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Dialog bears good fruit

(Article published in the Dec 27, 2006 issue of Manila Standard Today)

       In this season of feasting and celebrating, I propose a toast to the coming, if it has not come yet by the time this item gets into print, circular of the Bangko Sentral ng Pilipinas  amending the guidelines it previously issued on living trusts.  The most significant aspect of this amendatory circular on living trusts is that it is the result of a dialogue conducted in good faith by the regulators and the regulated.  May we have more such fruitful exchange of views and sentiments in the coming year.

       On 21 March 2006, the Bangko Sentral issued Circular No. 521 pursuant to Monetary Board Resolution No. 227 dated 23 February 2006.  The purpose of the circular was to set forth the standards which a living trust arrangement must comply with in order not to be subjected to reserves.  As pointed out in an earlier column I had written in anticipation of that issuance (January 25, 2006 issue of The Manila Standard Today), the set of new guidelines on living trusts was a dot in a long line of attempts by the Bangko Sentral (such attempts even dating back to when BSP was still known as the “Central Bank”) to frustrate deposits arrangements from masquerading a trust accounts. 

       There was a need to draw a line between the two classes of relationships with banks with a trust license since deposits are a bank’s actual liabilities duly accounted for in its balance sheet (hence, “on books”) while trust accounts are contingent accounts which do not go into the computation of the bank’s resources and obligations, (hence, “off-books”).  From this main distinction flows a whole set of different regulations relating separately to both and regulators insists that, to borrow a phrase from Rudyard Kipling, “ne’er the twain shall meet.”

       After all, when a person makes a deposit, he is doing business with the bank.  When he, on the other hand, enters into a trust relationship, he asks the bank to do business for him.

       When Circular No. 521 was issued, it was met with a collective cry and hue from the trust industry.  The standards set were perceived to be too strict and the consequence of not meeting them, i.e. the need to set up reserves as if living trusts were deposits, was seen as unduly burdensome to the personal trust business.  Fortunately, both the regulator and the regulated had enough openness in themselves and trust in each other to reach an acceptable middle ground, “in [the] medio” where says Horace, “stat virtus.”

       The first amendment to Circular No. 521 is to be found in the definition of a Living Trust, for purposes of the Manual of Accounts.  It will henceforth be:  “Living Trust is defined under the Manual of Accounts for Trust as a PERSONAL trust created by Agreement.” 

       The addition of the word “personal” limits the no-reserve treatment to those trusts established by individuals intended for their private benefit, including those of the trustor’s family.  Falling under this category would be trusts created as part of an estate plan, trusts for wealth management, trusts for asset protection, and, generally, trusts for family maintenance and support. 

       The major amendments are found in the additional standards under Section 2 of Circular No. 521.  First, on the matter of the size of the account, both at the start and during its existence.  The old rule provided for (a) a minimum initial amount of P100,000.00 and required investments of accounts less than P500,000.00 to be only in deposits.  This was intended to strike against accounts which are really time deposits by treating them as time deposits.  Unfortunately, the unintended effect was to also prevent small personal trusts in investing in instruments created by the government itself intended for small investors, such as the Retail Treasury Bonds. 

       Under the amendments, Php 100,000  is going to be both a minimum entry and maintaining balance requirement.  However, in addition to being invested in deposits, living trust accounts with balances of up to P500,000.00 may also be in government securities.  That should make National Treasurer Omar Cruz happy for the new year.

       The second change deals with the ticklish issue of termination.  Undoubtedly, a living trust’s strong point is its flexibility, particularly the need to meet the financial requirements of the beneficiaries when and as they occur.  However, it is difficult to determine when a capital withdrawal is due to a bona fide need on the part of the beneficiaries, or, just a subterfuge for a placements being terminated in accordance with the terms agreed upon in a “side letter” or mutual understanding at the start of the account.

       To plug this loophole, Circular No. 521 established a minimum holding period of 6 months and permitted a reversion of the property to the trustor only upon termination.  The unwanted import of this remedy was to severely restrict the flexibility of the trust.  For example, how is the trust bank to respond to a need of the beneficiary (who could be the trustor himself, if he is one of many beneficiaries) within the minimum period?  On the one hand, the terms of the trust require he makes a payment; on the other, Circular No. 521 prohibits payment without the trust meeting dire consequences.

       In such a situation, payment to the needing beneficiary (if so authorized by the dispositive provisions) will be permitted.  Such a payment, however, should not effectively result in exhausting, or nearly exhausting, the trust corpus.  In any case, the remainder must be no less than the maintaining balance.

       What if the situation of the beneficiary really required the payment of all of the principal pursuant to the dispositive provisions within the minimum holding period?  In that case, the likelihood is that the living trust was not, in the first place, suited to the trustor.  What he really needed was a time deposit, and so, even if he and the bank erroneously entered into a trust relationship, the arrangement will be treated, for reserve purposes, as a deposit.  This removes all incentive for the trust marketers to fool around with the trust concept. 

       And just to make it plain and unequivocal, I suppose, a separate paragraph in the amendatory circular states:

       “Any living trust account that does not meet the requirement on the minimum entry and minimum maintaining balance or is not invested in qualified outlets shall be considered as other fiduciary accounts subject to applicable reserve and other requirements.”

       The third and last major change in the rules relates to unrelated trustors.  Circular 521 originally provided only for joint accounts of trustors only if they are related and only if so related up to only the second degree of consanguinity or affinity.  This is relaxed by the amendatory circular. 

       Even those who are not related as well as those related but beyond the second degree may still open joint living trusts, provided that each of them contributes at least Php 100,000 each and that the living trust is established for a common purpose.  An example of such a living trust would be one set up by business partners to fund a cross-purchase agreement.  Essentially, under such a trust between two unrelated (in terms of blood or affinity) partners in business, the parties agree that (a) the trust res would be vested upon the death of one on the survivor, provided that the survivor is compelled to buy and the estate of the earlier to die is compelled to sell, based on an agreed formula, the decedent’s share in the business.  This is an estate planning tool which I recommend to business partners in a non-listed business.

       To enable the trust industry to adjust to the latest guidelines, another period of six (6) months was added to the original transitory period under Circular no. 521.  A trust account not find compliant by the lapse of this extra period will be considered as Other Fiduciary Accounts subject to applicable reserve requirements.

       The foregoing changes in Circular No. 521 should be sufficient to meet most, if not all, of the concerns that trust industry raised in March 2006.  If this spirit of cooperation between regulator and regulated continues in 2007, the greatest beneficiary, of course, is the country’s trust clientele.