One of the more interesting questions floating around the Academy at the moment—and with implications for real world businesses and regulators alike—is whether bilateral investment treaties undermine the ability of governments to apply cross-border financial regulations.

The concern stems in part from a case involving claims by Panama against Argentina’s “tax transparency regulations under GATS.  Argentina’s asserted that its measures “serve to prevent concealment and laundering of money of criminal origin” and were meant to “protect investors and the soundness of the Argentine financial system.

As White and Case summarizes the case:

The September 2015 Panel decision found, among other things, that the Argentine measures violated the MFN obligation of GATS Article II because they did “not accord, immediately and unconditionally, to services and service suppliers of non cooperative countries treatment no less favourable than that which they accord to like services and service suppliers of cooperative countries”. The Appellate Body overturned that ruling on the grounds that the Panel had used an erroneous “likeness” test. But it did not go on to determine for itself whether the services at issue were “like”. Indeed, having reversed the Panel on this threshold issue (and the consequent substantive findings that flowed from it), the Appellate Body took pains to emphasize that “we have taken no view on whether the services and service suppliers of cooperative countries are ‘like’ the services and service suppliers of non-cooperative countries, or ‘like’ Argentine services and service suppliers”.

Following the Appellate Body’s ruling it thus remains unclear whether WTO Members may take measures against countries that are considered to be “not cooperating for tax transparency purposes”. This presumably will have to be resolved in a future dispute, perhaps with other litigating parties.

Another notable feature of this decision is that this is the first case since the advent of the WTO to interpret the so-called “prudential carve-out”. This exception – set out in the GATS Annex on Financial Services – provides in part that “[n]otwithstanding any other provisions of the Agreement, a Member shall not be prevented from taking measures for prudential reasons, including for the protection of investors, depositors, policy holders or persons to whom a fiduciary duty is owed by a financial service supplier, or to ensure the integrity and stability of the financial system”.

Although I certainly see the (potential) basis of concern under the WTO, I’m not entirely sure it transfers neatly to BITS, at least as articulated under the modern BIT framework.  To be sure, many BITs place restrictions on the ability of countries to impose capital controls. That said, the prudential carveout is both substantively and procedurally capacious.  Take, for example, the 2012 Model U.S. BIT:

Article 20: Financial Services

  1. Notwithstanding any other provision of this Treaty, a Party shall not be prevented from adopting or maintaining measures relating to financial services for prudential reasons, including for the protection of investors, depositors, policy holders, or persons to whom a fiduciary duty is owed by a financial services supplier, or to ensure the integrity and stability of the financial system. (emphasis mine) Where such measures do not conform with the provisions of this Treaty, they shall not be used as a means of avoiding the Party’s commitments or obligations under this Treaty.
  2. (a) Nothing in this Treaty applies to non-discriminatory measures of general application taken by any public entity in pursuit of monetary and related credit policies or exchange rate policies. (emphasis mine) […]

(b) For purposes of this paragraph, “public entity” means a central bank or monetary authority of a Party.

  1. Where a claimant submits a claim to arbitration under Section B [Investor-State Dispute Settlement], and the respondent invokes paragraph 1 or 2 as a defense, the following provisions shall apply:

(a) The respondent shall, within 120 days of the date the claim is submitted to arbitration under Section B, submit in writing to the competent financial authorities of both Parties a request for a joint determination on the issue of whether and to what extent paragraph 1 or 2 is a valid defense to the claim. (emphasis mine) The respondent shall promptly provide the tribunal, if constituted, a copy of such request. The arbitration may proceed with respect to the claim only as provided in subparagraph (d).

(b) The competent financial authorities of both Parties shall make themselves available for consultations with each other and shall attempt in good faith to make a determination as described in subparagraph (a). Any such determination shall be transmitted promptly to the disputing parties and, if constituted, to the tribunal.  The determination shall be binding on the tribunal.

Unpacking the clause, we see that a) departures from the prohibition are permitted so long as they “relate” to prudential regulation.  This is an intentionally expansive phraseology—it is not tied to national emergencies (or fiscal emergencies) and can be deployed to help maintain (or “ensure”) stable financial systems.

Should market participants choose to nonetheless challenge a host state’s new prudential arrangement—say for its breadth—they must, critically, seek the opinion of both the home country and host state prudential regulators when making their case to the arbitral tribunals.  And getting either to condemn a country’s rules taken in the name of macro prudential regulation as anything but would be extremely unlikely.  Obviously, host state regulators will spell out the rationale and basis for their rules and regulation.  Meanwhile, home state regulators—in contrast say to trade officials—will be naturally incentivized to take a hands off view of their counterpart’s actions.

To understand why, it’s necessary to understand the incentives of a home state regulator.  Perhaps most important, this isn’t the case of trade officials, who seek to restrict one another’s rules, but have limited domestic authority.  Regulators have the power and responsibility to regulate their own local markets.  Effectively complaining about another jurisdiction’s approaches could, as a result, undermine and even restrict a home state regulator’s own ability in the future to impose similar rules and regulations if ever needed or warranted.

Second, prudential regulators have very particular mandates.  Regulators, tasked with investor protection and maintaining market integrity, aren’t in the business of punishing other jurisdictions for regulating; instead, they are rewarded (and tend to enjoy prestige from) exporting rules abroad and ensuring compliance with high quality international standards.  Forcing other jurisdictions to adopt rules that could ultimately undermine the welfare of local market participants abroad would be risky, economically and politically, especially if that risk is imported into the homeland.  Instead, regulators seek consensus–and cover–by persuading others to adopt weaker and stronger rules, often relying on the coercive power of repetitional and market mechanisms.

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