision of trust business in the Hong Kong banking sector. Responses are required to be submitted by 9 October 2020.

This follows proposals announced by the Securities and Futures Commission (SFC) in September 2019 to regulate depositaries (trustees and custodians) of SFC-authorised collective investment schemes (CIS) via a new Type 13 regulated activity (please see our e-bulletin of September 2019). The SFC is currently considering the feedback received on such proposals.

The HKMA intends to regulate and supervise trust business via a Code of Practice for Trust Business (see draft code) (Code), which will apply to authorised institutions (AIs) and subsidiaries of locally incorporated AIs that conduct trust business in Hong Kong. Other trustees and trust companies are encouraged to adopt the proposed Code to the extent applicable.

AIs and subsidiaries of locally incorporated AIs should start making plans to review their policies, systems and controls to ensure that they are ready to comply with the Code within 6 months of its finalisation and issue (as currently proposed by the HKMA).

Rationale behind the proposals

The HKMA notes there are some limitations in the current regulatory regime for trust businesses. In particular, the HKMA has not issued any conduct requirements specific to trust business conducted by AIs or their subsidiaries. While there are industry guides issued by the Hong Kong Trustees’ Association, membership of the association (and hence compliance with the guides) is voluntary.

The HKMA therefore sees merit in developing a regulatory code to strengthen the level of protection of customers making use of trust services, particularly for wealth management.

The Code is intended to enhance protection of client assets held on trust, better align with international standards and practices, and promote treating customers fairly and a customer-centric culture in trust businesses

Proposed implementation timeframe

The HKMA has proposed that AIs and subsidiaries of locally incorporated AIs be required to comply with the finalised Code as soon as practicable, and no later than six months from when it is issued. This is based on the understanding that most of the principles and standards under the proposed Code are in practice already being applied by the industry.

Other trustees or trust companies will be encouraged to follow the same timeline to the extent applicable.

Who will be subject to the proposed Code?

is proposed that the Code will be incorporated into a HKMA Supervisory Policy Manual (SPM) module and will apply to:

• all AIs; and
• subsidiaries of locally incorporated AIs,

that conduct trust business in Hong Kong.

“Trust business” refers to provision of the following services by a trustee (and is not confined to services involving fiduciary duties):

• setting up a trust;
• acting as trustee for a trust;
• arranging for any person to act as trustee for a trust;
• managing the assets held on trust;
• administration services for a trust; and/or
• eventual transfer of assets to beneficiaries.

The HKMA also encourages other trustees or trust companies that conduct trust business in Hong Kong (this would include holders of a Trust or Company Service Provider Licence issued by the Companies Registry / Registry for Trust and Company Service Providers) to adopt the proposed Code to the extent applicable.

AIs or subsidiaries of local AIs who merely introduce or refer another trustee to their customers for provision of trust services will not be required to comply with the Code. However, the relevant SPM module will require them to observe various principles for protecting customers, such as performing due diligence on the trustee and having in place an agreement with the trustee on how to handle operational incidents.

Who will be exempted from the proposed Code?

It is proposed that the following entities will be exempted from the Code to avoid regulatory overlap:

• depositaries licensed or registered for the proposed Type 13 regulated activity under the Securities and Futures Ordinance, insofar as the trust services provided relate to a CIS authorised by the SFC and form part of the Type 13 regulated functions;
• companies approved by the Mandatory Provident Fund Schemes Authority insofar as the trust services provided relate to specified mandatory provident fund products; and
• accountancy firms and law firms (which are subject to their own professional codes.

What will the proposed Code cover?

The proposed Code includes six general principles, together with practical standards relating to each principle, to govern the business conduct of trustees and trust companies.

The Code will not include trust-specific prudential requirements or anti-money laundering or counter-terrorist financing requirements, which are already covered by other legislation and rules.

Principle 1: Fairness, honesty and integrity

A trustee should act honestly, fairly and with integrity in conducting its business, including:

• acting fairly and objectively when dealing with the settlors and beneficiaries of a trust (customers);
• making adequate and accurate disclosure of information to customers;
• being open and transparent with customers about fees and charges and ensuring that the fees and charges are fair and reasonable; and
• ensuring that its invitations and advertisements are accurate and not false, misleading or deceptive.

Principle 2: Due skill, care and diligence

A trustee should (among other things):

• execute requests or instructions from customers promptly and effectively;
• act in the interests of its customers;
• properly identify and manage any actual or potential conflicts of interests; and
• possess and maintain sufficient skills, knowledge and expertise to conduct its trust business, and ensure that its staff are and remain fit and proper for their roles and responsibilities.

Principle 3: Management and control of trust assets

A trustee should (among other things):

• exercise care in safekeeping assets held on trust;
• ensure clear identification and segregation of assets held on trust; and
• conduct regular reconciliation of assets held on trust and verification of asset ownership.

Principle 4: Corporate governance and internal controls

A trustee should (among other things):

• establish and maintain a robust corporate governance structure, internal controls and risk management processes;
• ensure senior management are held responsible and accountable for running the trust business on a day-to-day basis in accordance with legal and regulatory requirements (appropriate individuals should be appointed to supervise the trust business, such as a manager under section 72B of the Banking Ordinance where the trustee is an AI);
• ensure that all trust related information and customer data are held in strict confidence;
• assess and continually manage the risks of any outsourced activities, in line with the HKMA’s requirements in SPM SA-2 on outsourcing;
• put in place adequate procedures and controls in managing and administering the trust, including business continuity plans;
• put in place adequate policies and procedures for handling customer complaints, in line with the HKMA’s SPM IC-4 on complaint handling procedures; and
• maintain professional indemnity insurance.

Principle 5: Compliance with legal and regulatory requirements and standards

A trustee should (among other things):

• establish a compliance function that is independent of all business and operational functions and reports to senior management directly; and
• establish a compliance program for planning and conducting regular independent review of its trust business operations, and take appropriate remedial measures to rectify any issues or weaknesses identified.

Principle 6: Co-operation with regulators

A trustee should (among other things):

• deal with relevant regulators in an open, cooperative and timely manner; and

(where the trustee is an AI or an AI subsidiary) promptly notify the HKMA of relevant matters relating to its trust business activities and operations, such as significant changes in business plans and material non-compliance with any legal and regulatory requirements (including the proposed Code

Supervision of compliance by HKMA

The HKMA will monitor the compliance of AIs and subsidiaries of locally incorporated AIs with the proposed Code in its ongoing supervision, and plans to adopt a risk-based approach to determine the means and intensity of the supervision. The HKMA may conduct off-site surveillance (such as via regular or ad-hoc surveys) as well as on-site reviews (such as examinations by the HKMA or engagement by AIs or subsidiaries of locally incorporated AIs with internal or external auditors to conduct reviews).

Failure to comply with the proposed Code may call into the question the fitness and proprietary of the trustee, whether the AI concerned satisfies the minimum criteria for authorisation under the Banking Ordinance, and/or the fitness and proprietary of the AI’s chief executives, directors and shareholder controllers.

Proposed list of trust companies

The HKMA is also seeking views on maintaining the following lists on its website:

• a list of AIs and subsidiaries of locally incorporated AIs that conduct trust business in Hong Kong, which are subject to the proposed Code; and
• a list of other trust companies that conduct trust business in Hong Kong (other than accountants and lawyers) that have submitted to the HKMA a declaration that they observe the proposed Code and that they wish to be included in the list for public access.

The above AIs and subsidiaries of locally incorporated AIs, as well as any other trust companies that have agreed to be published on the list, will be required to provide to the HKMA (initially and subsequently for each calendar year) a declaration signed by the relevant business head(s), and the head of compliance or head of an equivalent function, regarding their compliance with the proposed Code as applicable to their trust business.