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China¡¯s National Courts Financial Trial Work Conference has affirmed a collaborative approach to financial governance, setting a trend towards judicial regulation in financial adjudication.

In the Minutes of the National Courts Civil and Commercial Trial Work Conference, it is also clarified that financial regulatory rules may determine contract validity by taking reference to public order and good morals.

The challenge now facing adjudicators is navigating the myriad of regulatory norms to identify and correctly apply the appropriate standards for individual cases, ensuring effective co-ordination between financial judiciary and regulation.

This is where the flexible system theory can be applied.

The working principle of the flexible system theory involves externalising legal principles into multiple elements and deducing the final legal outcome through the balancing of these elements.

While it may appear that adjudicators arbitrarily ¡°create¡± elements, this is not the case. The extraction of elements is somewhat restricted, rather than entirely open, requiring adjudicators to derive elements from the legal values corresponding to the nature of the case.

This ensures that the extracted elements remain within the framework of civil law values, making the resulting judgments legally sound and predictable.

Q: Which elements are to be extracted from financial regulatory norms?

A: Extracted elements generally cover three key aspects.

(1) Degree to which a private interest infringes on interests protected by financial regulatory norms. Financial regulatory norms, whether departmental regulations or policy documents, safeguard non-private interests, while a contract typically represents private interests.

It is important to note that the extent of infringement cannot be absolutely quantified, as doing so would undermine the flexibility of the public order and good morals system, reverting to a rigid, criteria-based approach that lacks dynamic flexibility.

The flexible system theory involves comparing relevant facts of a specific case with non-private interests protected by regulatory norms to determine the severity of harm to those interests. When a contract violates financial regulatory norms, the greater harm it has done to protected interests, the more likely it is to be deemed invalid.

(2) Legitimacy of private interests in relation to enforcement of financial regulatory norms. When a contract representing private interests infringes on a non-private interest and upholds another ¨C both of which are covered by the financial regulatory norms ¨C the adjudicator is to balance these competing non-private interests, rather than seemingly weighing the non-private interests against private interests.

The value hierarchy of these non-private interests will influence the extent to which the private interest is legally protected. The real challenge lies in determining the degree of protection for such private interest that simultaneously infringes on one non-private interest while upholding another protected by the financial regulatory norms.

(3) Necessity of invalidating a contract while applying financial regulatory norms. Litigation and arbitration are not the only means of dispute resolution. Administrative and criminal measures are also effective, or even more straightforward in some cases.

When handling cases where a contract violates financial regulatory norms, adjudicators must thoroughly weigh the interests and values involved. They should consider whether declaring the contract invalid achieves the optimal balance of these values.

If administrative or criminal measures can achieve the same or better societal outcomes, it may not be necessary to invalidate the contract. Thus, a cautious analysis is required to assess the necessity of declaring a contract invalid.

Q: Is there an exemplary formula?

A: In an exemplary formula, a total value satisfying all elements corresponds to the legal effect S, which in this context means contract invalidity. To reflect detailed thinking, it is
S = F(A) + F(B) + F(C)
In specific cases, if f(A) >= F(A), f(B) >= F(B), and f(C) >= F(C), then f(A) + f(B) + f(C) will definitely achieve the legal effect S. If f(A) = F(A), f(B) > F(B), and f(C) < F(C), it needs to explore further whether there is a substantial difference between f(C) and F(C), or whether f(C) may compensate for f(B) to achieve balance.

Q: What is decision tree modelling?

A: The decision tree model of the flexible system theory sorts out cases in the financial regulatory field by extracting key elements through big data analysis. The weight of each element is calculated on a weighted average basis against its frequency in the dataset. When adjudicating individual cases, the judge multiplies the performance of each element by its weight to obtain a score for each element. These scores are then summed to produce a total score, which is compared to a default benchmark value to assess the validity of the contract in question. Such default benchmark value is to be set by the Supreme People¡¯s Court.

Key takeaway

In summary, under the current trend of financial regulation, when the regulatory lag prevents judges from finding directly applicable rules, they will no longer adhere to rigid criteria. Instead, through the flexible system theory, judges can identify relevant elements within the framework of legal values, and ultimately compare and balance these elements to achieve a fair and just verdict that aligns with the core values of socialism.

Shi Jiangheng and Zhou Yu are partners at Ronly & Tenwen Partners shijiaheng@rtlawyer.com.cn yhurrichou@rtlawyer.com.cn