Responsibility boundary among asset management players

By Ma Chenguang, Co-effort Law Firm

Asset management business disputes have shown an explosive trend since the start of 2018. The number of cases has grown explosively, the amounts involved have been huge and the legal relationships are complex.

Ma Chenguang
Co-effort Law Firm
Senior Partner

Among the numerous disputes regarding asset management business, the boundary dividing the responsibilities of the various entities has been the most crucial and fundamental. As the higher level legislation governing such business in China has yet to be unified, the level of many current rules is quite low, and the laws applicable to various asset management products overlap, this had led to a lack of clarity in the boundary dividing the responsibilities of managers and investors, managers and custodians, and of the various entities involved in the channel business, and a lack of uniformity in the criteria of judicial judgments.

Boundary dividing manager and investor. “Buyer bears liability himself, and the seller duly performs its responsibilities” are the essential attributes of the asset management business. In the legal relationships of asset management, the boundary dividing the responsibilities of the manager and the investor is the flash point of controversies and disputes. This is particularly manifest in such issues as the investor suitability obligation, the investor’s right to know and the determination of the nature of principal and return guarantee.

At the heart of the investor suitability obligation is the prohibition on asset management firms against recommending high-risk products to investors of low risk-bearing capacity, where there is a mismatch between the risks and their capacity. If the investor suitability obligation is breached, how is liability to be apportioned between the asset management firm and the investor? Are market factors to be taken into consideration? Different perspectives on these questions exist in practice.

The author reckons that if the investor is professional and willing to take on the risk, then, when he or she invests in a risk mismatched product, the investor suitability obligation of the fund offering firm should be suitably exempted to avoid investors’ claims in bad faith. However, when the investor is not a professional investor, more consideration may be taken in the matter of the manager’s liability.

With respect to disputes involving the investor’s right to know, the upsurge in the development of asset management has given rise to the topic of the conflict between the investor’s right to know and the manager’s right to operate at its own discretion. As the form of managed products varies, the scope and requirements in respect of information disclosure also differ, and in some cases, even the level of effectiveness of the legislation by which they are governed also differs. Under current circumstances, most judgments can at best only be made on the basis of current and effective legislation of higher level.

At the heart of disputes over principal and return guarantees is the issue of their validity. In practice, courts will generally deny the validity of principal and return guarantee clauses where the trustee is a specific financial institution. Furthermore, as a principal and return guarantee clause constitutes a core clause in an asset management contract, the validity of the entire contract will be called into question.

If the trustee is a natural person or a non-financial entity, a reasonable principal and return guarantee clause will generally be found to be valid, but a grey area exists between the above-mentioned situation and the illegal fund raising. Furthermore, professional lenders and non-financial entities whose main business is lending also exist in the market, and determining the validity of a contract in such a circumstance is also a problem. If such a contract is found invalid, then the guarantee measures arising as a result are also usually invalid, but if the contract is directly characterized as a loan, then not only the interest but also guarantee measures will be protected.

Boundary dividing manager and custodian. Generally speaking, the following boundaries should exist between the responsibilities of the custodian and the manager: (1) the custodian is required to resolutely stand on its independent third-party position, abide by the spirit of the contract, and adhere to its fiduciary duty; (2) an area of ambiguity around the boundary dividing their obligations requires further clarification; and (3) management and custody shall be distinguished, particularly the management responsibility if the manager absconds; if the custodian is required to take on the responsibilities when the manager absconds, a serious mismatch will arise between the custodian’s benefits and responsibilities, with the adverse consequences potentially falling on the investors in the end.

Accordingly, the relevant authorities could consider providing more detail in the guiding measures for risk resolution. In a situation of losing contact, the original intent of the management and custodial duties needs to be distinguished so as to avoid the substitution of management responsibilities with custodial responsibilities.

Boundary dividing the various entities involved in channel business. In channel business, there is the fund end, the principal, the manager and the underlying assets. In practice, the most common points of dispute are whether the investors may demand that the manager bears liability, whether they can assert the invalidity of the contract, whether they can exercise the principal’s rights based on the contract between the principal and the manager, etc.

The second point of dispute in channel business is whether the boundary dividing the responsibilities of the principal and the manager is a trust relationship or an appointment relationship. The Supreme People’s Court has found it to be a trust relationship, but this conflicts with taking the provisions of the contract as the prioritized handling basis.

The third point of dispute is the boundary dividing the responsibilities of the manager and the underlying assets; can the manager be exempted from liability on the basis of the channel contract? With respect to this question, the conclusion in judicial circles is that the contract is governed under the doctrine of privity, and the manager’s liability cannot be exempted because of the channel.

The overall trend displayed by the channel business is declining, but the lack of clarity in the division of responsibilities has buried risks in the large volume of channel business that previously existed. For the asset management business to grow steadily and over the long term, further strengthening of legislation and top-level design are needed to make regulatory rules more uniform, the asset management industry more predictable, lawyers’ opinions more definitive, and judges’ judgments fairer.

Ma Chenguang is a senior partner at Co-effort Law Firm


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