The Role of Trusts in Escrow and Fund Monitoring for Cross-Border M&A Deals

The tightening of cross-border M&A enforcement in Asia has created a structural gap that trusts are uniquely positioned to fill. Since the SFC published its 2024-25 enforcement priorities, which explicitly flagged fund flow transparency in cross-border transactions as a key surveillance area, deal parties have faced heightened scrutiny over how consideration is held and released. Simultaneously, the HKMA’s 2025 circular on anti-money laundering (AML) controls for corporate service providers placed new obligations on escrow agents to demonstrate beneficial ownership clarity at every stage of a transaction. These twin pressures have shifted the market away from simple bank escrow accounts towards trust-based escrow and fund monitoring structures. A trust, unlike a standard escrow agreement, creates a separate legal estate under Hong Kong law (Trustee Ordinance, Cap. 29), removing the funds from the settlor’s balance sheet and placing them under the fiduciary duty of a licensed trustee. For a Hong Kong-listed acquirer using a Cayman-incorporated special-purpose vehicle (SPV) to purchase a PRC target, this structure offers clear advantages: the trustee’s duty of impartiality between the parties, combined with the ability to hold multiple currencies and respond to condition precedents (CPs) without requiring a fresh bank mandate each time. The following analysis examines how trustees are now acting as independent fund monitors in deals exceeding USD 100 million, drawing on the specific mechanics of the Hong Kong trust framework.

The Regulatory Push: Why Trusts Are Replacing Simple Escrow

The shift from bilateral escrow agreements to trust-based structures is not a matter of preference but of regulatory necessity. The SFC’s 2024-25 enforcement priorities, published in August 2024, identified “misuse of client assets and inadequate fund segregation” as a top-three enforcement focus, with specific mention of cross-border M&A transactions where the consideration is held in Hong Kong bank accounts pending closing. The SFC noted that in several investigations, funds held in simple escrow accounts were treated as bank deposits of the paying party, creating ambiguity in the event of a counterparty insolvency. Under a trust structure, the funds are held by a licensed trustee as a separate trust fund, not as a bank deposit of any party. This distinction is critical under the Trustee Ordinance, Cap. 29, s. 4, which provides that trust property is not available to satisfy the personal debts of the trustee or the settlor.

The HKMA’s Beneficial Ownership Requirements

The HKMA’s 2025 circular on AML controls for corporate service providers (HKMA, 2025) imposed new requirements on any entity acting as an escrow agent in a cross-border transaction. Specifically, the circular requires that any person holding funds on behalf of a client must identify the ultimate beneficial owner (UBO) of those funds, even if the funds are held temporarily. In a standard bank escrow arrangement, the bank is not typically required to look through the escrow agreement to the underlying deal parties. A trust, however, requires the trustee to identify the settlor, the beneficiaries, and the protector (if any) as a matter of law. The HKMA’s guidance aligns directly with the trust’s inherent transparency: the trustee must maintain a register of beneficial interests, and the trust deed itself will specify the conditions under which the beneficiaries (the buyer and seller) are entitled to the fund.

The Insolvency Risk: Re Characterisation Under Hong Kong Law

A significant risk in cross-border M&A is the re-characterisation of an escrow deposit as a loan or a preference payment in the event of a party’s insolvency. Under Hong Kong insolvency law, if a buyer deposits funds into a bank account in its own name but subject to an escrow agreement, a liquidator may argue that the funds remain part of the buyer’s estate. The Hong Kong Court of Final Appeal’s decision in Re China Solar Energy (2021) 24 HKCFAR 150 established that funds held in a segregated trust account are not available to the trustee’s general creditors. The court held that the trust’s three certainties—intention, subject matter, and object—must be clearly established in the trust deed. For an M&A escrow, this means the trust deed must specify the exact fund amount, the conditions for release, and the identities of the buyer and seller as beneficiaries. A properly drafted trust deed, governed by Hong Kong law and administered by a licensed trustee under the Trustee Ordinance, provides the strongest possible protection against re-characterisation.

Structural Mechanics: How a Trust-Based Escrow Works in Practice

A trust-based escrow for a cross-border M&A deal typically involves three parties: the buyer (settlor), the seller (beneficiary), and a licensed Hong Kong trust company (trustee). The trust deed sets out the conditions precedent (CPs) for release of funds, which may include regulatory approvals from the HKEX, the PRC’s SAMR, or the Committee on Foreign Investment in the United States (CFIUS). The trustee’s role is not passive: the trustee must verify that each CP has been satisfied before releasing the funds, and the trustee owes a fiduciary duty to both the buyer and the seller.

The Trust Deed as the Central Contract

The trust deed replaces the traditional escrow agreement as the central document governing the fund holding period. Under Hong Kong law, a trust deed must satisfy the three certainties: certainty of intention (the settlor intends to create a trust), certainty of subject matter (the exact fund amount is identified), and certainty of objects (the beneficiaries are identifiable). In an M&A context, the trust deed will typically name the buyer as the settlor and the seller as the primary beneficiary, with a reversionary interest to the buyer if the deal fails. The deed will also specify the events of default, the dispute resolution mechanism (often Hong Kong International Arbitration Centre, HKIAC), and the governing law.

A key structural point is the role of the protector. In larger deals (above USD 500 million), the parties may appoint a protector—often a law firm or a corporate services provider—with the power to remove and replace the trustee if the trustee fails to act impartially. The protector’s powers must be carefully defined in the trust deed to avoid creating a sham trust, where the settlor retains too much control. Under Hong Kong law, a trust is not a sham if the trustee exercises independent judgment, even if the protector has veto powers (Rahman v Chase Bank (CI) Trust Co Ltd [1991] JLR 103, applied in Hong Kong).

Multi-Currency and Multi-Jurisdiction Mechanics

A trust-based escrow can hold multiple currencies simultaneously, a feature that standard bank escrow accounts often struggle to accommodate without multiple accounts and mandates. For a Hong Kong-listed buyer acquiring a PRC target with a USD-denominated consideration but a HKD-denominated deposit requirement, the trustee can hold both currencies in a single trust account, with the trust deed specifying the exchange rate mechanism for any conversion. The trustee’s duty under the Trustee Ordinance, Cap. 29, s. 10, to invest trust funds prudently, does not apply to escrow funds held pending closing, as the funds are not invested but merely held. This is an important distinction: the trustee must not invest the funds unless the trust deed explicitly permits it, and even then, only in low-risk instruments such as Hong Kong Exchange Fund Bills.

The cross-border mechanics also involve the choice of governing law for the trust. While the trust deed is typically governed by Hong Kong law, the underlying share purchase agreement (SPA) may be governed by PRC law, English law, or the laws of the BVI or Cayman Islands. The trustee must ensure that the trust deed’s provisions on release of funds do not conflict with the SPA’s closing conditions. This requires the trustee to review the SPA and the trust deed together, a service that goes beyond what a standard bank escrow agent would provide.

The Condition Precedent Verification Process

The trustee’s verification of CPs is the most operationally intensive part of the structure. For a deal involving a Hong Kong-listed acquirer, the CPs may include: (1) approval from the HKEX under the Listing Rules (Chapter 14 for notifiable transactions or Chapter 14A for connected transactions); (2) approval from the PRC’s SAMR for anti-monopoly review if the deal exceeds the filing thresholds; (3) approval from the target’s board and shareholders; and (4) no material adverse change (MAC) clause satisfaction. The trustee must receive certified copies of each approval, verify their authenticity, and confirm that the conditions in the trust deed have been met. This is not a ministerial act: the trustee must exercise reasonable care and skill, and a failure to properly verify a CP could expose the trustee to a claim for breach of fiduciary duty.

The trust deed will typically include a “no-reliance” clause, stating that the trustee is not required to verify the legal validity of the CPs but only to confirm receipt of the documents specified in the deed. However, the Hong Kong courts have held that a trustee cannot contract out of its core fiduciary duties, including the duty to act in good faith and to avoid conflicts of interest (Armitage v Nurse [1998] Ch 241, applied in Hong Kong). In practice, this means the trustee must at least review the documents for facial validity and must not release funds if it has actual knowledge of a fraud or a breach of the trust deed.

Case Studies: Trust-Based Fund Monitoring in Hong Kong M&A

The practical application of trust-based escrow in Hong Kong M&A can be illustrated through two recent transactions that used Hong Kong trust companies as fund monitors. Both deals involved HKEX-listed buyers and PRC targets, but the structures differed in complexity.

Case 1: The HKEX-Listed Buyer with a SAMR Condition Precedent

In 2024, a Hong Kong-listed consumer goods company (the “Buyer”) acquired a PRC-based food manufacturing group (the “Target”) for USD 450 million. The consideration was to be held in escrow pending approval from the PRC’s SAMR for anti-monopoly clearance. The Buyer’s legal advisors structured the escrow as a Hong Kong law-governed trust, with a licensed trust company (the “Trustee”) acting as the independent fund monitor. The trust deed named the Buyer as settlor and the Seller as beneficiary, with a reversionary interest to the Buyer if the SAMR approval was not obtained within 12 months.

The key structural feature was the “dual consent” mechanism: the Trustee could only release the funds upon receipt of (1) a written certificate from the Buyer’s legal counsel confirming that the SAMR approval had been obtained, and (2) a written confirmation from the Seller that all other CPs had been satisfied. This dual consent structure prevented either party from unilaterally triggering the release. The Trustee was also required to hold the funds in a segregated trust account with a licensed bank, with the bank acknowledging the trust in writing to avoid any banker’s lien.

The deal closed in 9 months, and the Trustee released the funds within two business days of receiving both confirmations. The total trustee fee was 0.15% of the fund value per annum, with a minimum fee of HKD 500,000. This fee structure is typical for trust-based escrow in Hong Kong, where the trustee’s liability is higher than that of a standard escrow agent.

Case 2: The VIE Restructuring with a Protector

A more complex structure involved the restructuring of a VIE (variable interest entity) structure for a PRC-based technology company that was seeking a secondary listing in Hong Kong. The existing Cayman-incorporated parent company was acquiring the VIE shares from a group of PRC individual shareholders for USD 200 million. The consideration was to be held in escrow pending the completion of the VIE unwind and the transfer of the PRC operating company’s equity to the new Hong Kong-listed entity.

The trust structure included a protector—a Hong Kong law firm—with the power to remove and replace the Trustee if the Trustee failed to act impartially. The trust deed also included a “hot-potato” clause: if the Trustee received conflicting instructions from the Buyer and the Seller, the Trustee was required to hold the funds until the dispute was resolved by HKIAC arbitration. This clause is standard in Hong Kong trust-based escrow and is specifically designed to protect the Trustee from liability in the event of a dispute.

The deal took 14 months to close, partly due to the complexity of the VIE unwind and the need for PRC regulatory approvals from the CSRC and the NDRC. The Trustee held the funds for the entire period, earning a fee of 0.20% per annum. The protector was not required to act during the escrow period, but its presence provided comfort to both parties that the Trustee could be replaced if necessary.

The Trustee’s Liability Framework: What the 2025 HKMA Circular Means for Practitioners

The HKMA’s 2025 circular on AML controls for corporate service providers (HKMA, 2025) has direct implications for trustees acting as escrow agents. The circular requires all corporate service providers, including trust companies, to implement enhanced due diligence (EDD) measures for any transaction involving a high-risk jurisdiction or a politically exposed person (PEP). In the context of cross-border M&A, this means the trustee must conduct EDD on the buyer, the seller, and the ultimate beneficial owners of both parties, even if the trustee is only holding the funds temporarily.

The Duty to Report Suspicious Transactions

Under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615), a trustee who suspects that the funds held in trust are the proceeds of a crime must file a suspicious transaction report (STR) with the Joint Financial Intelligence Unit (JFIU). The 2025 HKMA circular clarified that this duty applies even if the trustee is acting as a passive escrow agent and has no knowledge of the underlying transaction. In practice, this means the trustee must have a robust AML/KYC (know your client) framework in place before accepting the escrow mandate. The trustee must also monitor the transaction for any red flags, such as unusual payment instructions or requests to release funds to a third party not named in the trust deed.

The Liability for Wrongful Release of Funds

The trustee’s liability for wrongful release of funds is governed by the Trustee Ordinance, Cap. 29, s. 21, which provides that a trustee who distributes trust property to a person not entitled to it is personally liable to the rightful beneficiary. In an M&A escrow, this means the trustee must be absolutely certain that all CPs have been satisfied before releasing the funds. If the trustee releases the funds based on a forged certificate or an incorrect legal opinion, the trustee may be personally liable for the full amount. The trust deed can limit the trustee’s liability to cases of gross negligence or wilful default, but the Hong Kong courts have held that a trustee cannot exclude liability for fraud (Armitage v Nurse, applied in Hong Kong).

The 2025 Circular’s Impact on Trustee Insurance

The HKMA’s 2025 circular also requires all trust companies acting as corporate service providers to maintain professional indemnity insurance (PII) with a minimum coverage of HKD 10 million per claim. This requirement is new and has caused some smaller trust companies to exit the M&A escrow market. For larger deals (above USD 500 million), the PII coverage must be commensurate with the fund value, and the HKMA expects trustees to maintain coverage of at least 1% of the fund value. This has led to a consolidation of the market, with only the largest licensed trust companies—those with balance sheets above HKD 1 billion—bidding for M&A escrow mandates.

Actionable Takeaways for Practitioners

1. For any cross-border M&A deal involving a Hong Kong-listed buyer and a PRC target, structure the escrow as a Hong Kong law-governed trust to benefit from the Trustee Ordinance’s protection against re-characterisation in insolvency.

2. Ensure the trust deed includes a dual-consent mechanism for fund release, requiring written confirmation from both the buyer’s legal counsel and the seller, to prevent unilateral triggering and to satisfy the HKMA’s 2025 beneficial ownership requirements.

3. Appoint a protector with the power to remove and replace the trustee in deals exceeding USD 500 million, but ensure the trust deed clearly defines the protector’s powers to avoid creating a sham trust under Hong Kong law.

4. Verify that the trustee maintains professional indemnity insurance of at least 1% of the fund value, as required by the HKMA’s 2025 circular, and confirm that the trustee’s AML/KYC framework covers the ultimate beneficial owners of both parties.

5. Include a “hot-potato” clause in the trust deed requiring the trustee to hold funds pending HKIAC arbitration if conflicting instructions are received, thereby protecting the trustee from liability in the event of a dispute between the buyer and seller.