Docvit Research | The Effectiveness of Channel Business – Interpretation of the Latest Judicial Rules

Source: Beijing DOCVIT Law Firm  Time: 2019-08-28 16:14:08  Author: Dispute resolution team

Abstract: As The Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (YF [2018] No. 106) jointly issued by the People’s Bank of China, China Banking and Insurance Regulatory Commission, China Securities Regulatory Commission and State Administration of Foreign Exchange was introduced on April 27, 2018, the channel business has been increasingly strictly supervised. The channel business cannot penetrate into the underlying assets as the business chain is too long; thus, it is difficult to control its potential risks. Utilizing the trust channel to cover the risk essence may be involved at the time of carrying out such business; thus, the disputes on whether it should be invalid as it covers the illegal purpose in the legitimate form have been widely reported. Article 93 of The Minutes of Meetings on the Civil and Commercial Trial Work of the National Courts (Draft for Comments) clearly defines the effectiveness of channel business within the transitional period of the implementation of the new regulations on asset management, and the basic spirit of the Minutes of Meetings conforms to the consistent judgment though of the Supreme Court. 

I. What is the channel business? 

The Notice on the Matters Concerning Clearing up and Regulating the Channel Business of Insurance Asset Management Companies (BJZJ [2016] No. 98) issued by CIRC completely defines the channel business for the first time. According to this Notice, the business, such as the bank deposit channel refers to all kinds of businesses carried out before the date of releasing this Notice, with the capital sources and investment objects determined by the institutions, such as commercial banks, and in such business, the insurance asset management companies accept the entrustment of the institutions, such as commercial banks in the forms like establishing the asset management plans to carry out the investments, such as the bank agreement deposits according to their aspirations, and in their entrustment contracts, it shall be specified that the insurance asset management companies shall not undertake the active management responsibilities and that the Client shall assume the investment risks. 

Recently, the first half of Article 93 of The Minutes of Meetings on the Civil and Commercial Trial Work of the National Courts (Draft for Comments) has also defined the channel business: The parties agree in the trust documents that the Client shall independently decide the matters, such as trust establishment, the objects where the trust property is used and the management, utilization and disposal modes of trust property and shall assume the trust risks independently and the Trustee shall provide the necessary affair assistance or service and shall not undertake the trust property management responsibilities, which shall be affirmed as the affair trust or channel business. 

To sum up the definitions above, in the channel business, generally, the institutions, such as the commercial banks act as the Client; the entrusted property is the funds or property and property rights, and the channel institutions as the third party are the Trustee, and one or more levels of asset management plans, trust and other asset management products will be established at this moment. In this transaction structure, with the limited discretion, the Trustee manages and uses the assets mainly according to the Client’s instructions or aspirations. The core of such channel business lies in that the funds and assets and their applications are usually designated by the Client; the channel institutions as the Trustee only carry out the passive management, and the Client essentially assumes various risks, such as the credit risk generated in the transactions. 

II. Affirmation of the effectiveness of channel business 

The channel business is generated in the most cases that the Client is restricted by the regulatory rules and cannot directly implement the asset management, so it shall avoid the supervision and achieve the investment purposes though a third-party channel institution. Just for this reasons, as the regulatory rules become increasingly strict and especially the new regulations on asset management have been released, the effectiveness of channel business is in dispute. The second half of Article 93 of The Minutes of Meetings on the Civil and Commercial Trial Work of the National Courts (Draft for Comments) has defined the effectiveness of the channel business: Article 22 of The Guiding Opinions on Regulating the Asset Management Business of Financial Institutions has also clearly set the transitional period to the end of 2020 in accordance with the principle of that “the company for initial public offering does not distinguish the circulation stock and non-circulation stock after equity division reform” to ensure the smooth transition while stipulating that “the financial institutions shall not provide the channel services to avoid the regulatory requirements, such as the investment scope and leverage constraints for the asset management products of other financial institutions. Within the transitional period, if there is no other violations of mandatory provisions of laws and administrative regulations in the channel business where the trust channel is utilized to cover the risk essence and to avoid the regulatory provisions, such as capital investment direction, asset classification, provision and withdrawing, and capital occupation or the assets in the table are falsely moved out of the table through the trust channel, a party’s claim that the purpose of trust violates the laws and regulations shall be confirmed as invalid cause of action, and the people’s court will not support it. The division of responsibilities between the Client and the Trustee shall be handled according to the agreement in the trust documents. 

According to this provision, the judgment rule on judging the effectiveness of the channel business lies in whether there are other violations of mandatory provisions of the laws and administrative regulations at the time of carrying out the channel business. This provision seems to indicate that within the transitional period, if in the channel business, the trust channel is utilized to cover the risk essence and to avoid the regulatory provisions, such as capital investment direction, asset classification, provision and withdrawing, and capital occupation or the assets in the table are falsely moved out of the table through the trust channel, the people’s court shall not affirm it as invalid. 

III. The courts’ judgment viewpoints on the effectiveness of the channel business 

1. Case guidance: (2016) ZGFMZ No. 215 

In this case, the plaintiff was Nanchang Rural Commercial Bank Co., Ltd. (hereinafter referred to as Nanchang Rural Commercial Bank); the defendants were Bank of Inner Mongolia Co., Ltd. (hereinafter referred to as Bank of Inner Mongolia) and Minsheng Securities Investment Co., Ltd. (hereinafter referred to as Minsheng Investment Company), and Minsheng Securities Joint-Stock Co., Ltd. (hereinafter referred to as Minsheng Joint-stock Company) acted as the third party. In June 2013, the party not involved in the case, Huazhu Shoe Company issued “13 Huazhu Private Placement Bond” in the scale of RMB 80,000,000, which was subscribed by Minsheng Investment Company. Minsheng Investment Company transferred the right of earnings to Minsheng Securities after its subscription, and Minsheng Securities established “Minsheng No. 12 Directed Asset Management Plan” with it. Bank of Inner Mongolia was the entrusted investor, and it transferred the right of earnings of this asset management plan to Nanchang Rural Commercial Bank, that is, Nanchang Rural Commercial Bank was the final contributor of this private placement bond. A series of default problems were triggered subsequently due to the expiration and default of the private placement bond. 

Finally, Nanchang Rural Commercial Bank filed the lawsuit with Bank of Inner Mongolia as the defendant, requiring to confirm that The Agreement on the Transfer of Right of Earnings of Directed Asset Management Plan signed by this bank and Bank of Inner Mongolia should be invalid, to confirm that this bank’s factual legal relationship of bond “transaction by lending account” should be invalid and to return the principal of RMB 80,000,000 and the corresponding expenses and interest. The claims of Nanchang Rural Commercial Bank in this case were rejected in the first instance of Jiangxi Provincial High Court and in the second instance of the Supreme People’s Court successively. The Agreement on the Transfer of Right of Earnings of Directed Asset Management Plan signed by Nanchang Rural Commercial Bank and Bank of Inner Mongolia was affirmed as valid, and Bank of Inner Mongolia as the channel party was judged not to assume any responsibility. 

Notwithstanding in the judgment, the Supreme Court pointed out that: On April 27, 2018, the People’s Bank of China, China Banking and Insurance Regulatory Commission, China Securities Regulatory Commission and State Administration of Foreign Exchange jointly issued The Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (YF [2018] No. 106), putting forward specific normative requirements for financial institutions' asset management business. From the perspective of such new regulatory regulations, the regulatory departments have implemented the penetrating supervision of the asset management business of financial institutions and have prohibited the implementation of multi-layer nesting and channel business. However, the circumstance of extending the capital chain and increasing the complexity of products was indeed involved in the transaction mode of the parties in this Case, which may result in that the regulatory departments cannot monitor the final investor and have difficulty in implementing the penetrating inspection on the transaction risks, so it did not meet the requirements of the new regulatory regulations. Therefore, the parties in this Case shall carry out the business in a standardized way strictly according to the new regulations on asset management in future. But it did not deny the effectiveness of channel business. Such judgment thought was consistent with The Minutes of Meetings on the Civil and Commercial Trial Work of the National Courts (Draft for Comments). 

2. The Supreme Court (2015) MEZ Zi No. 401 

In this case, the plaintiff was China Everbright Xinglong Trust Co., Ltd. (hereinafter referred to as: China Everbright Xinglong Trust), and the defendant was Beijing Peking University High-tech Industry Investment Co., Ltd. (hereinafter referred to as: Peking University High-tech Company). On October 9, 2011, China Everbright Xinglong Trust and Peking University High-tech Company signed The Loan Contract for Trust Funds, agreeing that China Everbright Xinglong Trust would issue a trust loan of RMB 280,000,000 to Peking University High-tech Company. On October 11, 2011, China Everbright Xinglong Trust issued a trust loan of RMB 280,000,000 to Peking University High-tech Company in lump sum as agreed. On October 9, 2011, Lingrui Company signed GXJBZ Zi [2011] No. 010 Trust Fund Guarantee Contract with China Everbright Xinglong Trust. On October 9, 2011, Beijing Tianqiao Company signed GXJD Zi [2011] No. 041 Trust Fund Mortgage Contract with China Everbright Xinglong Trust. On October 10, 2013, the loan above was due, but Peking University High-tech Company only repaid the interest of the loan in this Case as of October 10, 2013 to China Everbright Xinglong Trust and has not paid off the principal of loan in this Case and the overdue interest after October 10, 2013; thus, the litigation of this Case was formed. 

The court thought whether The Single Fund Trust Contract and The Loan Contract for Trust Funds should be invalid due to the circumstance of covering the illegal purpose in the legal form. The court ascertained that both the annual interest rate and overdue repayment interest rate of the loan did not exceed the upper limit of interest permitted by law. In this case, China Everbright Xinglong Trust neither actively managed the trust property nor assume the essential business risks. Therefore, the trust loan involved in this Case was the banking channel business. The banking channel business is also involved in the problems, such as avoiding regulation and macro control in some business while meeting the investment and financing demands of the residents and enterprises. According to the current national financial regulatory principles, the financial institutions shall not provide the channel services to avoid the regulatory requirements, such as investment scope and leverage constraints for the asset management products of other financial institutions. However, the trust loan involved in this Case occurred in 2011; thus, it belongs to the stock banking channel business before the implementation of the financial regulatory policy above. For such stock business, according to the provision of Article 29 of The Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (YF [2018] No. 106), in order to reduce the stock risk, the transitional period is set to the end of 2020 according to the principle of that “the company for initial public offering does not distinguish the circulation stock and non-circulation stock after equity division reform” to ensure the smooth transition. Accordingly, The Single Fund Trust Contract and The Loan Contract for Trust Funds are the declaration of true intention of all parties in the Case, and don’t violate the mandatory provisions of laws and administrative regulations, so the appeal of the invalid contract of Peking University High-tech Company is not supported by law. The effectiveness of channel business was not denied by the Supreme Court. Such judgment thought was also consistent with the spirit of The Minutes of Meetings on the Civil and Commercial Trial Work of the National Courts (Draft for Comments). 

IV. Summary 

The above legal analysis shows that the supervision provisions that the risk essence is covered and the fund investment orientation is avoided by trust channel in the channel business, or trust service that the assets in the balance sheet are falsely transferred out by trust channel within the transitional period of new provision of assets management shall not be affirmed to be invalid if there are no other circumstances which violate the mandatory provisions of laws and administrative regulations. But how to judge the effectiveness of the channel business after transitional period? Article 29 “Invalidity in case of violation of public order” of The Minutes of Meetings on the Civil and Commercial Trial Work of the National Courts (Draft for Comments) stipulates that: The contract which violates the regulations, supervisory policy and other normative documents shall not be affirmed to be invalid. If the contract violates the regulations and supervisory policy and public order, the People’s Court shall affirm it invalid. When the People’s Court affirms whether it violates the public order, it can consider it from the normative content, supervision strength, legal consequence and other aspects, and fully explain the reason in the judgment document. It can be seen that the channel business will be further restricted after the end of transitional period, and it may be affirmed to be invalid due to violation of public order.

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