Just as asset management products are growing in diversity, so too are disputes over them: from those between investors and managers on the “capital end”, managers and counterparties on the “asset end”, and disputes arising from the “nested structure” of asset management products.
Some disputes have been resolved or alleviated by means of reconciliation and debt restructuring, and some by litigation and arbitration. But there have also been some projects that have had to go into bankruptcy. This article focuses on the five major evolving trends seen in these disputes in the past two years.
How courts approach “capital end” cases is clearer and more in tune with regulations
Investors and their fund managers not only establish a contractual relationship, but also a fiduciary relationship.
Previously laws were too stringent with regard to fiduciary duties, and asset management products had strong financial attributes and a high investment threshold.
This meant few reached the courts, and there was a lack of good judgments for reference. Judges also had different understandings of the fiduciary relationship, and the adjudicative approaches to capital end cases were not very clear.
In November 2019, the Supreme People’s Court issued the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts, echoing the regulatory policies of “strengthening the protection of financial consumers” and “breaking the prevalent practice of bailouts”. Since then, the courts have gradually clarified and unified their approaches on trying such cases. Arbitration institutions have also often referred to the principles set out in the minutes in order to make awards.
For example, there was no legal definition for bailouts of shadow banks, and the regulatory policy of prohibiting them was only clarified in a piecemeal fashion over time as it became clear this lack of clarity would have severe consequences. The minutes addressed the regulatory policy, making clear what constitutes an “invalid bailout”, and explaining its illegality. Since then, some courts and arbitration institutions have determined that the bailout commitment provided by managers to investors is invalid.
Regulatory protections have been strengthened, closing loopholes for sellers to avoid liability
With the deepening of regulatory concepts – such as the obligation to ensure a product’s suitability for a client, “the seller performing its duties and the buyer being at its own risk” and “trustees shall scrupulously perform their duties” – courts and arbitrators can focus on whether the seller is diligent and conscientious enough. If the seller fails to fulfill its fiduciary and effective management obligations, it shall bear the liability for compensation.
For example, if an investor holds a product that has no realistic possibility of recovering funds, but cannot be liquidated due to contractual agreements, managers have in the past argued that because no book loss has been realised there should be no compensation due. However, based on the judgments from the most recent trials, even if the investor has not suffered actual losses due this so-called stalemate, courts may still judge the proportion of the seller’s responsibility based on the principle of fairness and the seller’s level of conscientiousness, and require the seller to bear the responsibility in proportion after actual losses are found by court (sometimes from a separate case) to occur.
Diversity in both the types of products and disputes on the “asset end”
“Asset end” disputes include not only the traditional ones over creditors’ rights, equity or but also new forms. For example, due to the increase in bond defaults, there have been cases in which the manager files a lawsuit for bond infringement and default on behalf of the asset management products. For fund-of-funds (FOF) structures, upper-level managers may hold the lower-level managers liable to safeguard the interests of the upper-level funds and their investors.
The “asset end” disposal chain is getting longer
In multiple or mass defaults, the complexity of the situation is likely to mean that the outcome of an individual case will not be the end of the matter – managers would have to take part in the bankruptcy reorganisation or liquidation on behalf of the asset management products.
In this process, some conundrums emerge, including whether the rights of representatives of asset management products are equity or creditors’ rights, whether the relevant rights are special or prioritised, and how to restructure debts in the form of so-called special assets. If the manager does not have knowledge and experience of reorganisation, liquidation and investment in non-performing assets, these problems can prove difficult to address.
Judgment rules only got us so far, and some problems now urgently need to be solved
While the establishment of the judgment rules helped clarify some initial problems, more detailed and complex issues have emerged over time. These include: (1) whether a manager should bear the liability for compensation to the investors after a bailout is found to be invalid; (2) what are the compensation rules for fund pool products; (3) how is it determined whether the duty of care of upper-level managers in FOF and trust-of-trusts structures is fulfilled?; (4) how is the boundary of fiduciary duty of the manager determined if the investment of the standard product mainly relies on such tools as big data and artificial intelligence to make decisions?; and (5) how can managers prove their innocence due to a shift in the burden of proof?
Led by regulatory policies, the development of society, the economy and the rule of law, shadow banks that mainly undertook the “function of financing” have gradually evolved into “wealth management institutions” with stronger underlying foundations, showing an evident trend towards investment banking. For asset management products, regulatory policies, the industry environment, investors and the thinking behind judgments are all changing, and the only constant is the change itself.