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1

Trusts are:

a relationship between persons in which one has the power to manage property and the other has the privilege of receiving the benefits from that property.

2

Trusts could exist in many different situations; examples include

  unit trusts – a trustee can act to oversee the selection and management of assets 

  pensions – in many countries it is a requirement that a company pension scheme’s assets are segregated from the company’s assets. Appointed trustees are responsible for safeguarding the assets, selecting investment managers and generally ensuring the smooth running of the scheme. 

  charitable bodies – whose trustees determine how funds raised can best be used 

  trust funds for children – a fund may be set up for a child to provide money 
when that child reaches a certain age, eg 21.

3

no precise equivalent to the trust in civil-law systems, although


There issome civil-law systems have created an institution like a trust. This has normally been done by adapting trust ideas from the Anglo-American system. 
Civil law systems are those inspired by Roman Law, the primary feature of which was that laws were written into a collection; codified, and not determined, as is common law, by judges. Civil law systems prevail in most western European states, including Scotland. 
In contrast, common law systems, which rely heavily on precedent, operate in England, Wales and Northern Ireland, most Commonwealth countries, the United States and the Republic of Ireland.

4

Legal and beneficial ownership

Fundamental to the notion of the trust is the division of ownership between legal and equitable. The legal owner of the property (the trustee) has the right to possession, the privilege of use and the power to convey those rights and privileges. The beneficial owner (the beneficiary) receives all the benefits of the property. The trustee has the fiduciary duty to the beneficial owner to exercise his rights, privileges and powers in such a way as to benefit the beneficiary.
The trust therefore results in a clear separation between the ownership of the assets and the benefits received from the assets. Fiduciary duty simply the means the responsibility placed upon the trustees to look after someone else’s (ie the beneficiaries’) money in a correct way.

5

In a company pension scheme set up under trust the trustees have responsibility for:


  exercising control over the investment and management of assets 

  the payment of benefits to the beneficiaries (the members of the scheme) 

  ensuring compliance with the trust deed and rules and pension legislation 

  exercising discretionary powers in the interest of the members 

  ensuring the smooth running and administration of the scheme. 
The trustees may delegate the tasks, eg to specialist investment managers and administrators, but the trustees retain responsibility.

6

The divisions between legal and beneficial ownership are normally created by

an express instrument of trust (usually a trust deed or a will). The trust deed will specify the purposes of the fund and how it is to be administered.

7

A bond indenture trust is operated by a trustee (for example a bank) representing the bondholders in dealing with bond issuers. Outline the areas you think would be covered in the trust deed.

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8

Trustees are appointed

to carry out these provisions, and must operate solely within the provisions of the deed (although they may be allowed some discretion in this respect). The beneficiaries will also have been specified (by name or by class) in the original deed.
A unit trust for a child will specify the beneficiary by name. A pension scheme will specify the beneficiaries by class (eg active members or pensioners) because the membership of the scheme changes frequently.
Common law requires trustees to act in the best interests of the scheme’s beneficiaries. The standard of care required is that of the ordinary prudent person of business acting in the management of their own affairs. Subject to the terms of the trust deed, common law also requires trustees to exercise proper care when investing trust funds.
However, the standard of care which a trustee is obliged to take with regard to investment decisions is likely to depend on whether or not the trustee professes to be a professional trustee. A professional trustee will be assessed by a higher standard of care and must exercise the special skill and care which the role implies.
Many institutions provide trustee services as a commercial business. These institutions are staffed by professional trustees who provide trustee services in return for a fee.

9

List the main concerns of the trustee in carrying out his duties.

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10

Collective representation and protection

Trusts are a means of segregating assets for the protection of beneficiaries, thus insulating them from any consequence of the settler’s actions subsequent to the settlement. Another function is to provide a mechanism for the collective representation and protection of members of a group of people linked by a common interest.
Good examples of such a mechanism are the unit trust and the bond or debenture trust deed. Under these, the individual interests of substantial numbers of holders are channelled into the trust and held and protected by the trustees for the benefit of all holders, so providing the collective mechanism without which efficient administration would be impossible. This mechanism is valuable even where there is no trust property in the normal sense, merely an aggregation of personal rights.

11

Example of benefits of trusts

Company XYZ runs a pension scheme for its members. The pension scheme is set up under trust and the scheme’s assets are segregated from those of the company. If Company XYZ (the settler) should become bankrupt, then its creditors are unable to claim the assets of the pension scheme when seeking recompense.
Operating as a trust will also have other advantages. For example, the trustees provide a powerful lobby for the pension scheme in representing views to the company, for example regarding the distribution of any surplus, or the level of funding.

12

Corporate governance refers to the

high level framework within which managerial decisions are made in a company.
Typically, the governance of a company is the responsibility of its board of directors. The board is collectively responsible for promoting the success of the company by directing and supervising the company’s affairs.
A board of directors will typically include amongst its members:
  executive directors – drawn from the senior management of the company and including the chief executive officer (CEO) 

  non-executive directors – one of whom will act as Chairman, in which role he will be responsible for the successful operation of the board. 
Non-executive directors who have no (current or past) relationship with the company other than as board members are sometimes referred to as independent directors. 


13

The aim of good corporate governance is that

a company should be managed in order to best meet the appropriate requirements of its stakeholders – the shareholders, employees, pensioners, customers, suppliers and others who may be affected by the company’s operations whilst not having any contractual relationship with the company at any time.
Good corporate governance requires management to make decisions based on the interests of relevant stakeholders rather than on their own personal interests. An example would be promoting a takeover bid that is in the directors’ interest rather than that of the stakeholders.
Good corporate governance can be enhanced by ensuring that remuneration incentivises management to act in the interests of stakeholders. Share options may be seen as part of this, though the lack of sufficient downside for management can limit how well share options perform this function.
The general aim here is the interests of management should be aligned as closely as possible with those of the shareholders in particular. The most obvious way to do this is by giving the management shares in the firm, as is often the case in a private company. An alternative is to provide share options. However, any incentive package needs to be carefully managed. There have been many examples of directors leaving companies after poor performance with healthy bonus packages.
In the UK over recent years, salary and bonuses of senior staff in major firms have caused controversy, sometimes public outrage.

14

role of the non-executives in corporate governance is to provide an impartial view and represent the shareholders’ interests. In practice, this is likely to involve:

  challenging and contributing to the development of strategy 

  monitoring the performance of management 

  playing a leading role in setting the remuneration for executive directors’ pay 

  playing a leading role in the nomination and appointment of new board members 

  playing a leading role in the audit committee. This committee aims to monitor the financial reporting of the company, together with its financial and risks controls and will meet with external auditors with no members of the executive present. 
Separate committees for each of the remuneration, nomination and audit functions may be set up consisting exclusively of non-executive directors.

15

listings authority

is responsible for ensuring that any new issue of shares is conducted in an orderly and fair way, and that the conduct of the company remains consistent with the listing of the shares after the issue. This would include an initial offering of shares in a company that was previously privately held.

16

A listed company’s shares

may be bought and sold by any member of the public, without any direct negotiations with a current holder. The negotiation when the shares are sold is purely a matter of price and, unlike a transaction for the sale of a share in a private company, no financial information is disclosed as part of this process. It is therefore important that a reasonable amount of financial information is in the public domain.

17

Information in the public domain will include:

  current and historical share price 

  audited company accounts 

  interim reports 

  forecasts and profit warnings 

  interest by potential takeover parties 

  analysts’ comments.

18

Give reasons why a privately held company would wish to publicly offer shares.

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19

Listing authorities are normally concerned with:

  the production of relevant business and financial information on the issue of shares. 
This will be presented in the share prospectus. The prospectus will include:
–  details of the number of shares on offer and the offer price 

–  details of the number of shares (if any) currently in circulation 

–  the underwriters of the issue (if there are any) 

–  details of how shares will be allocated if the offer is over-subscribed 

–  how the money raised will be used 

–  the company’s intended dividend policy 

–  audited financial statements 

–  an outline of the aims and objectives of the company and any special factors 

–  details of the senior management and board directors and their salaries. 

  the process by which shares are offered to potential shareholders and the 
price is set for the issue of shares. 
Investment banks often lead the issue of shares for their clients (ie the companies looking to raise equity finance). The higher the price set, usually the higher the fee income generated. 

  the continuing production and dissemination of business and financial information on a timely basis on companies with listed securities. 
For example, companies listed on a stock exchange are typically required to make certain accounting information available each year. 

  the continuing conduct of the market in listed securities with a view to ensuring that the market is fair to all participants, and that the pricing process is fair and reasonable. 

  rules to ensure that companies with listed securities and connected parties continue to behave in a manner that does not conflict with other objectives of the listing authority. 
For example, market makers in the UK must be prepared to deal up to the normal market size at the prices they display on SEAQ, the Stock Exchange Automated Quotation system.

20

Ethical investment is

big business and an expanding area of the investment market.
Government, advocacy groups and the preferences of individual participants in investment markets have acted to ensure that the concern felt by the public on the environment, diversity and ethical issues impacts the behaviour of financial markets.
For example:
  listed companies now have to produce information on how they manage their behaviour on environmental, diversity and ethical issues. This is often referred to as Socially Responsible Investment (SRI). 

  SRI requires fund managers to consider a company’s ethical stance before deciding to invest in its shares. 

  UK pensions disclosure legislation requires pension trustees to disclose their social, environmental and ethical considerations in their Statement of Investment Principles. (This has been the main factor leading to the increase in the size of the UK ethical funds market.) 
Companies that want to be attractive to the widest possible universe of investors will want to be attractive to investors for whom environmental and ethical issues are part of the investment process and decision making. 
Operators of savings products (insurers, asset managers) have promoted products which aim to enhance the effect of the investment process on environmental and ethical issues. Products are sold which have a “socially responsible overlay” and the investment managers commit to engaging in a constructive dialogue with company management to promote environmental and ethical objectives. 
There are various definitions of “ethical” designed to meet different investors’ requirements. Some funds focus on the exclusion of investment in oppressive regimes or certain industries (eg tobacco, weapon manufacture). Other funds have a more stringent definition of ethical extending to only including companies that actively promote environmental and social issues, for example companies using alternative energy or promoting good employment practice. 
There is also an informal extent to which some investors will favour asset managers who appear more friendly to environmental and ethical objectives whilst making no formal commitments. Following the events of September 11 2001 and other acts of terrorism, many investors debated larger issues such as human rights abuse and its impact on terrorism. 


21

The primary reason for company mergers is to benefit from economies of scale. Outline the other main reasons why companies may merge.

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22

Why are natural monopolies likely to persist in the utilities, telecommunications and transport sectors?

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23

Regulatory concern is mostly aimed at protection of the interests of

customers (particularly individuals) and suppliers.
The aim of the regulators is to encourage competition and prevent mergers that would reduce competition through the exercise of market power.
Regulators are normally acting under national legislation and have responsibilities to national constituencies. (As a result of the move to a Single Market in Europe there are some barriers to mergers and acquisitions that apply across borders. ) On the other hand companies are often multinational. A company may therefore argue that a takeover resulting in a high market share in one territory will not confer unacceptable pricing power because of the potential entry of international competitors. It is up to the regulator as to how these arguments are treated.
The definition of the product is generally a second area of debate for competition decisions. A high market share in a narrowly defined product area may translate into a much lower share of a more widely defined product category that contains possible substitutes for the product under review.
For example, it may be acceptable for a company to have a 50% share in the market for “chocolate-covered ice lolly sales at seaside resorts”, but not acceptable to have “50% of the national confectionery market”.
Fair trading controls also aim to ensure that sellers do not exploit members of the public who may be in a weak bargaining position.

24

Mandate is the term often used to refer to the

authority given by the owner of investments to the investment manager whom they employ to manage their investments.

25

Fund managers may be engaged to invest:

  in one particular asset class, for example US fixed-interest bonds (a specialist 
mandate basis) 

  across a range of asset classes with certain restrictions (a balanced or multi-asset 
approach). 
Looking at pension fund investment in particular, fund managers are increasingly employed on a “specialist mandate” basis to invest in a single asset class, rather than on a traditional “balanced” or “multi-asset” mandate. However, this still requires them to make operational decisions in relation to stock selection (unless a “passive” index-tracking approach is to be adopted). Managers will therefore need to be given instructions regarding any restrictions to be applied. 
The instructions will be set out in the mandate. 
Within balanced mandates this may include the extent to which the manager is allowed to depart from the benchmark strategic asset allocation at any time. For example, the mandate might specify that the US bond holding must be between 25% and 35% of the total value of the portfolio.

26

Other restrictions, applying to all mandates, might include:

  asset classes that are entirely prohibited 

  limitations on the use of assets and asset classes, such as a prohibition 
on the speculative use of derivatives 

  maximum permissible holdings in individual assets or asset classes (to 
ensure diversification) 

  counterparty exposure limits for derivative investments 

  prohibitions on “self-investment” in the sponsor’s own securities 

  ethical or social limitations.

n some states there may be specific requirements such as holdings in government bonds and bills, or requirements to match assets and liabilities by currency. This is sometimes referred to as a localisation requirement. 
There may be restrictions on the choice of assets, such as a requirement that any equities held have paid dividends in recent years

27

Why is self-investment likely to be restricted?

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28

Explain the rationale behind a government requiring:
. (i)  the holding of government bonds 

. (ii)  the matching of assets and liabilities by currency. 


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29

The legislative (or regulatory) framework may take the form of the specification of

“admissible” assets, so that only those holdings which conform to the restrictions can be taken into account when demonstrating statutory solvency.
The Actuarial Education Company © IFE: 2018 Examinations
Page 18 F105-08: Applications of the legislative and regulatory framework (1)
Such an approach means that the fund can invest in a wide range of investments. However, since only a portion of the investments can be included when demonstrating solvency these admissibility regulations are an effective way of strongly encouraging the fund to hold the vast majority of its assets in the categories that the regulator has deemed to be admissible. (Such regulation applies to the UK insurance industry.)
This is a prescriptive approach because it will not be in a company’s interests to hold material amounts of inadmissible assets.
A less prescriptive approach is where the nature of any restrictions are left to the discretion of those awarding the fund management mandates, but with the requirement that such restrictions are set out in a “Statement of Investment Principles” for the information (and scrutiny) of the ultimate beneficiaries. This may include statements to highlight any departure from accepted “best practice” and justifications for such departures.
For example, UK pensions trustees set out a Statement of Investment Principles. The idea behind this form of regulation is that increased disclosure will enable the ultimate beneficiary to perform the regulatory function.
Underpinning such requirements, there is likely to be some measure of the standards against which fund management is to be judged, such as the standards of care, skill, prudence and diligence. The sanctions available for failure to meet these standards may range from withdrawal of authorisation to operate as a fund manager through to liability to make good shortfalls. There may also be provision for assets to be taken into custody or for funds to be managed by a statutory body.

30

The purpose of such restrictions can be seen as threefold:

1. to protect the ultimate beneficiaries from gross incompetence or mismanagement by fund managers 

2. to encourage confidence in investment schemes and the benefits they secure 

3. to promote the accumulation of investible funds. 

The first two of the above tie in with two of the three high-level aims of regulation as
discussed in Chapter 7.