Research On The Seller’s Liability In Financial Derivatives Transactions

The financial derivatives were created to be the instrument of hedging. But in the financial crisis, financial derivatives such as CDS were proved to fuel the crisis rather than prevent it. Regulators from EU and US are now beginning to reconsider the deregulation of financial derivatives, and special legislations on OTC derivatives has been made in recent years. The legislations focus on the relationship of buyer and seller of financial derivatives transactions, with more regulations on financial institutions and more protection for investors.Financial derivatives develop very rapidly in China recently. Derivatives including forward contracts, futures, options and swaps grow fast, with the amount of futures transaction becoming the largest in the world. On the contrary, legislations on the financial derivatives are not sufficient. News about the heavy loss of China enterprises and individuals drew much attention in the last years. Researchers had done many researches on financial derivatives. Otherwise, Few researches focus on the unbalance of the rights and liabilities for buyers and sellers to the financial derivative contract. This study is ready to discuss the liabilities of the seller from the point view of comparative law, and dedicated to provide more theoretical materials for the regulations of China financial derivatives. Due to the endophytism of financial law concepts, this paper discusses the concepts such as instruments, financial instruments and financial derivatives, and clarifies that all of such instruments belongs to legal contracts. What is different for financial derivatives is that the target subject matter of financial derivatives contracts are assets and liabilities, and their value varies with a specified index. Assets derived from rights, and liabilities derived from commitments, both of which are now legal concepts. Financial derivatives are both rights in personam, and rights in rem. The financial derivative, defined as a contract specifically, could be the target subject matter of another complex financial derivatives contract. All financial derivatives can be categorized as contracts for sales with buyers and sellers in contract law. However, financial derivatives do not engaged in the delivery and passing of title, and provisions concerned with liabilities for warranty against defects could not be applied directly to financial derivatives. Remedies such as further execution of the Contract are also different from the termination of contracts immediately in derivatives. In order to protect buyer in the financial derivatives contract, we should find a way to define the seller’s liabilities specifically.China courts used to make judicial determinations in accordance with the principle of "Caveat Emptor" to solve the disputes on the structured financial products. After the discovery of the history and development of Caveat Emptor, the paper clarifies that with the concept of consumer protection, Caveat Vendor come to rise rapidly in modern law, and the positive principle of Caveat Emptor has been abandoned. Liabilities of the seller are emphasized. Financial derivatives are so complex, abstract, opaque and monopolistic, that buyers usually could not know what they bought. Sellers often mislead buyers by their advantages in information and experiences. Except for the transactions between professional financial institutions with equal knowledge and experiences, both Caveat Emptor and Caveat Vendor should be applied for the settlement of financial derivatives disputes.If the buyer made his decision pursuant to the instruction of the seller, and relied on the seller’s professional skills to buy, then there should be a relationship of reliance between the buyer and seller; and the same thing will happen when the buyer could control the seller’s money or account. Thereafter, the seller should bear the duty of fiduciary for the buyer, which means that the seller should not put his own interests before that of the buyer at any time. Sellers who breached its fiduciary duty should return the property of pay the money to the buyers. China Trust Law had specified the fiduciary duty to some extent, but failed to implement the mechanism of the relationship of reliance. In the reality, Judges used to treat trusts as commissions in the financial derivatives disputes. The author suggest China government to make amendment to the Statutes to specify the relationship of reliance, the duty of fiduciary, and the claim for breach of the duty of fiduciaryThe seller should sell the suitable financial derivatives to the appropriate buyer in a proper way, as is called "the suitability liability" of the seller. Both US and EU are applying new legislations to enhance the suitability liability of the seller including the institutional investors now. If the buyer is harmed by the seller’s breach of its suitability liability, he has the right to file a private litigation against the seller. Regulations of the suitability liability in China sometimes act as the instrument of limitation on market access, and the process liability of the suitability are even not defined. The regulations of the suitability should be amended from the point view of the buyer to enhance the seller’s liability.Information disclosure plays the core role in the regulation of financial derivatives. In accordance with the legal concepts, disclosures of financial derivatives include the following three dimensions. The first is the disclosure to the buyer under the contract of financial derivatives, and the buyer should make such disclosure before the contract is signed, during the implementation of the contract, and after the contract. The second is the disclosure in the financial statement, pursuant to the financial accounting standards. The third is to report all of the transactions in details to the information deposits designated by the government. And all of the information disclosed should be open to the regulators and the public, in order to relieve the regulation and decision making. China should make further legislations on information disclosures. Because of the unbalance of the knowledge and experience between the buyer and seller in the financial derivatives, the seller usually specifies some exemption clauses of its liabilities or the deprival of the seller’s rights in the contract. In order to assure the contract freedom in reality, we should limit the seller’s freedom to introduce such kind of articles in the contract. From the comparative legal point of view, legislations usually prevent the seller from doing such unfair practices. China should make further amendments to the Contract Law and Consumer Protect Act.Finally, the author suggests that China should make some legislation to enhance the seller’s liabilities in the financial derivatives transactions, and statues and leading cases of EU and US could be comparative. It’s better to introduce a flexible conceptual framework of property rights, and not to restrict our thougts among the dual rights system. Contract Law should be revised to name the financial derivative as one of the typical contracts. Both the principle of Caveat Emptor and that of Caveat Vendor should be clarified in the Commercial Bank Act, Byelaw of Supervisory Management for Securities Company, Byelaw of Supervisory Management for Trust Company, and Financial Instrument Transaction Act. Furthermore, we could develop a legal concept of Fiduciary Duty derived from equity law, under which the liability of the seller could be specified. Besides, the legalization of Suitability Liability in the commercial subject statute is very important. Information disclosure regulations should also be revised from time to time, in order to enhance the transparency of the OTC financial derivatives. Exemption clauses in the financial derivatives contract should be regulated in Contract Law or Financial Derivatives Transaction Law.