Principal legal risks faced by asset management institutions

By Sherry Ma, Co-effort Law Firm

The incidence of asset management institution (AMI) risk events has been frequent in recent years, with many seemingly flourishing AMIs suffering a major setback on their path to growth. This column proposes to take a look at the principal legal risks faced by AMIs and makes suggestions of reasonable risk prevention measures for AMIs.


Offer promotion risks. It is extremely easy for AMIs to violate laws or regulations when raising funds. Taking private funds as an example, pursuant to the Administrative Measures for the Offering Activities of Private Investment Funds, when a private fund institution is making an offering, it is required to complete a number of procedures, such as confirmation of the specific targets, fund risk rating, investors suitability review and matching, risk warning, check of the lawfulness of the fund sources, qualified investor confirmation, etc., and failure to complete any of them can result in the assessment of penalties by the administrative or regulatory authorities. If investors are caused to incur a loss as a result thereof, the AMI may be liable for damages, and if there is a suspicion of taking deposits from people illegally, a criminal offence may even be constituted.

马晨光 协力律师事务所 高级合伙人
Managing Partner
Co-effort Law Firm

In practice, cases of penalties imposed for violating laws or regulations in the promotion of offerings are becoming more and more frequent, and large private offerers have not be exempted. For example, when Shaanxi Jinkaihong Investment Management was selling units of a limited partnership fund to investors, an investor had a third party subscribe for the fund on his behalf in the amount of RMB300,000 (US$45,187.5) and the manager, despite being well aware that his initial investment amount was less than RMB1 million, disqualifying him as an investor, nevertheless sold him the fund, for which it was assessed the maximum penalty by the CSRC.

Contract review risk. The asset management acts of AMIs comprise various contracts and transactions. Many AMIs lack the prudent design and practical study and assessment of contract terms, resulting in invalid contracts or disputes, causing them to incur a loss. Taking valuation adjustment mechanisms as an example, little attention was paid to the issue of the valuation adjustment entities before Haifu v Shiheng. In that case, it was precisely the past negligence of this issue that resulted in the valuation adjustment clause agreed between the investor and the target company being found to be invalid as it harmed the interests of other shareholders and creditors, resulting in an investment loss. Furthermore, fund investor rights clauses, minimum guaranteed return clauses, entrusted fund unit holding agreements, etc. have arisen in large numbers and with great frequency in the asset management industry and, with the appearance of relevant penalties and judicial precedents, the risks inherent in such clauses have progressively come to light. This should awaken AMIs to the importance of reviewing contract terms.

Mismanagement risk. The core of asset management is “management”, and management risks include the risk of diversion of funds, risk of erroneous instructions, misallocation risk, etc. The most frequent of such risks is management liability risk in channel business. Generally speaking, “channel business” means asset management business in which the investment targets, property management, allocation methods, due diligence, etc. are determined by the investors at their own discretion and the manager does not bear active management duties. Channel business are warmly welcomed by AMIs as the management responsibilities therein are minimal. However, the risks to AMIs in channel business are not completely nonexistent, and as AMIs generally do not conduct due diligence in such business, there are major risks of violations of regulations inherent therein. Once a risk event arises, a collective attack by investors could arise or even the imposition of administrative penalties by the regulators could occur, tarnishing the AMI’s reputation.


Regulatory trends and regular self-reviews. In recent years, deleveraging, substance over form and looked-through supervision have been the major trends in financial regulation, and the penalties imposed by the administrative authorities have mainly revolved around these issues. Accordingly, it is imperative for AMIs to closely track regulatory trends, and regularly conduct self-reviews to minimize the risks of violating regulations. For example, AMIs should carry out looked-through checks of the sources of investors’ funds, when determining qualified investors they should conduct looked-through determination and combined calculation, and in nested investments, they need to verify the compliance of the underlying assets. Attention also needs to be given to the training and management of working personnel, and exercising appropriate supervision over such personnel so as to avoid their operating in an illegal manner and triggering risks.

Evaluating risks and heeding compliance advice. In the asset management industry, over-emphasis on performance and business guidance are common, making the neglect of compliance risks more likely. To minimize risks, a contract should be submitted to the compliance risk control department for evaluation and verification before execution and the comments of the compliance department should be heeded. Reviews of contract risk mainly involve such issues as lawfulness, compliance, validity, clarity of expression, unity of rights and obligations, etc. The issues that need to be considered include whether approval is required for an asset transfer by an enterprise with state investment, the approvals of which authorities are required for investments abroad, whether the provisions of the valuation adjustment mechanism are lawful and valid, etc.

Establishment of an active management awareness, prudent engagement in channel business. With a view to reducing management risks, an AMI should strictly comply with specified requirements, faithfully and diligently perform its management obligations, notify investors when a risk could arise and promptly stop losses. In the present where financial regulation is trending toward “channel elimination”, AMIs need to act prudently when engaging in channel business. Where there is a genuine need to engage in channel business, (1) the rights and obligations of each party need to be clearly specified in the relevant contracts; (2) the risks need to be fully explained and disclosed to investors; (3) basic due diligence needs to be duly carried out so as to arrive at a basic understanding of the targets of investments and the sources of funds; (4) appropriate monitoring of the leading party and the investment targets needs to be duly effected; and (5) cooperation needs to be offered to investors when they seek recovery after a risk arises.

Sherry Ma is the managing partner of Co-effort Law Firm



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