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‘Symbiotic relationship’ by Paul Douglas – STEP Journal

01-Nov-2010

The debate rumbles on as to whether bank-owned trust companies are compatible with their parent banks. Some banks have been reviewing the ownership and future of their trust company. Captive trustees are expected to place assets with their bank, consequently finding themselves increasingly with a conflict of interests. Further the global economic crisis has put further pressure on trustees to assess investment performance of their parent bank against peer groups. It is possible however for there to be a compatible working relationship, especially for high net worth individuals, where there is a realistic recognition of the distinct roles and responsibilities of each operation.

Bank-owned trust companies fall into two categories. The first are the trust companies that are not obliged to invest trust assets with their bank and can select, sometimes more preferable, outside providers. The other category is captive trustees who are expected to put a significant amount of the assets held within a trust structure with their parent bank.

The economic climate of the last two years has stoked the debate on whether bank-owned trust companies are compatible with their parent. Some banks have been considering the financial and reputation risks associated with the trust environment and have consequently been reviewing the ownership and, in turn, the future of their trust company. Similarly, captive trustees have experienced conflict of interest situations where their parent banks have failed to deliver investment performance.

With increasing transparency and investment performance comparison, it is inevitable that all trustees and their banks are being scrutinised. There is a natural suspicion by the settlor/beneficiaries that a trustee that is pushing certain products (owned by the parent bank) does not necessarily have their best interests at heart. A more obvious issue is where the performance of the portfolios managed by the trustee’s shareholder bank has failed to meet the parameters of the investment mandate set by the trustee. Furthermore this position is exacerbated by the trustees’ failure to adequately monitor the assets resulting in financial losses that have significant impact, both monetary and reputational for the trust company.

There is no reason why the relationship between the trust companies and banks cannot be compatible but it has to start with an understanding by each that their respective roles and responsibilities are distinct and, by their very nature, should be completely different. If this difference is recognised and managed accordingly the relationship can be a mutually beneficial one and, most importantly, a positive one for the beneficiaries, the trustee and the bank.

It might sound obvious that trustees must be prepared to operate independently and always in the best interests of the trust’s beneficiaries but unfortunately there are examples where this has not been the case. As a result, it is the trustee’s responsibility to ensure that the services that the bank offers its trusts are the most current and the best available. This duty has been brought into sharp focus over the past two years as the global economic crisis has reinforced the obligations of trustees to continuously assess investment performance and to compare this against that of the investment managers’ peer groups. Should their bank’s performance consistently fail to meet the high standards required, then the trustees are obliged to take immediate and corrective action. Failure to take any action can potentially expose the trustee to challenges by the beneficiaries and potential litigation. Similarly it may be the banker who has the direct relationship with either the beneficiary or the family and, all too often, this can result in the banker ‘managing’ the trust relationship. It is in cases such as these that the banker can fail to appreciate the trustee’s position and the need for a high level of shared information in order for the trustee to carry out its responsibilities – leading yet again to an unnecessary risk of litigation for the trustee.

Another significant area to consider where banks and trusts differ is accountability. Trustees assume legal ownership of the assets of a trust structure, and must therefore account for this ownership to the beneficiaries of the trust. Ultimately, a failing in the execution of their legal duties can result in the trustees being liable for loss or damage caused to the trust fund. The need for ongoing review and management throughout the life of the trust structure has never been more evident. This review must use multi-disciplinary skill sets providing beneficiaries with security, stability and flexibility.

Provided the rules of engagement are established at the outset and adhered to, there are many significant advantages that bank ownership can bring to the trust relationship which in turn favours the beneficiaries.

With the increased introduction of regulations, and the welcome move by many towards transparent well-advised business, the market has divided trust providers into various levels depending on their client base. For example, the ultra high net worth families are much more sensitive to counterparty risk than other beneficiaries and therefore are inclined to move to professional trustees that ultimately have the backing of a bank’s balance sheet, with the reassurance of robust internal controls, and the appropriate levels of indemnity insurance. This approach of course places the bank-owned trust company at a competitive advantage against independent trust companies. It is also particularly comforting in Switzerland where trustees are not regulated apart from anti money laundering purposes as financial intermediaries.

Trust companies not only inevitably introduce such settlors and beneficiaries to the brand and services of their bank but also have an ability to retain them as bank clients for these very reasons – a successful bank has access to preferential rates, expert investment managers and a degree of leverage not necessarily available to independent trustees and their structures.

By the very nature of the relationship, a trustee is often privy to a high degree of information about the personal and business affairs of the settlors and/or beneficiaries that goes well beyond what is available to a banker. This provides the settlors and beneficiaries with a degree of comfort about the privacy of the relationship and allows the trustee to make informed decisions on their behalf. A professional trustee who has a close relationship with its parent bank colleagues can identify opportunities by leveraging the skills and resources of its bank. For example, bringing private company shares into the structure, portfolio management and property finance. This is compelling for ultra high net worth individuals looking for the best in wealth preservation, enhancement and succession planning.

The multidisciplinary nature of trust administration requires that the trustees build strong networks with an array of advisors such as legal, tax, investment, real estate, philanthropy, art and accounting experts with the consequence of spreading the brand of the bank into wider circles.

The preferred strategic vision for a trust company is to build relationships spanning generations with the beneficiaries of the structures they administer and understanding the intricacies particular to the family and their wishes across those generations. The result is that the income received is steady and not transactional. While interest rate yields have been marginal, banking customers have been nervous to enter the market and banking revenues have been significantly squeezed. Therefore the income flow from the bank-owned trust company provides an attractive addition to a parent banks income statement without the need to tie up its capital

So while it is vital that trustees understand and accept their duties to the beneficiaries of the structures they administer, it is also of equal importance that banks recognise the value of their trust companies as more than just a value-added service. Failure to do so results in an inevitable and unnecessary risk arising for both parties. This correct understanding by a bank of its trust business, and the necessary separation of the distinct roles and responsibilities of each, will enable a well-established and symbiotic relationship to thrive; strengthening each of their respective offerings.