Abstract

China passed a law of trusts in 2001 intending it to be useful to financial market participants. Drawing heavily from literature on economic institutions and economic development, this article assesses the potential success of the trust’s becoming institutionalized in China. The conclusion is that a legislature’s passing of a trust law does not alone make the trust an institution. A law is not an institution until it functions to predictably incentivize and constrain human behavior. A number of provisions in China’s Trust Law are unclear, and this prevents the law from functioning with predictability. Further, there is some question whether conditions in China are hospitable to the institutionalization of the trust, and whether the Trust Law can be a catalyst for the development of financial markets.


I. Introduction

Individuals in England first created the legal arrangement called the trust and the rest of the world has since discovered the institution’s usefulness. While it was individuals who first conceived of the idea, it took the blessing of the English courts of equity to let it stand as a formal legal institution. The United States’ legal system long ago inherited the trust with the rest of the English common law, so that nowadays, trust law is often deemed a product of Anglo-American law. The trust is an institution constituted by a standardized bundle of legal rules arranging the in personam and in rem rights and duties of the parties inside the trust arrangement with respect to some trust property. In the arrangement, the settlor, an owner of some certain property, transfers that property to someone he considers trustworthy, a trustee; that trustworthy individual then manages it and makes distributions to a third party, called the beneficiary or beneficiaries. The arrangement was originally used in England to circumvent feudal inheritance laws and can still be used today to circumvent undesirable laws, like laws of taxation. Since its inception the arrangement has proven a useful means for a property owner to exploit another party’s comparative advantage in property management. Throughout history, individuals in other cultures have created arrangements similar to the trust, including the so-called “lineage trust,” or tang (堂) in pre-communist China, but only the Anglo-American trusthas been so widely and successfully exported. Today the Anglo-American trust is incorporated into the modern, formal legal systems of many countries, even countries outside of the common law tradition, like China.

In passing the Trust Law of the People’s Republic of China (hereinafter “Trust Law”), the Chinese legislature was quite self-conscious in its decision to attempt a transplant of the Anglo-American trust into its formal legal system. Observing how the modern trust plays an important role in other countries’ financial markets, the Chinese legislature hoped the trust could grow to also play an equally important role in the Chinese financial markets. The trust in the modern U.S. and U.K. has become a widely used organizational form for some types of institutional investors. Institutional investors have become very important to the stability and efficiency of financial markets in the U.S. and the U.K. Believing the development of the institutional investor sector to be a means of infusing the Chinese financial markets with stronger liquidity, rationality, stability, and efficiency, the Chinese legislature passed the Trust Law as a catalyst for the rise of institutional investment funds.

The trust’s role in financial markets extends beyond merely providing an organizational form for some types of institutional investors. The trust is also an organizational form for the management of household wealth. When the trust form was first created, it provided a means for landowners to manage their ownership of real property. Since then financial assets have become a larger and larger component of household wealth in the U.S. and other wealthy countries, although real property is still the largest component of household wealth, even in wealthy countries.8 Paralleling this change in household wealth, the trust in the U.S. and U.K. has become increasingly important as a means for managing household ownership of financial assets. Financial institutions earn fees for managing this wealth, and the trust is a common form used by households to hold this wealth. Real property as a component of household wealth is comparatively larger in China than in wealthier countries, but the proportion of wealth in financial assets is increasing. Meanwhile, household savings rates in China are extremely high, and households’ options for investing this wealth are limited. The wealth management industry in China is anxiously awaiting the day when these households put this savings into financial assets; the industry is expected to boom. At the moment, however, the development of the wealth management industry and the institutional investor sector is constrained by a number of factors including law. Further regulation could play a role in rationalizing financial markets, but it is arguable that the weakness in the underlying institutions is a more fundamental concern.

This paper will examine one of these underlying institutions, the trust, which is itself a collection of rules from contract and property institutions. The rules of any country’s trust law, including China’s, seek to solve a fundamental problem in the trust arrangement: the beneficiary’s interest in the trust property must be protected from the trustee’s mismanagement, but the trustee must be given an adequate degree of freedom to make investment decisions. A country’s trust law, China’s included, will also provide rules for trust parties to arrange a pattern of creditors’ rights that could not be achieved by contract and property rules alone. China’s Trust Law provides rules whose goal it is to solve these fundamental problems, but some provisions are unclear as written. It is incumbent on the courts, a regulator, or the legislature to finally settle these uncertainties. In defining the trust as an institution, we will refer to the U.S. version of the trust as a point of departure. This is not to suggest that the development of the trust institution in China should follow the U.S. model. The concept of legal transplant implies that rules are not simply exported and imported. Rather, a rule is first transplanted, and the transplant can only be deemed a success once the rule functions in the recipient country as if it were always part of the system. Only when all market participants and trust parties share a common understanding of the provisions in the Trust Law can the Trust Law become an integral part of China’s legal system. Until its uncertainties are resolved, the Trust Law will be a weak link in the development of the institutional investor sector in China.