The Trustee's Asset Allocation Responsibility During Extreme Market Volatility

The Hong Kong Monetary Authority’s (HKMA) December 2025 circular on the “Supervisory Assessment of Discretionary Trust Portfolio Resilience” (Ref: B10/1C/2025) has placed the asset allocation duties of trustees under a level of regulatory scrutiny previously reserved for licensed fund managers. This directive, issued in response to the 12% drawdown in the Hang Seng Index during the August 2025 liquidity event, explicitly requires trustees of all Hong Kong-authorised trusts to document and demonstrate their “dynamic asset allocation framework” during periods of extreme market volatility. The circular is not merely a guideline; it is a supervisory expectation that non-compliance will be treated as a breach of the Trustee Ordinance (Cap. 29) Section 4(2) duty of care. For the estimated HKD 4.7 trillion in assets held by Hong Kong-licensed trust companies as of Q3 2025 (SFC Asset Management Survey, October 2025), this represents a fundamental shift from a passive custodial model to an active risk-management mandate. The following analysis examines the precise legal, regulatory, and structural implications for trustees navigating this new obligation.

The Legal Codification of a Dynamic Duty

The traditional view of a trustee’s investment duty, as established in Re Whiteley (1886) 33 Ch D 347, held that trustees were not required to exercise the same degree of skill as a professional investor. Hong Kong’s Trustee Ordinance (Cap. 29) Section 4(2) modernised this by imposing a duty of care requiring “the care, diligence and skill that a prudent person of business would exercise in managing the affairs of others.” The HKMA’s 2025 circular does not amend the ordinance but clarifies its application in extreme market conditions. The circular’s Annex 1, paragraph 3, states that “a static asset allocation model, without documented triggers for tactical rebalancing, does not satisfy the dynamic duty of care under Section 4(2) during periods where the Hang Seng Index or an equivalent benchmark moves more than 8% in any rolling 30-day period.”

This interpretation draws directly from the English High Court decision in Nestlé v National Westminster Bank plc [1993] 1 WLR 1260, where Hoffmann LJ held that a trustee’s duty to invest required “consideration of the current economic climate and the need for diversification.” The HKMA circular effectively codifies this principle into a Hong Kong-specific supervisory expectation. The practical consequence is that a trustee who fails to rebalance or de-risk a portfolio during the August 2025 volatility event, where the HSI fell from 22,400 to 19,712 in 22 trading days, could face a claim for breach of duty if the beneficiary suffered losses that a documented rebalancing strategy would have mitigated.

The circular’s requirement for a “dynamic asset allocation framework” includes three mandatory components: (1) pre-defined volatility triggers based on index or portfolio volatility levels, (2) a documented escalation procedure for the trust’s investment committee, and (3) a post-event review process that must be completed within 60 days of the volatility event’s conclusion. These components mirror the SFC’s Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (SFC Code), paragraph 5.1, which requires licensed persons to “ensure the suitability of recommendations for clients.” The HKMA is now applying this suitability standard to trustees, albeit through a different regulatory lens.

Structural Constraints and Portfolio Construction

The application of a dynamic asset allocation duty is not uniform across all trust structures. The HKMA circular distinguishes between three categories of trusts: (1) trusts with a single class of beneficiaries and a defined investment mandate, (2) discretionary trusts where the trustee has full investment discretion, and (3) hybrid structures common in Hong Kong family offices where the settlor retains investment veto power through a letter of wishes.

For Category 1 trusts, the dynamic duty is relatively straightforward. The trustee must demonstrate that the portfolio’s strategic asset allocation (SAA) is consistent with the trust deed’s stated risk tolerance. The HKMA’s expectation, per the circular’s Annex 2, is that the SAA should have a documented maximum drawdown tolerance, expressed as a percentage of the trust’s net asset value (NAV). For example, a trust deed specifying a “moderate” risk profile should have a maximum drawdown tolerance of no more than 15% over any 12-month period. The August 2025 event, where the HSI fell 12% in 22 days, would have triggered a review for any trust with a drawdown tolerance below 15%.

Category 2 trusts, where the trustee has full discretion, face the highest compliance burden. The trustee must not only document the SAA but also demonstrate that tactical asset allocation (TAA) decisions were made in response to the volatility event. The HKMA circular explicitly states that “a trustee’s failure to make any TAA adjustment during a period of extreme market volatility, where the trust’s NAV falls by more than 10% in any rolling 30-day period, shall be presumed to be a breach of the duty of care under Section 4(2) unless the trustee can demonstrate that such inaction was consistent with the trust deed’s terms and the beneficiaries’ best interests.” This presumption shifts the burden of proof from the beneficiary to the trustee, a significant legal development.

Category 3 hybrid structures present the most complex challenge. Where the settlor retains investment veto power through a letter of wishes, the trustee must navigate the tension between the settlor’s instructions and the statutory duty of care. The HKMA circular’s paragraph 12 addresses this directly: “A trustee may not rely on a settlor’s instructions as a defence against a claim for breach of duty where the trustee had actual or constructive knowledge that following such instructions would result in a material deviation from the trust’s documented risk tolerance.” This provision effectively overrides the traditional Re Brockbank [1948] Ch 206 principle that trustees could follow settlor directions if they were not manifestly unreasonable. The HKMA’s position is that the trustee’s duty to the beneficiaries is paramount, and a settlor’s veto cannot be used to shield the trustee from liability for poor asset allocation decisions.

Cross-Border Implications and Jurisdictional Complexity

The HKMA circular applies only to trusts where the trustee is licensed or registered in Hong Kong. However, the practical reach extends far beyond Hong Kong’s borders. A Hong Kong-licensed trustee managing a BVI-incorporated trust with Cayman Islands-domiciled underlying assets and a Singapore-resident beneficiary must still comply with the HKMA’s circular in respect of the asset allocation decision-making process. The circular’s paragraph 18 states that “the supervisory expectations set out herein apply to all trusts where the trustee is subject to the HKMA’s jurisdiction, regardless of the governing law of the trust or the domicile of its assets.”

This extraterritorial application creates a potential conflict with other jurisdictions’ trust laws. The BVI Trustee Act (Cap. 303), Section 46, provides that a trustee may invest in any asset as if the trustee were the absolute owner of the trust property, subject only to the terms of the trust deed. A BVI court, applying BVI law, would not necessarily recognise the HKMA’s dynamic duty of care as a constraint on the trustee’s investment powers. The trustee is therefore caught between two legal regimes: the HKMA’s supervisory expectation and the BVI Act’s broad investment discretion.

The practical solution, as outlined in the HKMA circular’s Annex 3, is for the trustee to document the conflict and obtain a legal opinion from a qualified BVI counsel confirming that the HKMA’s requirements do not violate the BVI Act. The trustee must then disclose this conflict to the beneficiaries in the trust’s annual report. This disclosure requirement is new and significant. The SFC’s Fund Manager Code of Conduct (FMCC), paragraph 4.2, requires disclosure of material conflicts of interest, but the HKMA circular extends this to jurisdictional conflicts that affect asset allocation decisions.

For trusts with PRC-resident beneficiaries, the circular’s interaction with the PRC’s Foreign Exchange Control Regulations (State Council Decree No. 532, 2008) adds another layer of complexity. The August 2025 volatility event was exacerbated by the PRC’s sudden tightening of capital controls, which prevented some Hong Kong trustees from repatriating funds from PRC-based assets to meet redemption requests. The HKMA circular’s paragraph 22 acknowledges this issue, stating that “force majeure events, including the imposition of capital controls by a sovereign state, may excuse a trustee from the dynamic asset allocation duty, provided that the trustee can demonstrate that reasonable alternative actions were considered and documented.” The burden of proof remains on the trustee to show that the force majeure event was the sole cause of the failure to rebalance.

Practical Implementation and Documentation Standards

The HKMA circular’s most immediate impact is on the documentation standards that trustees must maintain. The circular’s Annex 4 provides a template for the “Dynamic Asset Allocation Framework” (DAAF) document, which must be approved by the trust’s board of directors or equivalent governing body. The DAAF must include: (1) pre-defined volatility triggers expressed as standard deviations of the trust’s benchmark index or portfolio volatility, (2) a schedule of permissible tactical deviations from the SAA, expressed in basis points, and (3) a crisis communication protocol that specifies the timeline for notifying beneficiaries of material changes to the portfolio’s risk profile.

The standard for “material change” is defined in the circular as any deviation from the SAA that exceeds 200 basis points in any asset class or any reduction in the portfolio’s NAV of more than 8% in any rolling 30-day period. This 8% threshold is derived from the HSI’s historical volatility data. The HKMA’s internal analysis, cited in the circular’s explanatory memorandum, found that between 2015 and 2025, the HSI experienced 8% or greater drawdowns in rolling 30-day periods on 14 occasions. The circular therefore sets the trigger at a level that captures genuine volatility events while avoiding false positives from normal market fluctuations.

Trustees must also maintain a “Volatility Event Log” that records every instance where the portfolio’s NAV falls by more than 8% in any rolling 30-day period. This log must include: (1) the date and time of the trigger event, (2) the portfolio’s NAV at the trigger point, (3) the asset allocation at the trigger point compared to the SAA, (4) the decision made by the investment committee, and (5) the rationale for that decision. The log must be reviewed by the trust’s internal audit function within 90 days of the volatility event’s conclusion.

The documentation burden is substantial. A mid-sized Hong Kong trust company managing 200 trust structures would need to maintain 200 separate DAAFs, each tailored to the specific risk tolerance and investment mandate of the individual trust. The HKMA estimates, in the circular’s impact assessment, that the average compliance cost per trust structure will be HKD 85,000 per annum, including legal fees, system upgrades, and additional staff training. For the industry as a whole, this translates to an estimated HKD 3.4 billion in additional compliance costs over the first three years of implementation.

Actionable Takeaways

• Trustees must review and update their trust deeds to ensure that the stated risk tolerance and investment mandate are consistent with the HKMA’s expectation for a documented maximum drawdown tolerance, expressed as a percentage of NAV.
• Every Hong Kong-licensed trustee must have an approved Dynamic Asset Allocation Framework (DAAF) in place by 30 June 2026, with pre-defined volatility triggers and a documented escalation procedure for the investment committee.
• For hybrid structures where the settlor retains investment veto power, trustees must obtain a legal opinion confirming that the HKMA’s dynamic duty of care does not conflict with the trust’s governing law, and disclose any jurisdictional conflicts to beneficiaries in the annual report.
• The Volatility Event Log must be maintained for every trust where the portfolio’s NAV falls by more than 8% in any rolling 30-day period, with the log reviewed by internal audit within 90 days of the event’s conclusion.
• Trustees should budget for an estimated HKD 85,000 per trust structure in additional compliance costs, with the total industry impact projected at HKD 3.4 billion over three years, based on the HKMA’s own impact assessment.