Analysis of ‘risk fund’ system of financial institutions

By Shen Minquan and Chen Liang, Jingtian & Gongcheng
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The remuneration system of financial institutions is very particular to the industry. In practice, a certain number of financial institutions divide employees’ remuneration into two parts, fixed and variable, based on the Regulatory Guidelines for Stability of Remuneration in Commercial Banks (Yin Jian Fa [2010] No. 14) formulated by the former China Banking Regulatory Commission, and allocate a portion of the variable remuneration to a “risk fund”, which is then paid on a deferred basis.

沈敏泉, Shen Minquan, Partner, Jingtian & Gongcheng
Shen Minquan
Partner
Jingtian & Gongcheng

If the project being handled by an employee during this period triggers a risk, the financial institution will make a deduction from the risk fund according to the circumstances. This article briefly analyses the disputes that can easily arise from this risk fund system, in the hopes of providing food for thought to financial institutions when they formulate and apply the risk fund system.

First, pursuant to the CBRC guidelines, the remuneration paid by financial institutions consists of fixed remuneration, variable remuneration (performance pay and medium and long-term incentives) and welfare income. The most significant differences with the remuneration system of the average enterprise are that the medium and long-term incentives are subject to a lock-up period, the length of which depends on the duration of the corresponding risk, but is at least three years, and the release of which is subject to the consent of the board of directors.

Second, with the exception of the above-mentioned guidelines, current laws are silent on risk funds. As for judicial practice, the courts will regularly conduct their reviews of the risk fund system by focusing on the following key issues:

Was the formulation procedure lawful?

As a risk fund involves the immediate interests of an employee, it is required to be formulated by way of a democratic procedure, and announced to the employees, in order to satisfy the requirements of article 4 of the Employment Contract Law on the procedures for the formulation of rules and regulations.

Is it legal for a financial institution to make a deduction from an employee’s risk fund on the grounds that a project triggered a risk?

The courts will usually assess this issue by taking into account such specific circumstances as the conditions set by the financial institution for paying the risk fund, the risks associated with the project in question, and the connection between the risk that arose and the employee’s acts. However, in terms of discretion, differences exist between different courts.

For example, in the labour dispute of Liu Teng v China Jingu International Trust, the Second Intermediate People’s Court of Beijing Municipality held that the purpose of the risk reserve was to counter project risks, and the amount deducted in connection with performance was a potential benefit subject to a certain period and conditions, not one that was inevitably paid. Furthermore, the relevant project loss occurred within the lock-up period of the risk fund. Accordingly, when the loss in the project arose, it was natural that the project loss be deducted from the risk fund.

陈靓, Chen Liang, Associate, Jingtian & Gongcheng
Chen Liang
Associate
Jingtian & Gongcheng

However, in the employment contract dispute of Zhejiang Chouzhou Commercial Bank, Wuhan Sub-branch v Xu Chong, the Jinhua Municipal Intermediate People’s Court had a different view, holding that the emergence of risk assets was a business risk commonly faced by banks, the shifting by the bank of such risks onto the employee infringed his lawful rights and interests, and, in the absence of sufficient evidence showing that the overdue interest, etc., was caused by serious mistakes of the employee, it was clearly unfair to dump all of the responsibility on the employee and require him to bear the risk liability.

Is deferred payment of the risk fund applicable to an employee who has left the company?

In judicial precedents, whether an employee is currently employed by the employer or not is usually not a precondition for the payment of the risk fund, and there is no absolute link between payment of the risk fund and whether the employment relationship was lawfully terminated.

For example, in an employment contract dispute of Xiamen International Bank, Shanghai Branch v Luo Boshun, the Second Intermediate People’s Court of Shanghai Municipality recognised that whereas Xiamen Bank had the right to dismiss the employee for a serious breach of discipline, it nonetheless held a positive attitude toward the deferred payment by the bank of the employee’s performance wages for the period when he was in its employ, holding that although, pursuant to the Interim Provisions for the Payment of Wages, an employer is required settle in full the wages of an employee in one lump sum when terminating the employment relationship with him or her, nevertheless, pursuant to the Supplementary Provisions on Relevant Issues in the Interim Provisions for the Payment of Wages, the same may be adjusted under special circumstances, but doing so does not constitute a reduced payment of wages.

In the labour dispute of Wu Zheng v Bank of Hangzhou, the People’s Court of Xihu District, Hangzhou expressed a similar view, finding, on the one hand, that the employment contract was lawfully terminated for serious breach of discipline by the employee, while on the other hand that the deferred payment of performance remuneration likewise applied to a departed employee. Accordingly, as the Bank of Hangzhou failed to show that it ought to recover or claw back the employee’s performance pay, and was required to pay the performance pay that had fallen due.

Conclusion

Taking into consideration the guidelines and judicial precedents, a financial institution should pay attention to the following when formulating a risk fund or other such remuneration system: (1) that it be in keeping with the democratic and announcement procedures; (2) before making a deduction from the risk fund, it needs to fully assess the link between the risk triggered in the project and the acts of the employee; and (3) that deferred payment of the risk fund is usually not contingent on the employee being currently in service with the employer, and if the conditions for the payment are satisfied, it should be paid in a timely manner.

Shen Minquan is a partner and Chen Liang is an associate at Jingtian & Gongcheng

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