The New SPC Regulations on the Hearing of Futures Disputes: Striking a Better Balance

The task for establishing such rules was taken up by the SPC. In 1995, the SPC convened an internal symposium in Chengdu to discuss the applicability of laws in adjudicating futures disputes. At that time, however, civil laws and regulations applicable to the futures market were poorly developed. The result was the issuance of a not very detailed summary of the symposium's discussions (the 1995 Notes).

In addition to the Administration Regulations, the PRC Contract Law (中华人民共和国合同法)(the Contract Law) was also promulgated in 1999. The latter provided a clarification of important legal principles governing civil transactions and liabilities between parties. Perhaps prompted by the Contract Law (indeed, specific reference is made to it in the preamble to the Provisions), the SPC has issued the Provisions to redress the imbalance between the laws governing futures transactions, which are not many, and those regulating the futures market. Thematically, the Provisions reiterate the primacy of freedom of contract and fault-based liability (Articles 2 and 3 of the Provisions); while these principles had formed part of the basis of the 1995 Notes, the Provisions provide far greater clarity and detail. It is also clear that the influence of the Contract Law prevails throughout the Provisions, the more important aspects of which we will now examine.

JURISDICTION

The Provisions reiterate stipulations in the 1995 Notes that futures disputes continue to be heard by the Intermediate Courts and authorized lower people's courts (Article 7). However, the Provisions also make clear that Chinese courts will recognize choice of jurisdiction clauses in futures contracts, provided there is some factual nexus between the futures contract and the jurisdiction chosen; e.g., a defendant's domicile or place of the performance of a contract (following Articles 4 and 25 of the PRC Civil Procedure Law). The Provisions also clarify that the location of a branch office of a futures brokerage, and the location of a futures exchange (in a case concerning actual delivery of property) would constitute the place of performance of a contract (Articles 5 and 24 of the PRC Civil Procedure Law). The Provisions also permit a claimant to mount a suit based on both tortious and contractual liability (Article 6).

THE LIABLE PARTY

The principle of apparent or ostensible authority is found in Article 49 of the Contract Law: where a third party has reason to believe that a person is authorized to act as agent, then a contract concluded in the name of the principal is valid and binding, regardless of whether there is actual authority. The Provisions have similarly incorporated this principle, by stating that futures brokerages will be responsible for any action conducted by their brokers, subsidiaries or any other parties where a third party has reason to believe that such acts were authorized by the futures brokerages (Articles 8, 9 and 12). This appears to be an attempt to provide safeguards to a party trading in good faith with a futures brokerage.

VOID CONTRACTS

In addition to the conduct of futures business by an unqualified brokerage or a non-member of a futures exchange, the carrying out of a futures transaction by an unqualified client would also render a futures contract invalid (Article 13 (2)). This additional prohibition seems in line with Article 29 of the Administration Regulations, which prohibits futures brokerages from accepting engagements or providing services to any party conducting futures trading in the name of an individual (such individuals, i.e. natural persons, would not qualify as clients under the Administration Regulations).

TRADING LIABILITY

The Provisions impose an obligation upon futures brokerages to inform their clients of the risks of futures trading prior to signing a brokerage contract. Otherwise, a futures brokerage could be liable for any losses suffered by the client (Article 16). This mirrors the obligation under Article 42(3) of the Contract Law, where one party can be held liable for acting contrary to the principle of good faith. This is a foundational principle of the Chinese law of contract. By the same token the obligation to warn, which purpose is to provide clients with full knowledge of the risks involved, need not be complied with where experienced clients are concerned.

Similar to the 1995 Notes, the Provisions impose liability on futures brokerages for losses related to a failure to make explicit the method of taking instructions from the client (and the failure by the futures brokerage to prove that the instructions were those of the client), the taking of instructions from a person who has not been entrusted to give instructions, the acceptance and execution of unclear instructions, and the carrying out of wrong instructions (e.g., executing a trade at a higher than instructed price). However, the Provisions are also more flexible in that they provide the client with a right to elect between compensation and accepting the consequences of the transactions (Articles 18, 19, 20 and 22).

Part 22 of the Contract Law, on Commission Agency Contracts, provides that where a commission agent makes gains, e.g., by selling goods at a higher price or purchasing goods at a lower price than designated, the economic benefits of such transactions belong to the client of the commission agent (Article 418). This principle is recognized by the SPC, which regards a futures brokerage as a type of commission agent, by requiring the futures brokerage to refund the client on the latter's request in either of the above circumstances, unless otherwise agreed (Article 24).

At the same time, the Provisions also attempt to provide some measure of protection to futures brokerages. The Provisions state that the confirmation of the client shall be deemed a confirmation of all previous positions and settlements prior to that date (Article 27). This prevents a client from denying their liability, as they would have in the past, by claiming ignorance of trading results.

Another important breakthrough lies in the area of "mixed code" transactions. The Administration Regulations specifically provide that "futures brokerages shall open an independent account for and assign a trading code to each client, and may not conduct mixed code trading" (Article 36(4)). However, the reality in business is that mixed code transactions are not necessarily at variance with clients' interests. A client may, for various reasons, have several different codes in one futures brokerage company. The Provisions now state that where the futures brokerage is able to prove that the mixed code trading was fully authorized, the economic results of the transactions will be borne by the client (although this still leaves a futures brokerage at risk of prosecution under the Administration Regulations).

OVERDRAFT

The Provisions provide a clear definition of "overdraft", i.e., the volume of futures trading transactions that occur above the allowable margins (Article 31). Allowable margins are calculated based on the security deposits made by futures brokerages and clients to futures exchanges and futures brokerages, respectively. The Provisions also provide that the ratios governing the margins are to be established by the futures exchanges, and not between futures brokerages and their clients.

Whereas an overdraft in futures trading is prohibited (see for example Article 32 of the Shanghai Futures Exchange, Administration of Membership Regulations), the Provisions state that futures exchanges and futures brokerages are liable up to a maximum of 60% and 80%, respectively, for losses incurred in allowing the running of an overdraft (Article 34); previously the 1995 Notes provided that liability was for up to 100%. On the other hand, one interpretation of the Provisions is that if there is an agreement between the futures exchange and futures brokerage, or futures brokerage and client, as to the mutual benefits and risks in running an overdraft, the losses are to be equally shared (Article 35).

Both futures exchanges and futures brokerages have an obligation to give notice, where margins have been exceeded, for more deposits to be made. Any delay or error in so doing could lead to the futures exchange or futures brokerage having to compensate amounts of up to 60% and 80% of losses caused, respectively (Article 32). Again, under the 1995 Notes, the maximum liability was 100%.

The Provisions also permit a futures brokerage or client to provisionally hold their positions if they cannot contribute sufficient deposits on time. In such cases the Provisions provide that the futures brokerage or client shall enter into written agreements with a futures exchange and futures brokerage, respectively. Under such agreements, the futures brokerage (or client) shall ultimately be liable for the losses caused by such a holding of position, but in the first instance the futures exchange (or futures brokerage) endorsing such holding shall be liable for the losses caused attributable to such holdings (after setting off amounts held in deposit, Article 33). To this extent, the Provisions are particularly helpful to parties who, while being able to obtain funds, were unable to make the relevant margin contributions on time.

CLOSING OUT OF TRADING POSITIONS

The Provisions provide that where a client's unclosed positions have deteriorated and he has failed to respond to a margin call, then in the absence of further agreement, the futures brokerage is entitled to forcibly effect a closing out of unclosed futures contracts, with any attendant losses to be borne by the client (Article 36). This is subject to a prior right of the client to indicate to the futures brokerage what positions he wishes to have closed out. The same applies, mutatis mutandis, in the case of a futures brokerage's trading position with the futures exchange. Nevertheless, if losses are incurred through an excessive closing out, e.g. above the amount required to have been contributed by the client or the future exchange, these are to be borne by the party who effected the closing out.

GUARANTEE OF PERFORMANCE

The 1995 Notes stipulated that futures exchanges were the guarantor of the performance of a futures contract. However, although this imposed liability upon a futures exchange for a breach of contract by a futures exchange member, i.e. a futures brokerage, a client of a futures brokerage could only take action against the futures exchange through the cooperation of the futures brokerage (which would not have been forthcoming). In contrast and perhaps to address this practical hurdle, the Provisions now provide that if the futures brokerage refuses, the client is entitled to bring action directly against the futures exchange (Article 49).

Under the Provisions, the futures brokerage shall compensate clients' losses arising from false information, the undisclosed setting off of accounts, false representations, the transferring of deposits and other illegal behaviour (Articles 52, 53, 54 and 55). Where the client may have contributed to the losses, he shall be required to bear that part of the loss (Article 53).

BURDEN OF PROOF

Consistent with Article 9 of the 1995 Notes, the Provisions require futures brokerages to bear the burden of proof as to whether a client's order/instruction had been effected into the market for trading purposes (Article 56). However, the Provisions go on to provide details as to how the burden can be discharged: the futures brokerage need only produce the transaction records of the futures exchange and the settlement results notified by the futures brokerage to see if they are consistent with the client's instructions (Article 56).

Both a futures exchange and a futures brokerage bear the burden of proving that they had sent margin calls to the futures brokerage and client, respectively (Article 57).

CONCLUSION

The Provisions reflect a desire to focus on the trades underlying the futures market, in contrast with the previous focus on regulating the industry. The reliance on Chinese Contract Law demonstrates that the SPC is prepared to ensure that contractual principles achieve general application in other areas of law, while at the same time maintaining a balance between the interests of futures brokerages and their clients.

The author gratefully acknowledges the assistance of Mr Li Qian Yi for his input on this article.