Legal risks & arbitration of bank management cases

With the intensive expansion of all sorts of financial products since 2013, the China Banking Regulatory Commission has gradually encouraged steady growth in the bank asset management industry. Against this background, the Beijing Arbitration Commission/Beijing Arbitration International Centre (BAC/BIAC) has seen a number of cases relating to the bank asset management industry. Within these cases, a rational understanding of risk, solving disputes properly and balancing out different parties’ interests appropriately are yardsticks for determining the maturity of arbitrators and arbitration institutions in managing cases.

If you want to understand the essence of a bank asset management business, the first step is to distinguish clearly commercial risks from legal risks. Managing a business and complying with legal requirements often present different sets of risks. The better a business runs, the easier for the operator to over-focus on development and overlook legal-related flaws. So, when something bad happens, the so-called “business judgment rule” is often the primary blame for blurring legal and commercial risks. This naturally calls for asset management stakeholders to consider and draw a clear line between commercial and legal risks at the outset, so as to provide guidance for adjudicators in the event of risk incidents.

Risk planning for assets managers (within an asset management business relationship) can be generalized into four aspects:

1.Risks associated with legal determination. While asset management and trusts are in practice very similar, if not identical, in arbitration cases definition for even the most commonly seen asset managing products are disputed. To determine whether a trustor and trustee relationship exists (and whether fiduciary duty of trustee applies), the current practice of tribunal is to look substantively into the real intention of the parties;

2.Risks associated with information disclosure and truthful description. On one hand, product sales must put an end to giving misleading sales statements in the pursuit of higher performance. On the other hand, in determining whether the sales should bear the corresponding responsibilities for making any “cover all lost” commitments, the tribunal will generally also consider the identity of investors and their experiences on top of the sales representations;

3.Risks associated with identifying qualified investors. Due to high identification costs, asset managers may not be required to uphold a strict identification gauge at all times. However, where the circumstance suggests that an asset manager is aware of, or ought to have been aware of, an investor being unqualified, the obligation to investigate cannot be removed easily. Excuses such as the receiving of an “investor’s declaration of property” or a purchase amount over the required level are unlikely to be accepted;

4.Risks associated with the exercising of duty of care. Asset managers are subject to a strict duty of care throughout the asset managing period. Especially in the event of any investee’s capital crisis or breach of contract, the asset managers will be subjected to a higher standard of prudency in realizing and disposing assets. Where there is a sudden change of game plan, investors should be notified and explanation given in a sufficient and timely manner.

Similarly, risk planning for asset holders can be trimmed down to four aspects:

1.Risks associated with applicable regulatory measures. Although regulatory measures tend to confer control of investment projects to asset managers, to avoid investors from evading liability regulatory measures should be established in terms of the asset manager’s “right”, rather than the asset manager’s one-sided “authority”;

2.Risks associated with securities or guarantees. Asset managers often utilize securities or guarantees to protect themselves. When accepting a security or guarantee, it is necessary to pay attention to the expiry period. The scope of the security or guarantee can be drafted in accordance with relevant provisions in guarantee law or property law, so as to avoid omission of responsibility;

3.Risks associated with designing a termination clause. When a contract is breached, an explicit power to rescind the contract can give the parties, especially the innocent side, more flexibility. In the event of an anticipated breach, if the creditor can collect evidence of the parties’ anticipated default at an earlier stage, the creditor may take measures earlier to actualize the debt.

4.Risks associated with loss cutting. The insistence to cut losses according to the law and the agreed contract is indispensable in controlling risk for asset managers. Stop-loss trigger conditions should be stipulated clearly within the contract. Additionally, when disputes occur, asset managers must pay attention to and meet the procedural requirements of arbitral proceedings. For example, regarding the burden of proof, because asset managers generally have control and the operation right of specific products, based on the “principle of evidence proximity” they are likely to have to fulfil a higher standard of proof; evidence preservation can protect asset managers from being accused for breaching their duty, such as the duty of care.

When it comes to choices of arbitrators, be it from the perspective of arbitration process efficiency or risk minimization, arbitrators with expertise in the asset management industry are critical (sometimes even more so than the words of parties) in reaching a fair judgment. Therefore, it is important for parties to select an arbitrator who has the expertise in the asset management industry. Meanwhile, legal expenses, preservation fees, travel expenses, notary fees and other reasonable costs incurred during the course of the arbitral proceedings might be covered. Hence the costs for resolving disputes can be controlled with arbitration for cases as such.

In the waves of financial innovation within the banking industry, pseudo-asset management practices such as hidden guarantee or rigid payments, will gradually fade out. Light should be shed on both the reaction to, and handling of, existing risks, and the standardized control of risk. As such, and with a paradigm shift towards a legitimate asset management business model, the authors are hopeful in expecting a healthy and sustainable long-term development in the asset management industry in the future.

Zhang Haoliang is a division chief and Liu Nianqiong is a case manager at Beijing Arbitration Commission/Beijing International Arbitration Centre. BAC/BIAC’s intern Joshua Ngai Jun also contributed to the article

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