China’s Futures Law- a step forward?

After its first reading at the 28th session of the Standing Committee of the 13th National People's Congress, the draft Futures Law (the "Draft Futures Law") of the People's Republic of China ("PRC") was published for consultation on the website of the National Congress.   The consultation period ended on 28 May 2021.

The Draft Futures Law has attracted a lot of attention. There are a few reasons for that, we list here a few:

1. The background against which the Draft Futures Law was published

   The Draft Futures Law was published against the background of a so called "two way opening" of the Chinese financial markets and development of a "domestic and international double cycle" economic policy., The futures and derivatives market, , is recognized as strategically important for establishing a new economic development pattern in China, given how these markets contribute to commodity pricing.

2. While the Draft Futures Law is a domestic law, it may catch futures and derivatives transactions and related activities conducted outside the territory of the PRC

   Article 2 of the Draft Futures Law provides clearly that the law applies to futures, other derivatives transactions and related activities within the territory of the PRC.  However, it also says that if such transactions and related activities conducted outside of the PRC disrupts market order within the territory of the PRC or harms the legitimate interests of domestic traders, then the law will also be applicable to these transactions or activities.

   However, the exact meaning of a disruption of the market order is unclear.  Nor is it clear how the Draft Futures Law will be enforced in relation to transactions and the activities conducted outside of the territory of the PRC.

3. Cross border futures activities

   Chapter 12 of the Draft Futures Law addresses cross border activities:

   • A domestic entity which wishes to conduct overseas futures trading, either have an overseas brokerage business licence itself or must engage a domestic institution which has an overseas brokerage business license to do such trading. If such a domestic institution then entrusts an overseas brokerage, then such an overseas brokerage  must register with or apply for exemption of registration with the State Council authorized futures regulator;  The Draft Futures Law does not clarify when an exemption may be available.  Nor does it say which regulator will be a State Council authorized futures regulator.

   Article 135 provides clearly that no individual or entity may market an overseas futures exchange directly or through their onshore branches without the approval of the State Council authorized futures regulator.       

4. Futures brokers must use the real name of clients when opening accounts  for the transaction of futures transactions conducted on a futures exchange.  [Futures traders must report to the relevant exchange its actual controlling relationship.

   The actual controlling relationship is required to be reported under article 19. It is defined as an act or a fact that any entity or individual has the power to manage, use, gain or dispose and has decision power or has significant influence on futures trading decision. ]

5. Chapter 3 of the Draft Futures Law deals with other derivatives transactions including OTC derivatives transactions.

   For other derivatives transactions, Article 34 of the Draft Futures Law provides that industry associations or organizations supporting other derivatives transactions must file their master agreement templates with relevant authorities.

   This Article 34 requirement has stirred quite a lot of reaction from the industry.  It seems to refer to industry association master agreement templates.

   The interesting point is that this reaction is not only because of the filing requirement itself, but also it is related to Article 35:  Article 35 provides that for netting, and in particular, the "single agreement principle" commonly contained in OTC master agreements to be legally binding, the relevant master agreements (together with all supplemental agreements and any other agreements made by parties for specific transactions)must be filed according to this Draft Futures Law (ie, Articles 34).

   This is also linked to Article 37 which provides that those transactions entered into according to Article 35 (ie, using the templates filed under Articles 34) can be terminated in accordance with the agreement upon occurrence of certain events and close out netting and settlement will not be invalidated or revoked.

   In line with certain other jurisdictions, this basically has provided a statutory exemption from the application of the cherry-picking principle under the PRC insolvency law. Under current PRC insolvency law, the administrator can terminate contracts at his discretion, as the single agreement principle is not recognized.  This ability to cherry pick has made thrown the enforceability of early termination and close out netting of derivatives traded with Chinese parties into doubt

   These articles (34, 35 and 37) will, once adopted, provided a leap forward from current legal system to create an exception to the insolvency law principles for the derivatives transactions.  It brings them in line with the international practice.

However, it remains unclear whether such protection will be available where template master agreements are amended or whether they need not to deviate from the filed version for the protections to apply. 

In summary, besides setting out framework basic laws for futures exchange markets, ensuring the sound operation of these markets, the Draft Futures Law focuses sets out trading and settlement principles which are consistent with international markets for OTC derivatives transactions, so that OTC derivatives markets can develop under orderly supervision.

However, for the reasons set out above the Draft Futures Law would benefit from further clarification, especially in relation to its extra-territorial effect and the scope of the protection for OTC derivative master agreements.

The Draft Futures Law sets out trading and settlement principles consistent with international markets for OTC derivatives transactions.

In summary, besides setting out framework basic laws for futures exchange markets, ensuring the sound operation of these markets, the Draft Futures Law focuses sets out trading and settlement principles which are consistent with international markets for OTC derivatives transactions, so that OTC derivatives markets can develop under orderly supervision