Ejusdem regs

Canada and the EU’s draft trade agreement was recently leaked, and it appears to give more space to nations to regulate the financial services sector than past trade deals. (h/t @snlester) But CETA may actually introduce new problems for financial regulators.

A quick refresher: the Uruguay Round of trade talks produced the world’s first major “trade” deal that also included rules restricting what types of financial regulations countries could apply on their home turf. This obviously concerned financial regulators, who were worried that WTO adjudicators would give more weight to “trade” concerns than regulatory ones. The compromise was a “prudential measures defense” or “prudential carve-out” that a country could invoke in WTO proceedings if its financial regulations were ever challenged. The problem is that the defense is not clearly written, and may cause more problems than it solves, as I have written here and here.

The CETA drafters appear to be sensitive to this criticism, and have a lot more language emphasizing the importance of regulation. (I’ve posted the full thing below). But even the permissive language (e.g. “Each Party may determine its own appropriate level of prudential regulation”) does not mean that investors or states could not challenge that regulation once the state established it.

A few quick points.

First, the CETA text puts states back in the drivers’ seat. Other trade agreements outsource power to international courts and adjudicators, who are seen as trustees and independent interpreters of a system of rules that hold states to account. Some scholars have questioned the wisdom of this. As Eric Posner and John Yoo write,

Tribunals are likely to be ineffective when they neglect the interests of state parties and, instead, make decisions based on moral ideals, the interests of groups or individuals within a state, or the interests of states that are not parties to the dispute. The difference between our view and the conventional wisdom centers on the role of tribunal independence. A tribunal is independent when its members are institutionally separated from the state parties-when they have fixed terms and salary protection, and the tribunal itself has, by agreement, compulsory rather than consensual jurisdiction. Conventional wisdom holds that independence at the international level, like independence at the domestic level, is the key to the rule of law as well as the success of formalized international dispute resolution. We argue, by contrast, that independent tribunals pose a danger to international cooperation because they can render decisions that conflict with the interests of state parties. Indeed, states will be reluctant to use international tribunals unless they have control over the judges. On our view, independence prevents international tribunals from being effective.

In line with this type of concern, the CETA envisions giving a Financial Services Committee comprised of states a role in policing adjudicators’ work in the area.

But note that this is not a single state (like the regulating state being challenged) reasserting control, but a set of states reasserting control. This put a premium on those states agreeing with one another about appropriate financial regulation. Indeed, CETA emphasizes that regulations that reflect “common international prudential commitments” are more likely to survive challenge. Even provisions that sound deferential locate that deference with respect to the total of the signatory countries (e.g. tribunals “shall defer to the highest degree possible to regulations and practices in the Parties’ [plural] respective jurisdictions [plural]”).

What if a given state is out of line with others on desirable financial regulation? As Rawi Abdelal has written, politics and ideologies influence what is seen as good or bad financial regulation. A leftist government might want to restrict the financial sector more than international norms, and a right-leaning government may want fewer regulations or the promotion of national champion banks under the government’s control. Such a government faces a certain risk that a tribunal would see their regulation as “arbitrary”.

While CETA empowers the community of states relative to other agreements, it actually increases the burden of individual states – who now not only have to convince tribunals but also their peer states of the merits of the regulation. If there are herd mentalities among financial regulators (as David Victor and Lesley Coben have found are present in other areas of international negotiation), the optimal regulation may not be the one that most states are actually pursuing.

And just as with other agreements, tribunals retain substantial power to define terms like “prudential”, “arbitrary”, “severe” or “disproportionate”. After a tribunal evaluates all those matters, it will face the additional problem of dealing with paragraph 5 under “High level principles”. This paragraph reads that a measure that survives the other hurdle will be “deemed” compliant when it is:

– In line with our common international prudential commitments; or
– In pursuance of the resolution of a financial institution that is no longer viable or likely to be no longer viable;
– In pursuance of the recovery of a financial institution or the management of a financial institution under stress; or
– In pursuance of the preservation or the restoration of financial stability, in response to a system-wide financial crisis.

While the CETA draft is clear that its principles are not exhaustive, a tribunal would probably not see them as unlimited either. Under the “ejusdem generis” canon of interpretation, an arbitrator would look at a list like the one above, and try to infer some limiting principles. Overlooking the curious omission of the conjunction “or” in the second line, CETA seems to say that three things are prudential: policies in line with international norms, policies aimed at individual institutions, and financial crisis policies. Arbitrators would have to then define the bounds of all these terms. For example, how big is the “system” in a “system-wide financial crisis”. Can it be national or local system, or does it need to be regional or global? How precautionary can states be when seeking to avert crises?

In sum, CETA negotiators are clearly taking on board some of the concerns of financial regulators. Whether they went far enough will be determined in the court of public opinion.


Understanding between Canada and the EU Guidance on the application of Article 15.1 (Prudential Carve-out) and Article 20 (Investment Disputes in Financial Services)

The Parties recognize that prudential measures strengthen domestic financial systems, encourage sound efficient and robust institutions, markets, and infrastructure; and promote international financial stability by facilitating better-informed lending and investment decisions, improving market integrity, and reducing the risks of financial distress and contagion.

As a result, the Parties have agreed to a prudential carve-out in Article 15.1 allowing the Parties to take measures for prudential reasons, and to establish Financial Services Committee (Article 17) to act as a filter in investment disputes in financial services under Article 20.

1. The Financial Services Committee, in its role as a filter in investment disputes under Article 20, shall decide whether and, if so, to what extent the prudential carve-out is a valid defence to the claim.
2. The Parties undertake to act in good faith. Each Party shall present its position to the Financial Services Committee within 60 days of the referral to the Financial Services Committee.
3. Where the non-disputing Party notifies the Financial Services Committee within the 60 day period in paragraph (2) that it has launched its internal determination process on this matter, the timeframe in paragraph (2) is suspended until that Party notifies the Financial Services Committee of its position. A suspension beyond 6 months will be considered as a breach of the good faith undertaking.
4. Where the Respondent does not provide its position to the Financial Services Committee within the time period referred to in paragraph (2), the suspension of the time periods or proceedings referred to in paragraph 4 of Article 20 shall no longer apply and the investor may proceed with its claim.
5. Where the Financial Services Committee is unable to agree on a joint determination within 60 days in relation to a specific investor-to-state dispute concerning a prudential measure, the Financial Services Committee shall refer the matter to the CETA Trade Committee. This period of 60 days shall commence from the moment the Financial Services Committee receives the positions of the Parties pursuant to paragraph (2).
6. The joint determination of the Financial Services Committee or the CETA Trade Committee shall be binding on the Tribunal only in the case in question. The joint determination shall not constitute a binding precedent for the Parties with respect to definition and application of the prudential carve-out or other terms of this Agreement.
7. Unless the CETA Trade Committee otherwise decides, should the CETA Trade Committee not reach an agreement within 3 months of a referral of the matter by the Financial Services Committee pursuant to paragraph (5), each Party shall make its position available to the Tribunal arbitrating that particular dispute. The Tribunal shall take account of this record in reaching a decision.

High level principles:

The Parties agree that the application of Article 15.1 by the Parties and by tribunals should be guided by the following principles, which are not exhaustive:

1. Each Party may determine its own appropriate level of prudential regulation. Specifically a Party may establish and enforce measures that provide a higher level of prudential protection than those set out in common international prudential commitments.
2. Relevant considerations in determining whether a measure meets the requirements of Article 15.1 include the extent to which a measure may be required by the urgency of the situation and the information available to the Party at the time when the measure was adopted.
3. Given the highly specialized nature of prudential regulation, those applying these principles shall defer to the highest degree possible to regulations and practices in the Parties’ respective jurisdictions and to the decisions and factual determinations, including risk assessments, made by financial regulatory authorities.

(a) Except as provided in paragraph (b), a measure is deemed to meet the requirements of Article 15.1 where it:
(i) has a prudential objective; and
(ii) is not so severe in light of its purpose that it is manifestly disproportionate to the attainment of its objective.

(b) A measure that otherwise meets the requirements of paragraph (a) does not meet the requirements of Article 15.1 where it is a disguised restriction on foreign investment or an arbitrary or unjustifiable discrimination between investors in like situations.

5. Provided that a measure is not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between investors in like situations, or a disguised restriction on foreign investment, that measure is deemed to meet the requirements of Article 15.1 where that measure is:
– In line with our common international prudential commitments; or
– In pursuance of the resolution of a financial institution that is no longer viable or likely to be no longer viable;
– In pursuance of the recovery of a financial institution or the management of a financial institution under stress; or
– In pursuance of the preservation or the restoration of financial stability, in response to a system-wide financial crisis.

Periodic Review

The Financial Services Committee may, by agreement of both Parties, amend this Understanding at any time. The Financial Services Committee should review this Understanding at least every two years.

In this context, the Financial Services Committee may develop a common understanding on the application of Article 15.1 (Prudential Carve-out), on the basis of the dialogue and discussions held in the Committee in relation to specific disputes and mindful of common international prudential commitments.

Understanding on the dialogue on the regulation of the financial services sector

The Parties reaffirm their commitment to strengthening financial stability. The dialogue on the regulation of the financial services sector within the Financial Services Committee [established by Article X…] shall be based on the principles and prudential standards agreed at multilateral level. The Parties undertake to focus the discussion on issues with cross-border impact, such as cross-border trade in securities (including the possibility of taking further commitments on portfolio management), the respective frameworks for covered bonds and for collateral requirements in reinsurance, and discuss issues related to the operation of branches.


[UPDATE 9/1/14: Due to an editing error, the earlier post did not contain the prudential measures defense text itself, just the supplementary annexes. Here it is.


1. Nothing in this Agreement shall prevent a Party from adopting or maintaining reasonable measures for prudential reasons, including:

(a) the protection of investors, depositors, policy-holders or persons to whom a fiduciary duty is owed by a Financial Institution, or cross-border financial service supplier or financial service supplier;

(b) the maintenance of the safety, soundness, integrity or financial responsibility of a financial Institution, cross-border financial service supplier or financial service supplier; or

(c) ensuring the integrity and stability of a Party’s financial system.

2. Without prejudice to other means of prudential regulation of cross-border trade in financial services, a Party may require the registration of cross-border financial service suppliers of the other Party and of financial instruments.

3. Subject to Article X (National Treatment) and Article Y (Most Favoured Nation Treatment), a Party may, for prudential reasons, prohibit a particular financial service or activity. Such a prohibition may not apply to all financial services or to a complete financial services sub-sector, such as banking.

As Simon Lester notes here, the removal of the second sentence from the WTO language appears to be a major concession towards regulatory space. Of course, the altered core prudential measures defense would be interpreted in conjunction with all the other new language that I outlined above – which could create some new concerns.

Moreover, Article 15.3 appears to put some different types of restriction on countries’ ability to ban certain financial services. I highly doubt this new restriction will matter to any actually existing or potential CETA member: I haven’t heard too many (read: any) proposals to ban all finance or all banking. A problem would more plausibly arise if a “complete… sub-sector” were interpreted to mean “high frequency trading” or “credit default swaps” – an interpretation of the treaty language that would be difficult to support.]

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