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Financial services in the TPP and the interests of developing countries

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Financial services in the TPP and the interests of developing countries

Ashly Hope, tralac Research Advisor, comments on the potential impact of the Trans-Pacific Partnership Agreement for developing country economies, in particular regarding financial services sectors

On May 18, the United States International Trade Commission released a much awaited report (click here to download) on the expected impact on the US economy of the Trans-Pacific Partnership (TPP). The report was interpreted as only cautious support for the TPP, finding a small positive effect, with the agreement estimated to add 0.15 per cent to real GDP by year 15. This was not the death knell for the agreement as some had hoped, but nor was it such a strong endorsement that Congressional approval would be assured.

So, while TPP ratification may yet be derailed by the United States[1], the negotiated outcomes are a significant achievement in themselves, and provide useful insights into what a ‘21st-century trade agreement’ can look like. The text itself offers clues as to how a mega‑regional trade agreement can potentially bring together the divergent interests of members with varying levels of income, wealth and development across a wide range of sectors. One of these areas is financial services.

The TPP partners – Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the United States and Viet Nam – have diverse levels of financial liberalisation and development, as well as significantly varying capacity and development in terms of financial sector regulation.

For example, in their most recent financial sector assessment, the World Bank and IMF attributed weakness in the financial sector to (among other things) deficiencies in financial regulation and supervision. This is in contrast with, for example, Singapore’s financial sector, which the IMF has described as ‘highly developed, and well regulated and supervised’.

Given the significant differences in financial sector development and regulation among African countries, there are likely to be useful lessons as well as some cautionary tales to be drawn as negotiations on financial services proceed on a continent-wide basis.

The Financial Services Chapter of the TPP makes some incremental steps in further opening member country markets, while including a relatively wide prudential carve-out – preserving the ability for countries to regulate their financial sectors to preserve stability and ensure consumer protection.

The chapter covers financial institutions and their investors, including banks, insurers, credit providers, and the services they provide – including deposit taking, lending, insurance and reinsurance, payments services, clearing and settlement, trade in financial instruments and issuance of securities as well as auxiliary services. Government procurement is excluded, as are public entities and public retirement and social security provisions. Government subsidies, including in the form of government-supported loans, guarantees and insurance are also not subject to the chapter.

The primary obligations are standard services trade agreement fare – national treatment, most favoured nation obligations and market access. Unlike the GATS, which uses a positive listing approach, the TPP uses negative listing, so unless countries specifically schedule non-conforming measures, they are obligated to the opening as agreed, subject always to the prudential carve-out.

For cross-border trade, the ability to provide services in member countries is an obligation on specifically listed areas, generally for international insurances such as on freight; reinsurance; financial information and advisory or auxiliary financial services. Sale of these services may still be subject to registration by the seller in the country of the buyer. Member countries are not required to allow solicitation across borders. Senior management should not be required to be of a particular nationality and requirements for boards to include nationals or residents of a particular country are limited to a minority of the board.

A specific, tailored commitment on financial institutions providing cross-border portfolio management (collective investment schemes such as mutual funds) is included, as well as commitments enabling the transfer of information as well as a tailored and relatively cautious commitment opening electronic payment services for card transactions. This is cautious in that members may still impose conditions and there is a specific public policy measure exemption, but it is nevertheless a clear indication of the ambition of the agreement to support the kinds of cross-border transactions that consumers have come to expect.

The agreement also covers new financial services – requiring permission to supply on a national treatment basis, but unlike for ‘old’ financial services, allowing the receiving country to dictate the form in which such a service is provided. Consistent with the procedural safeguards embedded in the agreement, this provision includes an obligation for decisions on authorisation to be made within a reasonable period.

The TPP also includes more specific provisions, such as those imposing obligations or setting up expectations of member countries in relation to self-regulatory organisations, payment and clearing systems, expedited availability of insurance services and the performance of back-office functions.

Critically, the TPP includes a ratchet mechanism, binding future liberalisation decisions of members – in the case of cross-border trade, only from the time of the entry-into-force of the agreement, but for other key disciplines (National Treatment, MFN, Market Access and as regards key personnel) in an ongoing way. This means that any future liberalisation would be very carefully considered, because there is no scope to reverse or revert to a less liberal requirement under this mechanism.

Viet Nam has a three-year holiday from the ratchet mechanism, provided it does not withdraw a right or benefit that an organisation has taken concrete action in reliance upon – as long as 90 days’ notice is given to the other parties.

The ratchet mechanism holiday gives Viet Nam a very concrete deadline to make changes to its financial sector regulation and requirements that are less liberal than at the time of entering the agreement, while at the same time providing commercial certainty for those acting on the law as it is. The discipline of notification to the other members of the partnership throughout this process is also likely to make Vietnamese policy-makers think twice about restrictive measures as no doubt there would be significant pressure from partners to only make such changes with the most rigorous of grounds.

This is one of the mechanisms in the TPP to cater to the specific needs of developing countries, along with extended implementation periods, generous listing of non-conforming measures and limitations on the scope of coverage.

For a developing country, preserving policy space to ensure it can make appropriate adjustments to its still under-developed financial sector and to support a developing economy is essential. The TPP has seemingly successfully walked a path of putting in place trade and regulatory disciplines, while at the same time leaving space for the pursuit of policy goals and development. A consideration of Viet Nam’s various arrangements under the TPP can be instructional in this sense.

As well as the ratchet mechanism holiday, Viet Nam’s Schedule lists various non-conforming measures, including caps on total foreign equity in commercial banks at 30 per cent, and that only a Vietnamese national may be a founding shareholder of the same. Regulatory capital is required to be located in Viet Nam. Limits are also in place on the number of representative offices allowed to be established for both credit institutions and banks and residence is required for the boards of credit institutions. In terms of insurance, business must be conducted via a licensed broker or a licensed establishment in Viet Nam. Registration, depository and clearing and settlement of securities are limited to the existing Vietnamese organisation.

More interesting, however, is the policy space that Viet Nam preserves under its Section B schedule, including allowing Viet Nam to:

  • Take measures relating to the equitisation of state-owned banks and restructuring of credit institutions;

  • Grant advantages or rights to development finance institutions, co-operatives, people’s credit funds and microfinance institutions;

  • Impose a cap on the number, or restriction on the scope, of pilots of new financial services;

  • Adopt measures supporting a public purpose – such as income security, social welfare and small and medium enterprise development;

  • Adoption of any measures relating to the establishment, ownership and operation of securities markets and related infrastructure; and

  • Provide differential treatment to a foreign central securities depository with respect to its interaction with the Vietnamese depository.

These reservations give Viet Nam significant space in important policy areas, including enabling the careful facilitation of innovation and financial and economic development through piloting financial services and the support of SMEs. They will also enable Viet Nam to manage the transition from state-owned financial institutions as it sees fit as well as enabling a cautious approach to still-new central clearing authorities and take an approach to securities markets that is in Viet Nam’s interest. In a country with critical financial market infrastructure such as securities markets still in state hands, this is not unexpected.

Viet Nam provides a good example of where the particular circumstances of individual members have been accommodated to support both enhancements in financial sector regulation and broader economic and social development. It is by no means the only example – the TPP shows that with careful tailoring in the context of overarching principles of free trade and good governance, agreements can be made that accommodate diverse membership and support trade. This is particularly important in financial services – a complex, risky area for regulatory relaxation that supports and facilitates so much other trade and development.

There are similar challenges of diversity on the African continent – with financial sectors ranging from deep and broad to unsophisticated and underdeveloped, as well as economies of varying sizes, development and structure. As African countries negotiate services provisions under a continent-wide free trade agreement, considering how to allow for this and use the agreement to support rather than undermine inclusive development of financial sectors is critical. The TPP shows that it is possible to navigate this balance in a modern, detailed, rules-based trade governance instrument.

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[1] The TPP has two entry-into-force options – ratification by all members, or ratification by at least six members, covering at least 85% of the GDP of the members. That means, due to the proportion of total member GDP their individual economies make up, either the US or Japan could prevent entry-into-force by failing to ratify. While both the US and Japan have this power, Japan has consistently supported the TPP. On the other hand, the agreement has not been supported in the US Congress to date, and the two likely Presidential candidates have a non-supportive position (see for example commentary here)


Further reading

Full text of the TPP – via NZ Ministry of Foreign Affairs and Trade

Benefits to the United States of the financial services chapter

Peterson Institute – Assessing the TPP

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