UCITS

An Undertaking for Collective Investment in Transferable Securities (UCITS) fund is an open-ended CIS (see below) which adheres to the EU’s UCITS Directive. Satisfaction of the Directive’s criteria means that the UCITS may be sold in any country within the European Economic Area.

4.9.2 Unit trusts

A unit trust is a CIS constituted as a trust and is formed under a trust deed under which a trustee is appointed to hold assets – which are pooled in trust – for the investors (who are referred to as ‘unit holders’).

The aggregate value of the units represents the worth of the trust.

Although the units have no nominal value, they are all identical in value – which is the worth of the company divided by the number of shares in issue. The pooled money is invested in the name of the trustee (although the money and the assets acquired are owned by the unit holders). The whole process is administered by a manager. CISs in the form of a trust are prevalent in common law jurisdictions (see sections 4.10 and 18.3 below).

4.9.3 Companies

Although there is more than one permutation, companies are most frequently formed with limited liability. (Permutations include liability limited by guarantee or unlimited liability.) Limited liability companies are the most common type of vehicle used for CISs.

CISs may be open-ended (called mutual funds in the USA in which shares may be bought back from members and where new shares may be issued) or closed-ended (where the share capital issued is fixed and which requires a seller to obtain the approval of other shareholders before disposal). Closed-ended funds frequently have a finite life.

The partnership form is particularly useful for small numbers of institutional or professional investors – who become limited partners (while the management company becomes the general partner). The fund is not subject to tax, but the investors are personally liable. In this form, the life of the partnership is usually finite, which allows investors to liquidate their assets. This type of fund is particularly prevalent in

‘OVshore’ jurisdictions for hedge funds.

4.9.4 Hedge funds and ‘OVshore’

Simply stated, hedge funds are collective investment schemes that are entitled to invest in almost anything, for example secondhand life pol- icies, insurance covers or bets for hurricane loss, and commodity and equity derivatives. Hedge funds are entitled to invest in assets and to use techniques that are not permissible for collective investment schemes in general. Hedge funds can run short positions and leverage their portfolio by borrowing. The degree of risk and the fact that they are unregulated (which inter alia means that they are not obliged to disclose to the public what their asset portfolios comprise) combine to make them entirely unsuitable for most people. The fact that they may invest in complex and even custom designed derivatives means that the value of those assets may not be easily or accurately ascertained (since these instruments are unlikely to be listed on any exchange). Hedge funds were originally conceived as investment vehicles that were of specific interest to high net worth individuals but not the general public (in the USA the threshold for investment is US$1million). Accordingly, in the first in- stance, they were not given a high priority. However, this is now changing as more and more (ordinary) investors are lured by potential gains that have disappeared from many other types of investment. The Securities and Exchange Commission (SEC) in the USA is presently considering whether to regulate hedge funds fully. Some regulations came into eVect in February 2005 (these require some funds to register with the SEC by January 2006). One operational consequence is the extent to which the rules apply, for example in respect of advisors who are overseas and who advise funds other than US funds (such as funds domiciled in the Cayman Islands and those which do not permit invest- ment from US residents). Managers often earn an incentive fee which is paid by the fund itself out of its profits, which is in addition to the annual fee they earn. One problem that arises in comparing performance is that managers simply close funds that do not perform well, and this may aVect the performance index of the funds that remain. (It is anticipated that, for 2005, in the US, hedge funds will have US$1 trillion under management, shared amongst 7,000 hedge funds. This should be compared with 2,500 hedge funds with US$400 billion a decade ago.¹¹)

11 Anthony Slingsby, ‘Hedging and Ditching – Not Yet!’,OVshore Investment.com, April 2005, Issue 155, p. 21.

Amongst the factors that brought hedge funds to public attention was the near collapse of Long Term Capital Management (LTCM) – a hedge fund based in Greenwich, Connecticut. LTCM was founded in 1994 by John Meriwether, a former bond trader with Salomon Brothers. LTCM comprised a strong combination of traders and academics, whose market judgments and quantitative models were intended to combine to pro- duce profits not otherwise available. The fund started with US$1.3 billion but within four years found itself on the verge of collapse. This was avoided by the involvement of a US$3.5 billion rescue package put together by the US Federal Reserve in which participants received 90 per cent of LTCM’s equity. The people involved in LTCM included economists who were Nobel Prize winners and a vice-chairman of the Federal Reserve Board. LTCM’s strategy was to identify securities that were mispriced in relation to each other – taking long positions in those that were priced cheaply and short positions in those priced expensively.

Where diVerences existed, they were very small, which meant that LTCM was obliged to adopt large, highly leveraged positions to make profits.

Despite this high leverage, LTCM relied on its complex models to correlate long and short positions to minimise net risk.

[T]he ultimate cause of the LTCM debacle was the ‘flight to quality’ across the global fixed income markets . . . What LTCM had failed to account for is that a substantial portion of its balance sheet was exposed to a general change in the ‘price’ of liquidity. If liquidity became more valuable (as it did following the crises) its short positions would increase in price relative to its long positions. This was essentially a massive, unhedged exposure to a single risk factor.¹²

LTCM represented a fundamental problem that required attention to prevent systemic implications for the world’s financial system, not least because it involved 20,000 derivatives contracts with seventy-five coun- terparties outstanding.

There may be some correlation between hedge funds and ‘OVshore’.

Both are said to be unregulated, which means that the principle of caveat emptor prevails. Secondly, because of certain exemptions that are pro- vided in the US, hedge funds are not permitted to advertise and place- ments are private. ‘[I]nformation about the nature and performance of

12 ‘Case Study – Long Term Capital Management’,www.erisk.com/Learning/CaseStudies/

ref_case_ltcm.asp.

hedge funds has always tended to be masked in the protection of the professional secrecy of those running them.’¹³ The common feature appears to be ‘secrecy’.

4.9.5 Contractual

Funds in a contractual form are found in countries whose legal system is based on a civil code (e.g. France). The contract includes the rights of investors. This type of fund is formed under a contract made between the investor and the fund management company. The latter manages the assets, and appoints a depository to take responsibility for custody of the assets. Investors acquire units. This type of fund has no legal personality, which means that it is not taxable.

4.10 Trusts

As well as the incorporation of companies, the creation of trusts gives rise to substantial levels of business ‘OVshore’. The ‘trust concept’ is said to date back to the Crusades and twelfth-century property rights.

‘A departing Crusader would entrust his property to a trusted friend, to ensure his property passed to his lineal descendants in the event of his death and his widow’s remarriage.’¹⁴ Therefore, the ability of the Crusader to influence how his property would be dealt with continued after his death. ‘They were subsequently used to reduce feudal dues: there is nothing new in the idea that trusts can be used to mitigate tax or protect assets.’¹⁵

Trusts are frequently private in nature, being a contract between (usually) two private persons. In explaining trusts, ‘legal ownership’ is distinguished from ‘beneficial ownership’. Article 2 of the Hague Con- vention (see below) provides a description of the most fundamental characteristics of a trust (in order to enable the legal profession to determine whether a particular set of circumstances constitutes a trust for the purposes of the convention; accordingly, this is not a definition per se). Article 2 states:

13 Anthony Slingsby, ‘Hedging and Ditching – Not Yet!’,OVshore Investment.com, April 2005, Issue 155, p. 20.

14 ‘Will the Government’s Proposals Kill OVTrusts?’,OVshore Red, March 2004, p. 13.

15 Philip J. Hobson, ‘The Statute of Elizabeth’, www.trusts-and-trustees.com/library/

statute_elizabeth.htm.

For the purposes of this Convention, the term ‘trust’ refers to the legal relationships created – inter vivos or on death – by a person, the settlor, when assets have been placed under the control of a trustee for the benefit of a beneficiary or for a specified purpose. A trust has the following characteristics:

a. the assets constitute a separate fund and are not part of the trustee’s own estate

b. title to the trust assets stands in the name of the trustee or in the name of another person on behalf of the trustee

c. the trustee has the power and the duty, in respect of which he is accountable, to manage, employ or dispose of the assets in accordance with the terms of the trust and the special duties imposed upon him by law.

The reservation by the settlor of certain rights and powers, and the fact that the trustee may himself have rights as a beneficiary, are not necessarily inconsistent with the existence of a trust.

Often, it is not even necessary to identify the settlor (the person who creates the trust). Trusts are particularly useful vehicles and provide substantial anonymity. Trusts are used (inter alia) as a means of mitigat- ing future tax liability by surrendering ownership of assets to a trustee, who assumes responsibility for administering the assets in accordance with the settlor’s instructions for the benefit of specified beneficiaries.

However, the validity of a trust may be subject to challenge and so, generally, the less control the settlor retains over the trust and its trustees, the less vulnerable the trust will be to challenge in this respect.

The main reasons for creating a trust include:

to enable an individual during his lifetime to make provisions for others;

to enable the distribution of assets in a way that is outside the laws of succession (which apply under the terms of a will);

to enable the processing of transactions anonymously and confiden- tially;

to avoid death or estate duties or inheritance tax liabilities;

to shelter assets from litigation; and

to minimise the eVects of tax during a settlor’s lifetime.¹⁶

16 Alan Molloy,The OVshore Investment Market, Oak Tree Press, 1999, p. 36.

It is very rare for trusts to be regulated. There are a number of types of trusts, which include:

The Foreign Grantor Trust, also known as the Asset Protection Trust (APT), is often used by professional people whose circumstances (principally arising from their occupation) expose them to risk of suit and unlimited liability. Consequently, they enter into an arrangement to transfer the ownership of their assets, thereby protecting those assets from litigation onshore. In this respect, APTs provide legal protection against improper claims. APTs should not be used to avoid liability for contractual debts that a person has incurred. If a profes- sional person attempts to frustrate a potential attempt by any future creditor of the settlor of the trust while retaining access to the assets of the trust, the morality of the structure is called into question. For example, if a dentist in the USA injures a patient negligently, that patient will not be able to sue the dentist for assets that are owned by the APT located in an ‘OVshore’ jurisdiction. Although the dentist has protected his assets, the patient has been denied the proceeds of a (presumably) legitimate claim. This example presupposes legitimacy, but in fact some professionals would argue that they need an APT to protect themselves against illegitimate claims. Fraudulent conveyance is a particularly important criterion in demonstrating that an APT is valid (see the Statute of Elizabeth below). In some centres (e.g.

Gibraltar in 1990), the legislation has been amended to accommodate enhanced creditor protection.

A ‘Life Interest Trust’ arises where the assets of the trust pass to a beneficiary after the death of the life tenant. During his or her lifetime, the latter retains the right to trust property (including income).

‘Accumulation and Maintenance Trusts’ are frequently used to pay for education expenses or the living costs of children until the child reaches a predetermined age or until the child becomes an adult. They may give rise to inheritance tax onshore.

Discretionary trusts are often treated with scepticism by regulators because of the potential for misuse. These trusts allow the trustees to decide when distributions of trust assets will be made and to whom.

Such trusts are often used by families to hold assets such as property.

Purpose trusts, where the benefit is for a purpose, not for a person or an entity. Normally (although not exclusively), purpose trusts are used in charitable scenarios.

In respect of trusts, diVerent rules apply in diVerent jurisdictions. For example, the Virgin Islands Special Trusts Act (VISTA Trust). This accommodates a BVI trust regime ‘which allows trust assets to remain in trust for the life of the trust, rather than being sold simply to comply with outdated legal requirements, and which enables companies to be eVectively managed by their directors without counter-productive inter- ference by trustees. The new VISTA regime therefore enables settlors of trusts to retain eVective control of trust assets at the company level (if this is required).’¹⁷ Consider also the Special Trust Alternative Regime (STAR Trust), a regime for non-charitable purpose trusts.

Trusts are valuable instruments for a range of legal persons – their value is not restricted to individuals and families. Their uses include

charitable and family purposes, the creation of a business entity (the so- called ‘Massachussets’ trust in the United States, developed in the nine- teenth century), the formation of holding companies to concentrate the control of the stock of several corporations (the source of the so-called

‘antitrust’ laws in the United States, beginning in the late nineteenth century), and real estate investment trusts (to avoid limitations on own- ership of land by incorporated companies). We now see on the one hand, massive pension funds and investment trusts and those savings schemes known in Britain as ‘unit trusts’, many of which are structured using the traditional trust mechanism, whilst, on the other hand, we see large amounts of debt structured and collateralised by ‘trust indentures’.¹⁸

Thus, trusts may be used not only to protect the wealth of individuals and families but also for oVbalance sheet transactions and to acquire and dispose of a business. (‘Unit Trusts’ – a special type of Collective Invest- ment Scheme (as described in section4.9above).)

4.10.1 The Hague Convention

The Hague Convention on the Law Applicable to Trusts and on Their Recognition is the foundation document in respect of their international development. Volume II of the Proceedings of the Fifteenth Session (8/20 October 1984) edited by the Permanent Bureau of the Conference and

17 Humphry Leue, ‘The British Virgin Islands’, inThe 2005 Guide to International Financial Centre, Euromoney Institutional Investor plc, February 2005, p. 6.

18 Adair Dyer, ‘International Recognition of the Trust Concept’,www.trusts-and-trustees.

com/library/trust_concept.htm.

issued by the Government Printing OYce at The Hague in 1985, pro- vides a complete history of the Hague Convention.

The Hague Convention . . . was first conceived as an instrument which would build a bridge between the common law and the civil law countries providing uniform rules as to the law which applied to a trust and providing, for the civil law countries in particular, rules for recognition of this unknown form of property holding and for giving eVect to the intent of the settlor of the trust in so far as was possible given the conceptual and technical diVerences between the property systems of the diVerent countries.¹⁹

In the article just quoted, the author explained that, towards the end of the 1970s, with the development of what was known as the common market, civil law practitioners in Europe found themselves dealing in- creasingly with English and US trust matters as English and US citizens moved to Europe to live. In so doing, they acquired property in civil law countries. When they died, the property could conceivably form part of a trust created by the expatriate. A problem arose because the systems for registering land and categories of ownership of such civil law countries did not cater for this type of property holding.

Similarly, as people from civil law countries moved to England or the USA (common law countries) and acquired property, circumstances arose where a will might be created that contained trust provisions concerning their property. The complicating factor was that such trusts might apply to an inheritance received by someone in a civil law country of origin.

In principle, the rules of the Convention are universal and by defin- ition therefore cover all trusts that are governed under the Convention’s rules, whether or not the country involved is a contracting state under the Convention. There are two exceptions. Article 21 provides that ‘a contracting state may reserve the right to apply the provisions of the Convention on recognition only to trusts, the validity of which is governed by the law of a contracting state’.²⁰Secondly, Article 13 states that ‘No state shall be bound to recognise a trust, the significant elements of which, except for the choice of the applicable law, the place of

19 Adair Dyer, ‘International Recognition of the Trust Concept’,www.trusts-and-trustees.

com/library/trust_concept.htm.

20 Adair Dyer, ‘International Recognition of the Trust Concept’,www.trusts-and-trustees.

com/library/trust_concept.htm.

administration and the habitual residence of the trustee are most closely connected with states which do not have the institution of the trust or the category of trust involved’.

In making the previous points, Mr Dyer concludes that:

The influence of the Hague Trusts Convention is not limited to its concrete application in the countries which are parties to it. Indeed, very little court practice seems to have been developed in those countries which have ratified. Yet for countries that have no private international law rules for trusts, the Hague Convention oVers the only analysis and set of rules which have been negotiated in an international forum. Even in the common law countries the precedents for determining the applicable law for a trust are generally few and inconclusive.

4.10.2 Forced heirship

In a 1989 amendment to the Trusts (Jersey) Law 1984, forced heirship is said ‘to relate to a legal rule restricting the right of a person to dispose of property during his lifetime so as to preserve such property for distribu- tion at his death or having similar eVect’. Thus, forced heirship requires that, on the death of an individual, his or her assets must be dealt with in a way that ensures the deceased person’s heirs receive what is due to them.

So far as trusts are concerned, the implication is that a person must not dispose of property during his lifetime to trustees in circumstances that would deprive that person’s heirs partially or completely of their rights to the property. To make sure this does not happen, some juris- dictions invoke forced heirship rules that restrict proposed transfers.

If the transfer to a trust is not valid, the trust may not be valid and the trustees may have no title to the assets, so the implications are fundamental.

Forced heirship rules are most common in civil law countries (such as Europe). This compares with countries where English common law influence prevails, where generally no such restrictions apply. ‘Under the European civil law jurisdictions there is an absolute indefeasible right to a share in the estate. There is no defence and the merits are not relevant.’²¹

21 Anthony Dessain, ‘The Forced Heirship Issue and Jersey Trust Law’,www.trusts-and- trustees.com/library/v5no1.htm.