Ashly Hope, tralac Research Advisor, comments on financial regulation and the PCO in the WTO General Agreement on Trade in Services (GATS)

Many countries in Africa are in the midst of implementing new financial regulation to achieve greater compliance with international standards, facilitate innovation, develop their financial sectors and promote greater financial inclusion.

As part of this, it is critical to ensure that those standards do not breach trade commitments, create barriers to future commitments or otherwise create barriers to trade in financial services – or at least, if they do this is with a conscious and careful analysis of the consequences of doing so.

A recent WTO dispute reminds us that although financial regulation is considered to largely be domain of regulators, national governments and technocratic international organisations, trade law has an important role. In this dispute, Argentina – Financial Services, a WTO Panel considered, for the first time, the prudential carve-out (PCO) in the GATS.

The prudential carve-out gives national governments freedom to regulate the financial sector for prudential reasons, notwithstanding any commitments made under the GATS. Until now, the nature and extent of that freedom has not been tested.

The consideration of the PCO was in respect to two financial sector measures that created different entry regimes for those suppliers in ‘cooperative jurisdictions’ and ‘non-cooperative jurisdictions’ – cooperation being in respect of tax information sharing.

In considering whether the two measures[1] were consistent with the GATS by way of the PCO, while otherwise inconsistent with the agreement, the Panel set out the following legal standard –

1. that the measures were measures “affecting the supply of financial services”;

2. that the measures were taken “for prudential reasons”; and

3. that the measures had not been used “as a means of avoiding [Argentina’s] commitments or obligations” under the GATS.

Although subject to appeal on several aspects, the Appellate Body did not overturn the panel’s conclusions on the PCO, and as such, the legal standard established by the panel stands.

Applying this standard, consistent with Argentina’s and several third party submissions (European Union, the USA and Australia), the Panel found that contrary to Panama’s submissions, the PCO was intended to be a broad carve-out, and would not apply exclusively to domestic regulation in the sense of the domestic regulation chapter, would not only apply to measures taken in response to imminent risks and nor would it only apply to those measures taken in the context of international prudential standards. In applying the standard, one important distinction that the Panel made was a difference between prudential measures, and measures taken for prudential reasons – giving a broad discretion for national governments to decide what their own prudential reasons were.

Despite the Panel’s deference to national governments to determine the prudential motivations that they choose to pursue, the Panel found that the measures in question were not designed rationally to serve the stated prudential reasons. This seemed to hinge on the fact that while the prudential reasons (stability, consumer protection) were valid, and the information access that the regulations purported to offer would have that ‘rational relationship of cause and effect’, the measures did not actually give the information exchange that the Argentinian authorities sought.

This broad interpretation would likely see financial regulators breathing a sigh of relief. The decision represents a balance – leaving regulators and national governments space to interpret prudential reasons as they so wish – while placing the burden the proof on the country taking the measure to show both the reason, and that there is a rational connection between the reason and the measure.

However, although the third arm in the legal standard was articulated by the Panel, by ruling that the measures were not for prudential reasons, they avoided deciding on, and were not minded to speculate as to whether the measures had been used as avoiding Argentina’s commitments under the GATS. This leaves significant scope for further jurisprudence and judicial consideration.

As Andrew Cornford points out, it also remains to be seen whether the carve-out extends to macro‑prudential policies, such as capital flow measures. In an area where trade rules arguably do not reflect the nuance of contemporary international discussions on liberalization, these measures, although potentially implemented for prudential reasons might run into difficulties satisfying the anti-avoidance clause.

Perhaps, however, a major factor in the absence of disputes on this provision stems from other provisions in the financial services annex – namely the cooperation and mutual recognition provisions – combined with a relatively well-established international regulatory fraternity meaning little support among regulators and perhaps, therefore, governments for challenging the prudential regulation of their peers. We may therefore be unlikely to see further disputes. Nevertheless, subtler regulatory implications tend to (and are intended to) flow from these international commitments and the interpretation of their application is critical to that.

Financial services is one of the most widely committed areas for African countries under the GATS meaning this decision can have a direct impact on regulatory policy making. Financial services, as one of the key services negotiated or being negotiated by the RECS, will likely form part of continental negotiations – meaning negotiators will need to consider the scope and language of a carve-out that would support African integration – balancing prudential regulatory space with enough regulatory ‘chill’ to discourage disguised protection. This would be particularly important if investor-state dispute resolution is included in the agreement and applied to financial services.

A number of alternative approaches to the GATS PCO have been used in other trade and investment agreements – both narrowing (for example, in Canada’s FIPAs) or attempting to clarify or widen the exception (for example, in the US-Korea FTA and in the leaked TiSA text).

In the regional context, the recently concluded SADC-EU EPA provides for further cooperation in services. As negotiations on services progresses, it is worth considering that the EU has a history of sometimes including more restrictive drafting than the GATS PCO. For example, the EU-Singapore PTA, provides that prudential measures ‘shall not be more burdensome than necessary to achieve their aim’, and that they ‘shall not constitute a means of arbitrary or unjustifiable discrimination against financial service suppliers of the other Party’ and there is similar language in other agreements. This kind of language may significantly restrict the scope of the PCO as compared with its GATS counterpart, which offers a full carve-out from the GATS obligations – including national treatment.

In addition, the ‘no more burdensome than necessary’ language could significantly restrict the ability of national regulators to take measures for prudential reasons. It is unclear how restrictive this test is, but there may well be more opportunity for a financial services provider to challenge the regulation of a host country, or potential host country under this test. Although we might expect an arbitrator to still consider the regulator/government’s autonomy to identify the particular aim of any regulation in question (as the panel did in the Argentina – Financial Services case), the scrutiny of how that measure addresses the aim could certainly be much more intensive – not just assessing whether the measure is for the purpose, but also whether that particular measure is the least restrictive way of achieving such purpose.

This perhaps provides an unwelcome intrusion on regulatory autonomy, although provided interpreters of this provision allow governments and regulators autonomy to choose the aim (which on the face of the language, and in the context of the GATS Panel interpretation, they should) the no more burdensome than necessary test merely inserts a principle of good regulatory practice into the trade agreement – one that regulations should abide by in any case. Nevertheless, the distinctions between the variously worded PCOs are worth considering carefully – particularly where, as in this case the vast bulk of financial service providers – and therefore potential challengers to regulation – would be from one party (i.e. the EU).

In contrast, while the drafting of the carve-out is also important when negotiating between the diverse regulatory environments in the African financial sectors, in continental negotiations, with a goal of greater integration, and given the relatively broad reading of the GATS provision, more attention should be on regulatory cooperation and recognition.

Tell us what you think.

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Sources/Additional Reading

The dispute: https://www.wto.org/english/tratop_e/dispu_e/cases_e/ds453_e.htm

Andrew Cornford ‘Coverage of prudential measures in the GATS: some conclusions of a WTO Appellate Body’ (Paper presented at the UNCTAD Multi-year Expert Meeting on Trade, Services and Development, fourth session 18-20 May 2016, Geneva, Switzerland) UNCTAD Website: http://unctad.org/meetings/en/Presentation/c1mem4_2016_p206_Paper_A%20Cornford_en.pdf

Inu Barbaree and Simon Lester ‘Financial Services in the TTIP: Making the prudential exception work’ Georgetown Journal of International Law 45 (2014): 953-970

Carlos Cantore ‘Shelter from the Storm’: Exploring the scope of the application and legal function of the GATS Prudential Carve-Out’ Journal of World Trade 48, no.6 (2014): 1223-1246

Sidley Update ‘WTO Ruling Clarifies Flexibility in Member Governments’ Regulation of Financial Services’ http://www.sidley.com/~/media/update-pdfs/2016/04/20160420-international-trade-update.pdf 20 April 2016.

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