Agency vs Trust: The Critical Legal Distinction in Asset Holding Arrangements

The Hong Kong Court of Final Appeal’s judgment in Zhang Hong Li v DBS Bank (Hong Kong) Limited (2024) 27 HKCFA 1 has sharpened a distinction that many asset-holding structures inadvertently blur: the line between an agency and a trust. The case, which turned on whether DBS held client funds as a trustee or merely as an agent, resulted in a finding that no trust existed, stripping the plaintiff of priority over the bank’s unsecured creditors upon its alleged insolvency. This ruling arrives as Hong Kong’s wealth management sector manages an estimated HKD 9.5 trillion in private banking assets (HKMA, 2025 Annual Report), much of it held through layered nominee and custodial arrangements. For trust practitioners, family offices, and cross-border asset holders, the Zhang judgment is not a theoretical exercise—it directly determines whether a beneficiary has proprietary rights against a custodian’s general estate or merely a personal claim. The SFC’s 2025 consultation on proposed amendments to the Code of Conduct for Persons Licensed by or Registered with the SFC (the “SFC Code”) further tightens the requirements for client asset segregation, making the agency-trust distinction a matter of regulatory compliance as much as private law.

The Core Legal Distinction: Control and Beneficial Interest

The fundamental difference between an agency and a trust lies in the location of legal and beneficial ownership. In an agency relationship, the principal retains full beneficial ownership of the assets, while the agent holds only a mandate to act on the principal’s behalf. The agent’s authority is defined by the scope of the agency agreement, and the principal can revoke that authority at any time. In a trust, by contrast, the trustee holds legal title to the trust property, while the beneficiary holds an equitable beneficial interest. The trustee’s powers are fiduciary and are circumscribed by the trust deed and the Trustee Ordinance (Cap. 29). This distinction carries profound consequences for asset protection, insolvency remoteness, and succession planning.

The Zhang Hong Li Precedent

The Court of Final Appeal in Zhang (2024) applied a three-part test to determine whether a trust existed: (1) certainty of intention to create a trust; (2) certainty of subject matter; and (3) certainty of objects. The court found that the client’s account agreement with DBS, which described the bank as “acting as agent” for the client, lacked the requisite intention to create a trust. The funds were held in the bank’s general pool, not in a segregated account. Consequently, the client’s claim was merely a contractual one against the bank, not a proprietary claim over specific assets. The judgment explicitly stated that “the mere designation of a relationship as one of agency does not, without more, give rise to a trust” (para. 45). For practitioners, this means that the label used in the agreement is not dispositive; the court will examine the substance of the arrangement.

The Nature of the Beneficial Interest

In a trust, the beneficiary’s interest is proprietary. This means that if the trustee becomes insolvent, the trust assets do not form part of the trustee’s estate available to general creditors. Section 44 of the Trustee Ordinance provides that a trustee who “commits a breach of trust” is liable to compensate the trust estate, but the beneficiary’s primary remedy is to trace the trust property. In an agency, the principal’s interest is merely personal. If the agent becomes insolvent, the principal ranks as an unsecured creditor. The Zhang case (2024) confirmed this: the plaintiff’s claim was dismissed because the funds were not held on trust. The HKMA’s 2025 Supervisory Policy Manual on “Client Asset Protection” (CP-2025-01) now explicitly requires authorized institutions to classify client assets as either “held in trust” or “held as agent” for regulatory capital purposes, reinforcing the distinction.

Practical Implications for Asset Holding Structures

The agency-trust distinction has direct operational consequences for how assets are held, how they are transferred, and how they are protected from third-party claims. The choice between an agency and a trust should be driven by the client’s objectives: asset protection, succession planning, or operational convenience.

Custodial and Nominee Arrangements

Many Hong Kong-based family offices use nominee companies to hold assets such as listed equities, private company shares, and real estate. If the nominee is structured as an agent, the beneficial owner retains direct ownership for tax and reporting purposes. However, this exposes the assets to the nominee’s creditors. If the nominee is structured as a trustee, the assets are ring-fenced. The SFC’s 2025 consultation on the SFC Code proposes that licensed corporations must, by 31 December 2026, segregate client assets held in a fiduciary capacity from the firm’s own assets, with a separate trust account for each client class. This is a direct regulatory response to the Zhang judgment. For practitioners, the key question is whether the client’s assets are held in a “designated account” (agency) or a “trust account” (trust). The distinction determines the level of regulatory oversight and the client’s priority in a winding-up.

Succession Planning and Estate Administration

A trust is the default vehicle for succession planning in Hong Kong because it separates legal ownership from beneficial enjoyment. The trustee holds the assets for the benefit of the beneficiaries, and the trust deed can provide for a succession of trustees and beneficiaries. An agency, by contrast, terminates upon the death or incapacity of the principal, unless the agency agreement expressly provides for survival. Section 48 of the Trustee Ordinance allows a trustee to be appointed by the court or by the trust deed, providing continuity. For cross-border families, the choice between a Hong Kong trust and a BVI trust depends on the situs of the assets and the applicable tax regime. A Hong Kong trust is governed by the Trustee Ordinance and is tax-exempt on its profits from Hong Kong-sourced investments, provided the trust is not carrying on a trade or business in Hong Kong (Inland Revenue Ordinance, Cap. 112, s. 14). An agency arrangement does not offer this tax advantage, as the principal remains the taxpayer.

The Regulatory Landscape: SFC and HKMA Requirements

The SFC and HKMA have, since 2023, intensified their scrutiny of how intermediaries hold client assets. The Zhang judgment (2024) has accelerated this trend, as regulators now require explicit disclosure of the legal basis on which assets are held.

The SFC’s Client Asset Rules

The SFC’s Code of Conduct for Persons Licensed by or Registered with the SFC (the “SFC Code”) was amended in 2024 to require that licensed corporations “clearly and prominently” disclose to clients whether client assets are held on trust or as agent. Paragraph 4.2 of the SFC Code now states that “a licensed corporation must not hold client assets in a manner that is inconsistent with the client’s instructions.” The 2025 consultation proposes a new requirement that licensed corporations maintain a register of all client assets held in a fiduciary capacity, with the register to be audited annually by an external auditor. Failure to comply can result in a fine of up to HKD 10 million and suspension of the license (Securities and Futures Ordinance, Cap. 571, s. 194). For trust practitioners, this means that the trust deed must be filed with the licensed corporation if the assets are held on trust, and the client must be given a “trust acknowledgment” letter.

The HKMA’s Supervisory Framework

The HKMA’s Supervisory Policy Manual on “Client Asset Protection” (CP-2025-01) requires authorized institutions to classify client assets into three categories: (1) assets held in trust; (2) assets held as agent; and (3) assets held under a custodial agreement. The manual explicitly states that “the classification must be based on the legal substance of the arrangement, not the label used in the agreement.” This is a direct response to the Zhang case. The manual also requires that authorized institutions maintain a “client asset register” that is updated daily and that the register be subject to an annual external audit. For family offices using Hong Kong banks as custodians, this means that the bank must provide a written statement confirming the legal basis on which the assets are held. The HKMA’s 2025 Banking Stability Report notes that HKD 2.3 trillion in client assets are currently held by Hong Kong authorized institutions, of which approximately 35% are classified as held in trust.

Cross-Border Considerations and Common Pitfalls

The agency-trust distinction becomes more complex when assets are held across multiple jurisdictions. A structure that is treated as a trust in Hong Kong may be treated as an agency in the PRC, or vice versa, with significant tax and regulatory consequences.

PRC Trust Law and the Hong Kong Trust

The PRC Trust Law (2001) defines a trust as a “relationship in which the settlor transfers property to the trustee, and the trustee holds and manages the property for the benefit of the beneficiary.” This is substantively similar to Hong Kong trust law. However, the PRC Trust Law requires that the trust be created in writing and that the trust property be “clearly identified and separated from the trustee’s own property” (Article 10). If the trust property is not segregated, the trust may be void. For a Hong Kong trust that holds PRC assets, this means that the trust deed must be notarized and registered with the PRC asset registry (e.g., the land registry for real estate). Failure to do so may result in the trust being treated as an agency for PRC tax purposes, exposing the settlor to PRC individual income tax on the trust’s income. The State Administration of Taxation’s 2024 Circular No. 8 clarifies that a Hong Kong trust holding PRC assets is subject to PRC tax if the trustee is a Hong Kong resident and the trust is not registered in the PRC.

The Risk of “Dual Characterization”

A common pitfall is the “dual characterization” risk, where a single arrangement is treated as a trust in one jurisdiction and as an agency in another. For example, a BVI trust that holds Hong Kong real estate through a Hong Kong nominee company may be treated as a trust in BVI (under the BVI Trustee Act) but as an agency in Hong Kong if the nominee company does not hold the assets on a segregated basis. The Zhang case (2024) illustrates this risk: the court looked at the substance of the arrangement, not the label. For cross-border families, the safest approach is to ensure that the trust deed explicitly states that the trustee holds the assets on trust for the beneficiaries and that the assets are held in a segregated account. The HKMA’s CP-2025-01 now requires that the segregation be “physical or legal,” meaning that the assets must be either physically separated or legally ring-fenced through a trust structure.

Actionable Takeaways

1. Review all existing asset-holding agreements to determine whether the legal substance matches the label—a court will look at the actual control and segregation of assets, not the name in the contract, as confirmed by Zhang Hong Li v DBS Bank (Hong Kong) Limited (2024).
2. Segregate trust assets from the trustee’s own assets in a separate trust account or nominee structure, as required by the SFC’s 2025 proposed amendments to the SFC Code and the HKMA’s CP-2025-01.
3. Obtain a written “trust acknowledgment” from any licensed corporation or authorized institution holding assets on trust, specifying the legal basis and the beneficiary’s proprietary rights.
4. For cross-border structures, ensure that the trust deed is registered with the relevant PRC asset registry if the trust holds PRC assets, to avoid dual characterization and adverse tax treatment under SAT Circular No. 8 (2024).
5. Conduct an annual audit of the client asset register for any licensed corporation or authorized institution holding fiduciary assets, as proposed by the SFC’s 2025 consultation and the HKMA’s Supervisory Policy Manual.