China’s Stellar Economic Growth – exponential growth of HNWI
China’s breathtaking economic growth over the last few decades has been accompanied by a commensurately rapid rise in the number of high-net-worth individuals (“HNWIs”) and levels of personal wealth. According to CapGemini, the number of HNWIs in China (defined as holding investable assets of USD$1m+) increased from nearly 180,000 in 2006, to 1.256 million in 2018 – a sevenfold expansion, with no sign of a slowdown in pace: growth between 2016 and 2017 was 11% in itself. China’s private wealth has burgeoned to RMB165tn (approximately US$24tn), more than six times its level in 2006, according to the 5th China Private Wealth Report, developed by Bain & Company in collaboration with China Merchants Bank. This period of wealth creation is one of the fastest in modern history. China now has over 400 billionaires, second only to the United States.
Challenges faced by the Wealthy
However, as seen in other parts of the world, this new wealth brings new challenges. A key issue that is often overlooked is how to pass the accumulated wealth to the next generation in an appropriate and controlled way.
Lack of focus on inter-generational wealth succession
Wealth advisers and their clients tend to focus on preserving or growing the wealth over the medium term, while longer term plans for its disposition to the next generation are often overlooked. There are a number of reasons for this: the fact that decisions about sharing wealth between potential heirs are not easy, and the tendency to believe that there is “still time” to make plans, are the main culprits for deferring a succession plan. In China, there is a further complication, as conversations around mortality are not culturally de rigueur, so the issue is difficult to table for discussion. As a result, wealth managers engage more proactively on immediate investment priorities and park this more uncomfortable topic for a later date. This can be a mistake.
China’s one child policy
It is tempting to view China’s legacy one-child policy in this context, and perhaps draw a conclusion that succession planning is not so much of an issue. But this is a superficial analysis. The one-child policy has been loosened recently, but notwithstanding that, China’s HNWIs have the same family intricacies as their counterparts elsewhere. HNWI’s siblings develop expectations of a share of the wealth, marriages break-down, new partners come on the scene, parents become concerned about the lifestyles of, and impact of the wealth on, the next generation, or distrust the husbands and wives of their children, and so on. In any cases, sons and daughters have no interest to continue the family business, leaving a two-fold problem of how to handle the transition of both corporate and personal assets.
Increasing concern in succession planning
There are visible indicators that succession planning concerns are increasing. Will writing in China has not featured historically, with wealth transfer typically taking place in imperial China between the parents and the first son, and not really on the radar in more recent times due to the legacy levels of poverty. However, following the reforms and the wealth creation of the last 40 years, the issue is now higher on the agenda. The number of wills handled by notaries in Guangzhou and Shanghai increased by 20% between 2016 and 2017, and (according to the Chinese Ministry of Justice) 1.4million wills are lodged at notary’s offices, an increase of fivefold from 20 years ago.
Diversification and asset protection: offshore trust arrangements
Wealth management strategies in general sit on a continuum between risk-taking and preservation: succession planning sits very much on the latter pole. Key wealth preservation strategies centre around diversification - of assets, currencies and jurisdictions, carefully designed to avoid overconcentration in specific areas and allowing financial crises to be ridden out without significantly impacting the quantum of the wealth.
Partly as a result of the focus on diversification and asset protection, Chinese HNWIs have increasingly established private trust arrangements. These typically involve the HNWI placing assets into a trust structure, managed by a professional trustee, who is given guidance in the form of “wishes” on how the assets should be managed before and after their demise. This allows an orderly disposition by a trusted third party, helps set expectations for the next generation, and avoids uncertainty (and as a result much vitriol and distress in the family).
Trust arrangements are drafted to be as robust as possible, but of course can be legally challenged by disgruntled third parties. Hence, they function more reliably if established in a jurisdiction with a mature framework of legacy trust case law. Given the responsibilities placed on the trustee, HNWIs also have a preference for selecting trustees in jurisdictions with strong regulatory frameworks. For these reasons, for Chinese HNWIs, Hong Kong and Singapore are the preferred locations for the law of the trust and the location of the trustee, although it is equally common that the trusts are written under another jurisdiction’s law, for example Jersey.
Trusts to address concern over losing control of assets
HNWIs, Chinese or otherwise, often baulk at the concept of gifting their assets to another party (the trustee), who has discretion over how they are managed, and the assets are distributed. The wealth has often been generated by entrepreneurialism and hard work of an individual or couple, and it is uncomfortable to imagine losing control of the assets by settling them into a trust. The trust industry has, of course, recognised these genuine concerns, and has adapted its range of solutions accordingly: reserved power trusts, Cayman STAR trusts, BVI VISTA trusts and private trust companies confer different levels of influence over the trustee’s discretion. Add to this that larger trust companies administer trusts possibly for hundreds of HNWI families, and are invariably regulated in their home jurisdiction, and the risk of trustee malfeasance is very much reduced.
Hong Kong’s IPO boom
Trust arrangements have been particularly popular with Chinese entrepreneurs who have built successful businesses in China, and now wish to access global markets to raise funds for further expansion, or to realise some (or all) of the value of their business. Typically, such companies are brought to the Hong Kong Stock Exchange for an Initial Public Offering (“IPO”). Activity this year has been very strong, with high profile flotations such as Xiaomi and China Tower making the most recent headlines. A typical pre-IPO structure sees the shares in the business placed into a trust structure initially, the IPO subsequently takes place, a proportion of the shares is retained in the trust along with the (usually very substantial) proceeds from the IPO. The latter are then invested by the trustee (under the guidance of the entrepreneur and his advisers) into a portfolio of assets to protect and diversify the wealth for the long term benefit of the entrepreneur and his/her family.
Singapore: a popular trust jurisdiction
Commonly, the transaction is engineered and executed in Hong Kong, although Singapore is increasingly emerging as the preferred location for Chinese HNWIs. There is a view that Singapore as a jurisdiction is more arms-length from China itself, and has a more established and comprehensive regulatory regime for trustees. In addition, Singapore has cultural links which are as strong as Hong Kong’s and has Mandarin capability, which is attractive to wealthy Chinese.
Next step: family office
Some Chinese HNWIs have gone a step further, and established more formal family office arrangements. Family offices are a concept developed in the US and Europe, but are becoming increasingly relevant for Chinese and other Asian clients. Typically, they involve dedicated investment and finance professionals with a specific mandate to manage family governance, investment management, physical asset management, estate planning, tax planning and concierge-type arrangements for their families, providing a single focal point for the family’s immediate and longer term financial needs. Singapore’s accommodative financial services regime strongly supports the family office industry and many Chinese HNWIs have taken advantage and established themselves there.
Early start: succession planning
However, the real message here is to address succession planning decisions as soon as possible. HNWIs should not leave this important decision for another day: the future is too difficult to predict. Across the world (including in Asia), there are numerous examples where HNWIs have not designed sufficiently robust wealth succession plans. This has left a legacy of long term, irreconcilable conflict between next generation siblings, which would have broken the hearts of the parents had they been able to see the consequences of not planning comprehensively enough. The combination of the prospect of inheriting substantial wealth, and the emotional aspects of sibling rivalry, make a toxic mix that rarely has a good outcome.
The Fundamentals of Transfer Pricing and Country-by-Country Reporting
20 August 2019
The international tax landscape has undergone radical changes in the last half dozen years. Multinationals everywhere are being forced to increase corporate transparency and disclosure. The rules for and risks of minimizing tax are evolving fast…
How to choose an employee share scheme that will drive business growth
14 August 2019
Vistra shortlisted in four categories at Citywealth Powerwomen Awards 2020
14 August 2019
International Expansion and Operations Basics: An Updated Review
13 August 2019
What is the Vistra Economic Substance Classification Questionnaire?
13 August 2019
What is the Economic Substance legislation and why should you care?
08 August 2019