Next week the World Trade Organisation (WTO) will consider a proposal by a group of emerging market and developing countries led by Ecuador requesting the WTO members to undertake a discussion on the relationship between recent financial regulatory reforms and global trade rules. Such a discussion is urgently needed to ensure that efforts to re-regulate global finance in the wake of the financial crisis are not constrained by trade commitments.
Whether it be in the form of preventing systemic risk, regulating securitisation, hedge funds, or credit rating agencies, revising accounting standards, or raising capital requirements, since 2009, there has been a significant effort across the globe to re-regulate the financial sector. The hope is that we will be able to prevent or better mitigate the next financial crisis and steer finance toward more productive and employment generating ends.
As many of these regulations have started to materialise, there have been murmurings by the financial sector and others that such regulations may be in violation with the WTO and the many regional and bilateral trade and investment deals that take the WTO as their starting point. Global Trade Alert, a watchdog of trade measures from the University of St Gallen, has labelled numerous financial regulations since 2009 as “protectionist”.
Cross-border financial flows
In 2011, Ecuador joined with India, Argentina and South Africa to request that the WTO study the inter-relationships between trade rules and regulatory reform. The US however, blocked the request. The US, South Korea, Norway and Canada, all said that the WTO, and particularly the General Agreement on Trade in Services (GATS), had a “prudential carve-out” that provided WTO Members with the flexibility to regulate their financial systems. Thus, they were implying, there was no need to have such a discussion.
Ecuador and other emerging market and developing countries want to see that in writing. They worry that their regulations could eventually result in a WTO challenge or cause nations not to put in place needed reforms for fear of being challenged.
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One set of measures, that has been identified by legal scholars and economists to be of concern are the renewed efforts to regulate cross-border financial flows. Nations such as Brazil, Peru, South Korea, Uruguay, Taiwan and others have regulated stock, bond, currency and derivatives markets in order to stem the inflows of short-term capital flows into their nations in the wake of the crisis.
Loose monetary policy and slow growth in the industrialised world has caused what the International Monetary Fund (IMF) terms a “surge” in harmful financial flows that have triggered asset bubbles, current appreciation and rendered developing country monetary authorities weaker. A new IMF study suggests that industrialised countries may need to regulate the outflow of capital as well.
At a symbolic workshop in Argentina this summer (Argentina has been subjected to numerous trade cases for measures it took to mitigate its 2001 crisis), economists, policymakers, legal scholars and members of civil society met to conduct a “compatibility review” regarding the extent to which nations have the flexibility to regulate cross-border finance under global trade and investment rules.
The review found that numerous incompatibilities between trade rules and efforts to regulate cross-border finance, finding that regional and bilateral deals are far more incompatible with the ability to regulate cross-border finance than is the WTO regime.
But there are still a number of concerns about the WTO. The IMF now defines cross-border financial regulations (which they call “capital flow management measures”) as “measures affecting cross-border financial activity that discriminate on the basis of residency”.
Thus, for the 100 or more WTO members that have liberalised trade in financial services, almost by definition alone, measures to regulate cross border finance violate the “national treatment” principle of the WTO whereby regulations have to give the same level of treatment to domestic trade or investors as those that are enjoyed by domestic counterparts.
“A new IMF study suggests that industrialised countries may need to regulate the outflow of
The GATS has both “prudential carve-out” and a “balance of payments safeguard”, but there is real concern that the conditions under which nations can evoke such safeguards are overly narrow. Scholars and policymakers point to the language in these safeguards that say prudential measures must be temporary and that they may have to undergo a “test” by the WTO to see if an alternative measure should have been used.
These concerns have implications well beyond the WTO, as WTO language becomes the foundation for numerous regional and bilateral trade and investment treaties that go even deeper than the WTO. The Trans-Pacific Partnership (TPP) under negotiation between the US and numerous Pacific Rim nations, as currently proposed, would mandate that all forms of cross-border finance be allowed to flow “freely and without delay”.
The draft treaty (like most US treaties) has language similar to the WTO’s prudential carve-out but makes the circumstances under which it can be evoked even more limiting – and there is no balance of payment safeguard whatsoever. Moreover, the TPP would allow private investors to directly file claims against governments that regulate them, as opposed to a WTO-like system where nation states (i.e., the regulators) decide whether claims are brought.
Therefore, under investor-state dispute settlement those sectors that may bear the cost have the power to externalise the costs of financial instability to the broader public while profiting from awards in private tribunals.
The proposal by emerging market and developing countries for the WTO to have an open discussion on trade rules and financial regulatory reform is overly modest and urgently necessary. The US and the other nations that blocked the initial proposal should not stand in the way of re-regulating global finance. A healthy and balanced financial system is paramount to a functioning trading system, a system that the US and the whole world so vitally depend on.
Kevin P Gallagher is an associate professor at Boston University and a co-chair of the Task Force for Regulating Global Capital Flows for Long-Run Development. He is the co-author of a new policy brief with Leonardo Stanley titled Global Financial Reform and Trade Rules: The Need for Reconciliation.