SOMO | December 2012
New free trade agreements threaten financial reforms
By Myriam Vander Stichele, SOMO
While financial reforms are ongoing in the EU and many other countries, little attention is paid to free trade agreements that continue to liberalise financial services as well as restrict regulatory freedom (‘policy space’) and controls on capital movements.
Exporting EU financial services to fight the crisis
The EU continues to consider financial services as one of its key export industries and as part of its aggressive trade strategies. ‘Trade in financial services’ does not only mean trans-border movements of financial services (e.g. internet banking with foreign customers) but also the establishment of foreign banks or insurance companies, etc. abroad (i.e. foreign direct investment) and movement of high level personnel. In 2011, the EU’s export surplus of financial services, including insurance services, was € 36.5 bn ( € 40.4 bn in 2010), almost 30% of the total EU services trade surplus of € 121 bn in 2011. The European Commission’s directorate general responsible for trade issued a document explaining that aggressive trade negotiations were needed because “the contribution of trade to GDP in 2012 (+0.7 percentage points) should enable the EU economy to avoid falling back into recession” in 2012 since EU domestic demand is expected to be negative in 2012, and 90% of the world’s growth will be outside the EU by 2015.
Especially the City of London is keen to continue its export surplus and retain its competitiveness through an extensive institutionalised lobby programme on regulations and market opening abroad, especially in profitable emerging markets. The UK’s financial services trade surplus was £46.7 bn in 2011, of which £10 bn resulted from UK banks’ export earnings on international derivatives trading.
Free trade agreements contradict financial reforms
New free trade agreements that cover financial services and are negotiated after the financial crisis of 2008, are all based on the GATS agreement and its financial services provisions. However, the GATS agreement has a pre-crisis model which promotes ‘light touch’ regulation in the financial sector, proposing that regulation should be minimal and not undermine profitability and innovation — however risky. Also, due to a well-organised lobby, the liberalisation of financial services and financial services providers has been far reaching, and this is especially visible in some GATS rules and the “GATS Understanding on commitments in financial services”, which includes a prohibition against future regulatory measures that are more restrictive.
During current and recent negotiations, as in the past, there is no guarantee or mechanism to ensure that sufficient regulation and (cross-border) supervision is in place. This contrasts with the EU’s recognition that creating a free market in financial services without sufficient common regulation and joint or overarching supervision, is a recipe for a crisis and, moreover, leaves supervisors and governments without sufficient means to tackle a crisis.
The free trade agreements impose disciplines on regulators that are tantamount to deregulation. For instance, the signatory countries of GATS and FTA, which have liberalised financial services without exceptions, are forbidden to take measures that limit the total of financial services’ operations or output, or to take measures that require specific types of legal entities. These rules are contrary to measures that, for example, can stop banks to become too big to fail or to impose position limits. However, GATS and FTA have a special clause that allows countries to take prudential financial measures for the integrity and stability of the financial system and protect investors and consumers, as long as those measures are not considered as a way to not implement the rules and liberalisation commitments under the agreements. In other words, this so-called prudential has many grey areas, so that prudential financial regulations could end up for arbitration by a GATS or FTA dispute panel even if this has not happened so far.
NGOs like SOMO, some WTO member countries and several academics have warned that GATS and FTA rules might undermine financial reforms to prevent a financial crisis as well as measures to handle a financial crisis. Particularly the EU, the US and the WTO secretariat have always strongly denied that there is any problem. They have blocked discussions on potential contradictions and problems by GATS rules in the WTO Committee on Trade in Financial Services. This blockage was only halted after years of NGO campaigning and an NGO open letter in September 2012 requiring support for Ecuador’s modest proposal to discuss in that Committee whether GATS rules provide sufficient policy space to respect macro-prudential regulations promoted by other financial institutions. However, in a reply to the NGO letter, the European Commission (EC) continues to deny that GATS rules can undermine financial regulation and considers the prudential carve-out a "flexible instrument to safeguard WTO members’ right to regulate the financial sector". However, informally EC staff admit that regulators and supervisors are limited in how prescriptive they can be. NGOs dispute that the GATS’ prudential carve-out totally excludes legal challenges to financial prudential measures (e.g. in case of a dispute whether a measure is prudential). At least the EC recognizes that a prudential carve-out is needed to prevent financial reforms from being contrary to GATS rules.
New negotiations to liberalise financial services and restrict regulation
New negotiations on financial services are under way at the international level. Since the GATS negotiations on services in the context of the WTO’s Doha Round are not progressing, the EU, Australia, the US, Canada, and 16 other WTO member countries have been preparing how to negotiate an International Services Agreement (ISA) from 2013 onwards. Of course, financial services would be part of it, but no information is available about if they would be covered by special clauses. The ISA agreement would not include all WTO members and not even formally be a WTO ‘plurilateral agreement’. The EU, however, has insisted that WTO members who are not part of ISA would be able to join later, and that the agreement should be able to be integrated in the WTO system at a later stage. The European Commission, which is the negotiator for the EU, still needs to get a mandate for these stand-alone negotiations from the EU member states.
Apart from negotiating commitments for more market opening in many sectors, the most controversial ISA elements, which should also apply to financial services, are:
National treatment for all foreign services and their providers, even if no liberalisation commitments were made.
Any unilateral and bilateral/regional liberalisation of services already undertaken by a country that signs ISA should constitute market opening for other signatory countries of ISA.
Through a ‘ratchet’ mechanism, any future unilateral liberalisation and relaxation of regulations automatically applies to ISA signatory countries.
A ‘standstill’ obligation so that regulations that are not compatible with GATS rules cannot become more trade restrictive nor can services market liberalisation be rolled back.
The EU has been and still is negotiating free trade agreements (FTAs) that include financial services in more or less the same way as the GATS model, with many countries and regions around the world, some of which have important financial centres, or even tax havens, such as South Korea, India, Singapore, and Central America (including Panama, Costa Rica). A recent report by the GUE fraction of the European Parliament warned that the FTA with Colombia and Peru will increase illicit flows and money laundering.
In 2012, the EU has been expanding its FTA negotiation mandate to include specific measures that protect foreign investors, including in the financial sector, against regulatory or other measures by the host state – notwithstanding protests by NGOs.
The problems from such an expanded mandate for financial services already become apparent during the final negotiations between the EU and Canada for a free trade agreement during which some hurdles remained, in November 2012. Canada is an important financial services market to get more access for the EU financial industry. According to a leaked negotiation paper, the EU is pushing during the negotiations to restrict policy space by Canada, and the EU, on financial regulation. The most worrying statement from the leaked EC negotiation text is where the EC states that "there are no sound reasons why investors in the financial sector should be treated differently compared to other investors when regulators adopt measures for prudential reasons". However, Canada does not want an investor to be able to sue the state over a prudential financial measure that affects protection of an investor, resulting in a dispute settlement system. Canada has so far treated financial services as a special case in its FTAs because of Canada’s high level of regulation and supervision that is praised worldwide and recognised by the EU!