By Zhang Chenghui, Wang Gang & Zheng Hong, Research Institute of Finance of DRC

Research Report Vol.17 No.2, 2015

I. Necessity and Urgency of Improving the Legal Framework for China’s Financial Sector

Legal system exercises great impacts on the development of financial sector due to its nature of being a “contract-intensive industry” which involves much more intensive and complex contractual arrangements in the production and transaction of financial products than any other industries. Accordingly, it is more likely to see problems like “asymmetric information” and “moral hazard”. Should contracts are implemented without supervision, trading risks are bound to greatly increase, affecting investors’ information and willingness to enter transaction, and even triggering or aggravating systemic risks.

It is the financial laws that ensure contracts to be correct and also be effectively enforced. Experience has shown that the falling-behind construction of financial laws is a common problem during previous financial crises which were caused by various reasons①. Only with an open and transparent system of financial laws which effectively protects the rights of market participants, can the system successively attract market players from home and abroad to invest and participate in market transaction, and achieve the sustainable development of the financial industry so as to effectively advance real economy.

China’s economy is currently in a crucial period of restructuring. It will become more market-oriented with the market, rather than administrative power, playing the key role in allocating resources. A faster economic restructuring requires that financial system in the future boost the real economy in a more efficient way through a series of reforms, which obviously should be led, promoted and safeguarded by a perfect system of financial laws. On the other hand, it is no longer feasible to overly depend on administrative power to legislate and enforce financial laws. With limited resources for law enforcement, regulatory authorities find it hard to deal with the complicated financial market, which will easily lead to the fact that supervision goes missing or lags behind. Besides, regulators strengthen their authority by expanding power, worsening problems like vying to regulate, getting profits from regulation, and overlapping regulation. Therefore, potential financial risks and the cost of regulation are on the rise. There is a growing urgency to adjust the legal framework for financial sector with intensifying competition in financial market, quicker integration of various financial business and emerging financial innovation. It is urgent to change the general, abstract and vague way of authorizing the power of law enforcement, and institutionalize the exercise of the public power of financial management. Moreover, it is important to regulate and adjust relations among financial regulators, institutions, markets, and clients through legal means, handle financial risks and maintain a good financial order based on laws.

II. Principles for Improving the Legal Framework for China’s Financial Sector

The first principle is to promote fair competition and improve the financial market mechanism. The key to building a financial market lies in increasing the efficiency of allocating resources, which cannot be achieved without effective competition. Hence, the improvement of financial laws should be guided by the idea that market plays a decisive role in allocating capital while government plays its role in a better way. It also requires to reduce administrative intervention, properly assign legal responsibilities to critical links and to law enforcement institutions so as to create effective judicial restraint, and promote stability and fairness in the financial market.

The second principle is to effectively steer clear of financial risks and strengthen coordination in supervision. As financial market is highly leveraged, participants are more likely to be driven by profits, which easily leads to systemic risks. Previous financial crises in different countries indicate that weak regulation is partly to blame. When building the legal framework for financial sector, special attention should be given to supervising the financial products and activities that are multi-sector, highly leveraged, off-balance-sheet assets, complicated and with critical risks. Attention should also be given to avoiding damage to counterparties’ interests and accumulation of systemic risks due to unfair factors, such as imbalance between power and responsibility, imbalance between cost and profit, and opaque information. Besides, it is necessary to match usufruct of financial business with corresponding legal responsibilities, regulate sellers of high-risk products, severely punish fraud, induction, and non-compliance transaction, regulate credit rating and trading clearance. Furthermore, we should make law a stronger deterrent, regulate the mechanism of ascertaining relevant parties civil or criminal liabilities, and rigidly bind unlawful acts.

The third principle is to pay more attention to protecting the rights and interests of financial consumers (especially small and medium investors). The primary participants in financial market are investors, without whom the development of financial market is nowhere to see. In the process of transaction, small and medium investors will most easily suffer losses because of opaque information, market manipulation and fraud. Therefore, financial consumers, especially small and medium investors should be the focus under the protection of financial laws in any country. To protect them, we should create a mechanism operational in the legal framework, and empower them to safeguard their lawful rights and interests.

III. Suggestions on Improving the Legal Framework for China’s Financial Sector

1. Legislating financial laws

(1) We should adjust our idea for legislation. First, we should keep the legislative objective stable, and avoid frequent adjustments with the changes in situations so as not to impair the authority of laws and weaken the stability of laws as well as social relations they adjust. Second, laws should protect the groups in a balanced and fair manner. In addition, it is important to formulate laws and regulations with protecting rights as the priority, and prevent political judgments from undermining the impartiality of laws. Third, we should formulate detailed rather than general laws, and meanwhile make it easier to enforce laws by making articles as detailed as possible, reducing ambiguity, and avoiding the situation where higher-level laws are inconsistent with the lower-level laws because of the subjectivity of law enforcement agencies in decision making. Furthermore, we should add articles for judicial decisions to improve the justifiability of financial laws.

(2) We should legislate in a more scientific and democratic way by adjusting the legislating process, increasing the transparency of legislating and amending laws.

…

If you need the full text, please leave a message on the website.

①Problems exist in the financial infrastructure of countries that suffered most in the Asian financial crisis.