[Abstract]
It is not improper for a futures firm to issue a margin call without force-liquidating a client’s position when the client’s risk ratio at the firm goes beyond 100% but that at the exchange is still under 100%. Client margin falling to zero should be the latest point at which a futures firm should carry out forced liquidation. Where a client’s risk ratio at the exchange reaches 100%, if the futures firm, having fulfilled its notification obligations and given the client a reasonable amount of time to take corrective actions, attempts forced liquidation but fails to close out the positions due to market conditions, the resulting losses exceeding the margin should be borne by the client.
[Keywords]
Forced liquidation; client risk ratio at futures firm; client risk ratio at exchange; losses exceeding the margin
Plaintiff: Everbright Futures Co., Ltd., domiciled in China (Shanghai) Pilot Free Trade Zone.
Legal Representative: Yu X Wei, General Manager.
Defendant: Bao X Ming.
Everbright Futures Co., Ltd. (“EBF”) alleged that: on June 21, 2018, Bao entered into a Natural Person Futures Brokerage Contract with EBF. On September 3, 2019, because Bao had failed to either timely satisfy the margin call or voluntarily reduce his positions in accordance with the futures brokerage contract and EBF’s notification, EBF force-liquidated his positions. After settlement, Bao’s account balance became negative, resulting in losses exceeding the margin of RMB 1,439,790.85, which was covered by EBF with its own funds; Bao should therefore be ordered to compensate EBF for the advance.
Bao argued that: at the opening of the market on August 30, 2019, his account’s risk ratio was already higher than 100%. EBF should have fulfilled its obligation of forced liquidation after EBF had notified Bao to dispose of his positions but Bao failed to do so. The losses exceeding the margin were caused by EBF’s postponed forced liquidation, and thus should be shared by both parties in proportion to their comparative fault.
During the trial, the Shanghai Financial Court (the “Court”) found the following facts:
On June 21, 2018, EBF and Bao signed the Natural Person Futures Brokerage Contract, agreeing: in Article 42 thereof that the risk ratio (“RR”) shall be calculated as: RR = client’s maintenance margin / client’s equity ×100%; and in Article 44 thereof that, if the RR exceeds 100% at settlement following market close, EBF will issue a margin call and a forced liquidation warning to Bao and Bao should meet the margin call within the prescribed period of time, or EBF would be entitled to force-liquidate part or all of Bao’s positions held under his futures account until his available balance reaches or exceeds zero, with all consequences of such forced liquidation to be borne by Bao.
Bao held 171 lots of ni1910 contract. At the end-of-day settlement on August 29, 2019, Bao’s RR at the futures firm (the “Futures Firm RR”) was 104.69% and his RR at the exchange (the “Exchange RR”) was 83.75%. Bao made a deposit of RMB 300,000 that evening. Despite this deposit, at market opening on August 30, 2019, Bao’s Futures Firm RR was still higher than 100%, while the Exchange RR remained under 100%. As the Exchange RR reached 100.21% at 2:41 p.m. on August 30, 2019, EBF issued a margin call to Bao and phoned him about this matter at around 2:56 p.m. During the call, Bao requested he be allowed to see how the night session would go before further actions. At end-of-day settlement on that day, Bao’s Futures Firm RR rose to 134.08%, the Exchange RR to 111.73%, and the client’s equity was RMB 1,972,736.45. After close of the day session on that day, EBF notified Bao multiple times that additional funds must be deposited or EBF would be entitled to carry out forced liquidation. At 9:00:20 p.m. on August 30, 2019, EBF tried to force-liquidate the 121 lots of the ni1910 contract held in Bao’s account but failed to do so because the contract was kept at the price limit during the night session that day and throughout the day session on September 2, 2019. At end-of-day settlement on September 2, 2019, the Futures Firm RR hit 753.78% and the Exchange RR 394.84%, while the client’s equity fell to RMB 650,906.45. EBF called Bao, who then agreed that all 171 lots of ni1910 contract be sold during the call auction of that day’s night session. At 8:55:00 p.m. on September 2, 2019, EBF closed out all 171 lots of ni1910 contract in Bao’s account for RMB 148,850. According to the settlement statement for September 3, 2019, Bao had then in his account an available balance of RMB -1,439,790.85, a loss from liquidation of RMB -2,089,620, and an equity of RMB -1,439,790.85.
During the trial, the parties confirmed that the RR specified in the Futures Brokerage Contract referred to the Futures Firm RR.
Through the trial of the first instance, the Court held that the parties in this case had no disagreement on the conditions for forced liquidation, but disagreed on: (1) whether a futures firm should conduct forced liquidation when the Futures Firm RR exceeds 100% while the Exchange RR stays under 100%; (2) which party should bear the losses in this case, given that they are losses exceeding the margin (i.e., original equity capital) rather than mere losses of the original equity capital.
Futures firms act as brokers for their clients and are not a party to clients’ futures transactions. They have the responsibility to execute trades in strict accordance with client instructions but not the right to dispose of client properties. The law vests futures firms the power of forced liquidation so that they can ensure the safety of their own funds when they have to make advances for client trades. To avoid drawing on their own funds for such advances, futures firms often establish stricter margin requirements than those set by the exchange in light of such factors as market risks, product volatility, and the price limits and circuit breakers implemented by the exchange. Because of their higher margin requirements, futures firms do not have to immediately advance their own funds when a client’s Futures Firm RR exceeds 100%, but only when the Exchange RR hit 100%. Also, the futures brokerage contract entered into by the parties only entitles, rather than obligates, EBF to execute forced liquidation once the Futures Firm RR goes beyond 100%. Therefore, that EBF did not carry out forced liquidation when the Futures Firm RR exceeded 100% while the Exchange RR had not, does not constitute a violation of the law or a breach of the contract between the parties.
Although futures firms have the legal right to execute forced liquidation, such right is not without limitations. It is stipulated in Article 33(2) of the Provisions of the Supreme People’s Court on Issues Concerning the Trial of Futures Dispute Cases that: where a futures firm has duly notified its client of insufficient trade margin balance but the client fails to make additional deposit in a timely manner, if the client requests to maintain the positions and a written agreement is reached, the client shall bear the losses incurred during the maintenance of positions and the futures firm shall bear any losses in excess of the margin deposited by the client. Hence, according to this provision, client margin falling to zero should be the lowest (i.e., “at the latest”) triggering condition for a futures firm to carry out forced liquidation. If this forced liquidation is not performed after the client fails to deposit additional funds or reduce positions in time after receiving the margin call, the futures firm should be deemed to have allowed client to trade with insufficient margin and to have indirectly offered its client financing support, in violation of applicable regulations. Moreover, if client margin balance falls below zero in such a case, the losses arising therefrom should be borne by the futures firm and the client.
This case is different. According to the facts found during the trial, EBF placed orders during the night session on August 30, 2019 to force-liquidate Bao’s positions, after notifying Bao that his Exchange RR exceeded 100% at 2:41 p.m. that day due to major price fluctuation in the contract he held and giving him a reasonable amount of time for closing the positions at his own initiative. EBF did not act improperly here. However, because the fast-worsening market conditions had drained Bao’s contracts of their liquidity, EBF’s liquidation orders could not be executed until the night session on September 2, 2019, when the losses incurred already exceeded the margin in Bao’s account. In this present case, EBF did not violate mandatory regulations by indirectly providing financing to its client and allowing him to trade with insufficient margin. The principle of allocating liability in proportion to fault would also absolve EBF from bearing the losses exceeding the margin due to changing futures market conditions.
In summary, EBF demands Bao to repay the RMB 1,439,790.85 it had advanced Bao to cover his losses exceeding the margin, together with the interest accrued thereon for the period from September 4, 2019 to the repayment date at the Loan Prime Rate (“LPR”) over the same period as published by the National Interbank Funding Center (“NIFC”). This demand has both factual and legal grounds and should thus be upheld. In accordance with Article 36(2) of the Provisions of the Supreme People’s Court on Issues Concerning the Trial of Futures Dispute Cases, Article 35(2) of the Regulations on the Administration of Futures Trading and Article 60(1) of the Contract Law of the People’s Republic of China, the Court rendered the following judgment on August 27, 2020:
Bao should repay EBF an amount of RMB 1,439,790.85 together with the interest accrued thereon for the period from September 4, 2019 to the repayment date at the LPR over the same period as published by the NIFC.
After the first-instance judgement was rendered, neither of the parties filed an appeal within the statutory period and the first-instance judgement therefore has entered into force.
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