Future contracts are a complex financial derivative tool, and entering into these kinds of contracts could bring not only market risks but also potential legal risks to the parties. Understanding these legal risks can help investors and businesses protect their rights and comply with legal regulations. Below are the main legal risks associated with entering into future contracts.
1. Definition of Future Contract
• Future contracts are used in various fields, but in Vietnam, they are most commonly seen in the financial sector, specifically in the stock market. According to Clause 12, Article 4 of the Securities Law 2019, a future contract is a listed derivative security that confirms the commitment between parties to execute a transaction.
• Accordingly, a future contract is an agreement in which the seller commits to deliver a certain amount of goods or securities, and the buyer will pay upon receipt at a predetermined price in the future set at the time of contract signing. Typically, to avoid losses when the contract is not honored, both parties are required to make a margin deposit at the time of signing the contract.
• Common products involved in future contracts include:
– Basic commodity future contracts: Commodities here include agricultural products, metals, and energy, etc.
– Currency future contracts.
– Interest rate and bond future contracts.
– Stock index future contracts.
– Stock future contracts.
2. Legal risks of entering into future contracts
Although future contracts are considered a risk mitigation strategy for investors and businesses, in practice, entering into future contracts still entails the following legal risks:
a. Changes of Law
The laws on future contracts and financial derivatives in Vietnam are still in the process of development and completion. Legal regulations on commodity trading are frequently updated to reflect market fluctuations and economic policies, which can impact the parties involved in the contract.
• For traditional commodities, the government may adjust legal regulations such as those on import-export and product standards to protect domestic production or maintain price stability. For example, an increase in export taxes on certain traditional goods can significantly affect future contracts that have already been signed.
• However, these changes will directly affect businesses involved in this field. Signing a future contract might lead businesses to face risks related to increased costs, non-qualifying goods for import/export, resulting in the inability to fulfill commitments in previously signed contracts.
• In the stock market, legal regulations and policies on the stock market and future contracts can change, affecting the execution of contracts. These changes can include adjustments in margin requirements, trading regulations, or tax changes. Adjusting margin requirements to control risks can increase costs and capital requirements for investors.
b. Contract-performing risks
Credit risk is one of the major risks when entering into future contracts. Credit risk arises when one party in the contract cannot fulfill their obligations.
• In the traditional commodity market, producers might face significant financial difficulties due to price fluctuations, rising production costs, or poor financial management. If the supplier does not have sufficient financial resources to invest or faces difficulties in borrowing capital, they may not be able to supply goods as per the signed contract.
Future contracts can involve ownership or usage rights of an asset in the future. If the ownership or usage rights of this asset are disputed or unclear, it can lead to legal risks for the parties involved in the contract. Thoroughly checking the legal status of the underlying asset before entering into the contract is very important.
• Additionally, with future contracts, transactions are set to be performed at a specific time in the future. However, if the buyer or supplier encounters financial difficulties and declares bankruptcy during business operations, they will not be able to fulfill obligations to the other party as per the agreement. Recovering the margin deposit or profits from the future contract may become challenging, causing severe financial damage.
Entering into future contracts entails various legal risks that investors and businesses need to consider carefully. To minimize these risks, it is necessary to understand and comply with current legal regulations, ensure clear and detailed contract terms, thoroughly check the legal status of the underlying asset, and prepare effective dispute resolution measures. By doing so, the parties involved can protect their rights and minimize legal risks during the process of entering and executing future contracts.
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