On February 22, the Shanghai Financial Court publicly pronounced its Judicial Opinion on the first financial market test case. In the Opinion, the principles on the application of law in disputes involving the financial market infrastructure are clarified and a decision is made regarding the underlying legal issues in the first test case. The first test case was tried in accordance with the Rules of the Shanghai Financial Court on Financial Markets Test Case Scheme (For Trial Implementation) (“Rules”). It was initiated upon the joint application by Interbank Market Clearing House Co., Ltd. (“SHCH”), Bank of Communications Co., Ltd., Shanghai Pudong Development Bank Co., Ltd., Industrial Bank Co., Ltd. and Société Générale (China) Limited to test the validity of the default disposal rules on the central counterparty clearing business of the Shanghai Clearing House and the reasaonability of the Shanghai Clearing House’s disposal acts. The first test case was conducted in the form that the four banks collaboratively as claimant Institution A, suing the respondent SHCH to compensate the loss of margin due to default disposal.
According to the undisputed facts acknowledged by all parties, the SHCH signed the Central Counterparty Clearing Agreement (“Clearing Agreement”) with Institution A, under which Institution A participated in the central counterparty clearing business of the SHCH as an ordinary clearing member. The Clearing Agreement stipulates that Institution A accepts and agrees to abide by the rules already issued by the SHCH and the amendments and supplements thereto and that in case of default, the SHCH has the right to conduct default disposal in accordance with SHCH rules. After Institution A defaulted on the margin, the SHCH determined as per its rules that Institution A had committed a permanent default and thus initiated the default disposal by dividing, hedging and auctioning the positions of the derivatives held by Institution A and having Institution A to bear the resulting disposal loss. Institution A claimed that the SHCH failed to fulfill the obligation of explaining and reminding it of the relevant rules on default disposal, that the subsequent revision of the rules, being a major revision which was not reported to the regulatory authorities for approval, should be invalid, and that in the specific disposal process, the SHCH failed to conduct the disposal at the optimal hedging period and the optimal price, leading to expansion of the loss, in light of which Institution A claimed against the SHCH for compensation of the loss.
On December 12, 2022, the Shanghai Financial Court conducted a public trial of the case. After the trial, the judicial panel, following the principles of independent voting, majority decision and reservation of dissenting opinions, fully deliberated the underlying legal issues in the case to make a decision according to law and publicly pronounced the trial result of the case in accordance with Article 21 of the Rules. It’s determined that the relevant default disposal rules of the SHCH meet relevant conditions and are legally binding and that the specific default disposal acts thereof are not obviously unreasonable and shall have legal effect on Institution A. Regarding the legal risks identified in the trial of the first test case, the Shanghai Financial Court will issue judicial advice to prevent financial risks and promote the collaborative good governance of the financial markets.
The trial result of this case is of great significance for the SHCH to improve its rules as a financial market infrastructure. As a central counterparty clearing institution, SHCH formulates specific rules for dealing with the defaults in financial derivatives and forms disposal plans under specific circumstances, which may influence the stability of the financial markets and the interests of counterparties. During the trial of the case, the two parties held several rounds of pleading and defense, fully expressing their legal opinions on the various details of the formulation and modification of the rules and the specific disposal, while the judicial panel addressed these opinions one by one with elaboration and offered its judicial opinion. This process is like giving a thorough “physical examination” of the legal risks in the default disposal rules and acts of the SHCH as a financial market infrastructure. Given that the current legislation is silent on the specific issues about central counterparty clearing, the Shanghai Financial Court’s judicial opinion on the test case will not only provide futures and derivatives market participants with clearer expectations for rules but also promote compatibility with international practices in financial markets, so as to effectively prevent systemic financial risks and safeguard the institutional opening-up of financial markets.
The case, which relates to disputes that may arise due to cutting-edge and major legal issues in the central counterparty centralized clearing business, fully reflected the characteristics of the financial market test case scheme pioneered by the Shanghai Financial Court, such as initiation upon mutual consent, comprehensive discovery of evidence, selection of good attorneys, substantive defense and full participation of all sectors of society. The test case scheme, through a judicial trial mode different from the traditional civil litigation system, expands the service function of financial justice in the new era and forms a new path of Chinese-style financial dispute resolution that conforms to the regulatory sandbox mechanism and the concept of coordinated and comprehensive governance in financial markets.
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