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The #TPP text reveals some subtle shifts in governments’ approach to financial and investment regulation in trade deals.

For the uninitiated, the text for the 12-nation Trans-Pacific Partnership (TPP) has been kept secret for years. Yesterday, the governments dumped 30 plus chapters into the public domain.

The “green flag” has supposedly been waved for the debate to begin. As someone with the rare and terminal condition of having read many trade agreement texts, I was skeptical that a public text would add up to many changed positions. That’s in part because trade debates are often more about politics than substance, and in part because these texts don’t vary that much.

For example, investor-state dispute settlement (ISDS) is the most important institutional innovation in recent trade pacts. This allows foreign investors to challenge host government regulations for cash compensation outside of national courts. While lawyers pay a lot of attention to how the fine print of these pacts vary, the fundamental governance aspects of ISDS (ad hoc tribunals, no appeals, cash remedies, ample treaty shopping opportunities) are remarkably constant over 3,000 plus pacts around the globe. TPP is no exception.

Nonetheless, there is some variance at the margins. I took a look at the TPP’s investment chapter, financial services chapter, and a general exception related to balance of payments. For the wonky at heart, here is a quick and dirty run-down of the changes relative to past pacts and texts (memo – Pro-state and pro-investor changes in TPP).

Apologies in advance, as I make no real attempt to explicate anything in much detail. The audience is probably only those people who really care about the difference between the final TPP text (on the one hand), and (on the other) leaked text from January 2015, Korea FTA (Obama’s most recent major trade deal), and the WTO’s services agreement. Let me know if I have gotten anything wrong.

I group the textual changes into a few buckets: pro-investor, pro-state, mixed/cosmetic, and pro-contract norms. I include the latter as a separate category because some investment tribunals have allowed free-floating treaty obligations to substitute for specific obligations that specific states and specific investors hammered out with each other. (This divergence is important for both normative and empirical reasons, as one of the supposed channels connecting treaties to economic growth is through promoting contract sanctity.)

Ecuador has been partially relieved of its debt to Occidental in an annulment of the largest investor-state award ever.

Back in 2012, an arbitral tribunal at ICSID (the World Bank arbitration facility) ordered Ecuador to pay Occidental nearly $1.8 billion for the country’s natural resource policy changes. This was the largest award ever for an investment treaty claim,* as I noted at the time. This amounted to several percentage points of the country’s national income, and 79 times greater that US foreign aid to the developing nation. Ecuador immediately applied for annulment of the tribunal’s decision.

A bit of background: when a company brings an investor-state lawsuit, the case is decided in the first instance by a panel of three arbitrators. Typically, the investor appoints one, the state a second, and the two arbitrators (or litigants) agree on a third. In contrast, annulment committees are appointed by the World Bank president – who is currently Jim Yong Kim, an Obama appointee. In theory, this second level is more subject to state control – as state appointees run the World Bank. In practice, annulment is a very limited form of appeal that has only been successfully invoked by states a handful of times over hundreds of cases.

Today, the annulment committee sided with part of Ecuador’s appeal. Specifically, they aligned themselves with a dissenting opinion by Brigitte Stern – the state-appointed arbitrator in the original tribunal. As Luke Eric Peterson at IAReporter.Com notes, Stern’s dissenting opinion was so specifically laid out that it virtually constituted a roadmap for how to annul the case.

On the one hand, the ruling is by far the most economically and substantive annulment action in ICSID history. It also shows that dissents matter. Even when states don’t win a case, today’s decision shows that convincing even one of the three arbitrators on even part of the sovereign defenses – and then getting that arbitrator to dissent – can matter for case outcomes.

On the other, the annulment committee was careful to leave most of the tribunal’s award intact. Today’s decision reduced the damages owed by Ecuador to a bit over $1 billion – or a third of Occidental’s original $3 billion request. That still constitutes over a percentage point of Ecuador’s 2012 GDP.

More importantly, the tribunal did not side with any of Ecuador’s broader political and economic arguments about its national sovereignty. Indeed, the tribunal maintained that Ecuador had done nearly $2 billion in damage, but that Occidental wasn’t owed all of it. As today’s decision read,

Occidental “had transferred 40% of its interest to a third party, initially the Bermudan company AEC, which thereafter sold it to the Chinese company Andes”…

The extent and scope of Claimants’ investments is more than a purely legal issue, relevant only for the calculation of damages in this case. It has wider repercussions, touching on the natural tension between general principles of equality and equity vis-à-vis the jurisdictional scope of ICSID arbitration. This tension is inbuilt in a legal system which only protects investments held by investors of a certain nationality, covered by a specific BIT, but denies protection to other investors, including domestic investors.

(As I wrote here, the jurisdiction of investment tribunals are not as narrow as this quote suggests. Nonetheless, it is undeniable that a tribunal should not be awarding damages to parties not involved in the litigation in question – and especially not awarding their damages to the claimant.)

Indeed, today’s decision is arguably a very pro-investor decision, in two ways.

First, the original tribunal unanimously declared that Ecuador’s “administrative goal[s] must be balanced against the Claimants’ own interests”. While such so-called proportionality analysis has precedent in legal systems, this was the most significant application of it to investment arbitration. It effectively declares that governments must always be on the lookout to make regulations less onerous on foreign investors. Today’s decision reads:

Ecuador … argues that the Tribunal has manifestly exceeded its powers because the principle of proportionality is allegedly not encompassed in the Participation Contract, Ecuadorian law, or in customary international law.

The argument cannot succeed, because the standard for annulment in allegations of misapplication or misinterpretation of law applicable to the merits is especially high: only exceptionally gross or egregious errors of law could be construed to amount to a failure to apply the proper law to the merits, and could give rise to the possibility of annulment. The Tribunal has not committed any gross or egregious error of law.

In other words, the committee will not second-guess a tribunal’s re-visioning of the very content of investment treaties.

So annulment committees are supposed to be modest…

…Except when they choose not to be.

Second, annulment is meant to be a blunt instrument. Annulment committees can vote up or down on the whole award of the original tribunal. They can vote up or down on specific paragraphs. They have not traditionally been willing to revisit the merits of decisions, or edit and revise specific tribunal conclusions. Under that old paradigm, the annulment committee would have ix-nayed a specific paragraph on damages, and the investor would have had to re-litigate the whole case to get a second tribunal to insert a new amount of damages. Today’s annulment committee struck out in a pro-investor direction by saving them from this step, and simply inserting in a revised damage calculation:

The next question to be addressed is whether the Committee is authorized to substitute the annulled figure of damages with the correct number, or whether this task must be entrusted to a new investment tribunal. The parties have discussed this issue, and while Respondent favours the constitution of a new tribunal, Claimants have accepted that in the proper circumstances annulment committees are authorized to insert correct data in partially annulled decisions.

The Committee concurs with Claimants.

It is true that annulment committees are not empowered to amend or replace awards. But this is not the task at hand. What is required in this case, in which the Committee is partially annulling the Award, is for the Annulment Committee to substitute the Tribunal’s figure of damages with the correct one. If this task can be performed without further submissions from the Parties and without additional marshalling of evidence, committees should be entitled to do so. Basic reasons of procedural economy speak in favour of this solution. There is no need for the parties to incur the additional cost and delay of going through a second investment arbitration, when the correct number can be inserted by the annulment committee, after performing a very simple arithmetic calculation and without further input from the parties.

In short, from a quick reading of the annulment committee decision and Stern’s original dissenting opinion, today’s events are not so much a statist remaking of investment arbitration. Instead, they constitute a pretty legalistic and conservative application of property rights by a state appointee dissenter. This was in turn adopted by an annulment committee that was modest (as to the state’s further claims) and ambitious (as to the investor’s further claims).

Nonetheless, the decision is remarkable. Annulment almost never happens, so the mere occurrence is noteworthy – as it a dissent actually mattering in some way. Ecuador will breathe easier, to the tune of nearly $1 billion.

Read the annulment decision here. HT IAReporter.Com.

++++++++++++++

* Another case, Eureko v. Poland, reportedly produced a larger nominal state-to-investor payment – although this was in the form of a post-award settlement.

The fifth and final lesson from last month’s World Trade Organization ruling against Argentina’s anti-tax haven policies is:

Naming is (or should be) half the battle.

When countries have disputes over goods trade, it’s relatively straightforward what to compare. If my country makes cars, and your country keeps them out in favor of your nation’s carmakers, then you are discriminating against LIKE goods.

In services trade, matters are less clear. Is a haircut by an expert stylist LIKE a haircut from your dad, who uses a razor he got in the 1970s from Sears Roebuck? Is a haircut by someone who doesn’t speak your language (and so can’t understand your style preferences) the same as someone who does? Is a haircut in a place that doesn’t regulate and license barbers like a haircut from a barber that had to pass aptitude exams? The opportunity for qualitative distinctions in the services arena is  limited only by your zest for Seinfeld-ian discursions.

It is unsurprising, then, that disputes under the WTO’s General Agreement on Trade in Services end up coming down to how the service is characterized. When the gambling haven Antigua challenged the US Internet gambling ban, the island’s lawyers had to show that the US GATS commitment in “recreational services” implicitly included “gambling services”. The US had to contest that claim. They also had to try to convince WTO adjudicators that “gambling via the Internet” was not like “gambling in a brick and mortar casino”, as the latter is easier to regulate.

What is surprising, however, is how little attention WTO panelists dedicated to likeness in their recent ruling against Argentina.

Continue reading “WTaxO Lesson #5: Name It” →

Hillary Clinton made waves yesterday by announcing her opposition to the Trans-Pacific Partnership, or TPP.

As Simon Lester notes, her opposition seems to be based on two issues: the TPP’s lack of disciplines on currency manipulation and some of the pharmaceutical provisions.

Where does Hillary stand on investor-state dispute settlement, or ISDS – one of the most controversial provisions in the TPP?

The campaign has not yet announced a position, but the candidate has made statements in the past that give some hints.

As HuffPo has reported, her 2014 book Hard Choices has the following passage:

Currently the United States is negotiating comprehensive agreements with eleven countries in Asia and in North and South America, and with the European Union. We should be focused on ending currency manipulation, environmental destruction, and miserable working conditions in developing countries, as well as harmonizing regulations with the EU. And we should avoid some of the provisions sought by business interests, including our own, like giving them or their investors the power to sue foreign governments to weaken their environmental and public health rules, as Philip Morris is already trying to do in Australia. The United States should be advocating a level and fair playing field, not special favors. (Emphasis added.)

Seems very critical, especially the framing of investor rights as “special favors”.

Continue reading “What does Hillary Clinton think of #ISDS in #TPP?” →

The fourth lesson from last week’s World Trade Organization’s ruling against Argentina’s anti-tax haven policies is:

Use your defenses; that’s what they are there for.

One of the key issues litigated in the case was the meaning of a defense for prudential measures under the WTO’s General Agreement on Trade in Services (GATS).

The clause appears to be more broadly worded than other defenses that countries have against violating their WTO commitments. It reads:

Notwithstanding 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.  Where such measures do not conform with the provisions of the Agreement, they shall not be used as a means of avoiding the Member’s commitments or obligations under the Agreement.

I had long warned that this prudential measures defense (PMD) language could be problematic from a regulatory perspective: does the second sentence cancel out the first?

From the US’ oral statements to the recent WTO panel, it is clear the US did NOT want an answer to the question…

Continue reading “WTaxO Lesson #4: Use Your Defenses” →

I have a piece in today’s Washington Post Monkey Cage based on my PhD research.

Here’s the lede:

With the conclusion of negotiations in Atlanta on the Trans-Pacific Partnership (TPP), we will soon have texts to look at, and, eventually, a vote in Congress. It’s the biggest deal in trade politics in several years. It will be widely covered in the media against the backdrop of the presidential election — where many candidates, both Republicans and Democrats, are touting their TPP opposition.

The vote on Fast Track Trade Promotion authority earlier this year showed that opponents of trade deals can get within striking distance of a win in the House of Representatives. In the final vote, it passed by only 219-211. The administration will have to hold on to roughly the number of votes it got then, and opponents will try to get a few to flip.

One sticking point will be the agreement’s chapter on investor-state dispute settlement (ISDS).

If you want to read the full thing, including this bizarro graph below that I made to look like a Christmas tree, head on over to the Monkey Cage site.

A third takeaway from this week’s World Trade Organization’s ruling against Argentina’s anti-tax haven policies is:

Proving protectionism doesn’t require statistics or demonstrated injury.

One would think that a body tasked with enforcing open trade would have a very clear and consistent methodology for examining trade impact. Not so.

When development economists talk about trade disputes and protectionism, they think of situations where:

1. there is an actual good or service
2. from the complaining country
3. being harmed in the challenged host country
4. in a significant
5. and demonstrable way
6. to the benefit of host country providers
7. that sell the same thing.

As it happens, this is also consonant with part of the broader justification for trade agreements: create legal penalties that can deter countries from injuring one another. Less conflict, more peace – everybody wins.

As I write in this book chapter, the WTO has developed an odd approach to evaluating trade distortions. Instead of a more traditional economic analysis of protectionism, the panel report released this week used a “conditions of competition” (COC) framework. This was developed by trade lawyers over many WTO cases.

Here, there needn’t be suppliers or goods present in the host country – the logic being that the protectionism might be so bad that they the foreign products don’t get into the local market in the first place. That has a certain appeal. (Although mostly in the the case where a country is blocking market access (which was not the case here).

Where I get lost is the rest of the formulation. Under COC, no amount of discrimination is too little to be a violation, and it needn’t be proven that the discrimination generates a tangible benefit reaped by any identified domestic interest. What products or services get compared in the likeness tests is a freewheeling enterprise with substantial discretion for panelists.

The recent WTO decision revealed some of the quirks of COC. Continue reading “WTaxO Lesson #3: Trade Without Stats” →

A second takeaway from yesterday’s World Trade Organization’s ruling against Argentina’s anti-tax haven policies is:

Trade lawyers won’t solve your regime complex problems. As political scientists Kal Raustiala and David Victor write in their classic article on regime complexes:

Regime complexes are marked by the existence of several legal agreements that are created and maintained in distinct fora with participation of different sets of actors. The rules in these elemental regimes functionally overlap, yet there is no agreed upon hierarchy for resolving conflicts between rules. Disaggregated decision making in the international legal system means that agreements reached in one forum do not automatically extend to, or clearly trump, agreements developed in other forums. We contend that regime complexes evolve in ways that are distinct from decomposable single regimes.

Trade is an example of a regime complex. As WTO cases continue to be brought on more areas of non-trade law (like financial services and taxation), the potential for conflict between trade and non-trade obligations grows.

With yesterday’s ruling, the WTO is trying to allay fears that trade obligations necessarily threaten other forms of international and national regulation. Indeed, the WTO panel conceded that tax justice was an important goal throughout their entire analysis. The panelists extensively cited papers by the G-20, United Nations and other bodies on the importance of tax justice. (Interestingly, the panel also approvingly cited the US and Europe’s interpretations on almost every contentious point – as if to signal that they were allowing the WTO to evolve in a way consonant with the views of its most powerful members.)

One reading of their decision was a critique of Argentina for not doing ENOUGH for tax justice. Arguably, if Argentina had not exempted Panama from its sanction regimes, the Kirchners would have won their case. If correct, this is an example of two elements in a regime complex being harmonized: trade needn’t trump tax justice.

I’m a bit skeptical of this reading, for two reasons.

First, we’d be hard pressed to identify regulations in any country so flawless, that so perfectly achieve their objectives, that enterprising complainants and WTO panelists couldn’t find fault with them. That’s not a defense of bad policy-making, but it is policy realism.

And that gets to my second reason. While some elements in a regime complex can be harmonized with each other (in this case tax justice and trade), not all elements can be. For example, countries might simultaneously want to ensure tax justice, have viable trading rules, and also diplomatically reward countries that are cooperative. The WTO decision (arguably) harmonizes the first two objectives, but not the last one.

There are five major legal/policy takeaways from yesterday’s World Trade Organization’s ruling against Argentina’s anti-tax haven policies. I am going to post them separately over the next few days. The first takeaway is:

Financial services defenses are not that different from other defenses.Old WTO hands know that countries with services trade commitments benefit from general exceptions and specific defenses. Argentina invoked both for different aspects of its anti-tax avoidance regime, to no success.

Examples of general exceptions include the right to break your WTO commitments if necessary for certain law enforcement or taxation purposes (WTO General Agreement on Trade in Services Article XIV(c) and XIV(d) respectively). Specific defenses include the hitherto uninterpreted prudential measures defense (PMD, in the GATS Annex on Financial Services).

From the plain text, the general exceptions seem to be much harder to use. For instance, a country invoking XIV(c) must show that:

1. The law they are trying to enforce is not itself GATS inconsistent;
2. The measure they are using to enforce the law is designed to do so;
3. The measure is “necessary” to enforce the law, which in turn requires showing that: a) the measure’s policy objective is important; b) the measure contributes to fulfilling the objective; and c) the measure reduces trade as little as possible. WTO panels “weigh and balance” these different factors. The second test involves a lot of discretion, as it involves assessing whether the measure does what it says it does and how much it helps (in the case law, it’s a gray area between more than marginally but not necessarily indispensably);
4. Any alternative measures the complainant suggests do not better achieve the objective in less trade restrictive fashion;
5. The “measures are not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where like conditions prevail, or a disguised restriction on trade in services”. Note the use of “or”, so any of the above could do the measure in. (See paragraphs 7,614-.764 for discussion.)

In contrast to this nine-hurdle ropes course, the PMD merely states that members “shall not be prevented from taking measures for prudential reasons”. This would seem to be an easier test to meet.

Not so, as it turns out. The panel (at paras 7.808-.949) was surprisingly willing to consider a very wide range of policies “prudential”, including long-term and short-term, responsive and preemptive.

Where Argentina got stuck was on the word “for”. As I mentioned in yesterday’s post, Argentina goes after tax havens through the stick of sanctions, coupled with the carrot of being removed from the list once the tax haven comes to the negotiating table. As a consequence, the world is divided up into non-tax havens (who aren’t sanctioned), tax havens (who are sanctioned) and tax havens in the process of cleaning up their act (who aren’t sanctioned). By implication, groups in the third category are treated better than the second – despite no difference in tax transparency.

The panel argued that the word “for” implied essentially the test at 3(b) above, namely that there had to be a “rational relationship of cause and effect” between the measure and the prudential objective (para. 7.942). Indeed, in some ways, the test is harsher than the standard GATS analysis, as the panel did not look at the degree of goal achievement. In their assessment, any inconsistency in a tax justice framework rendered the whole thing null.

(The panel did not even get to the PMD hurdle that myself and others had warned was the harsher hurdle, the requirement that prudential measures “not be used as a means of avoiding” WTO obligations.)

In short, while finance seems to benefit from additional protections at the WTO, it ain’t necessarily so.

Tax justice and diplomacy were pitted against one another in today’s World Trade Organization ruling. Diplomacy was a clear loser, but tax justice was not an unambiguous winner.

The bad news first. For years, the Kirchner administration had been gradually expanding its efforts to go after offshore jurisdictions that entice Argentine customers with low or no tax. The government argued that these countries cost the treasury, upset financial stability, and facilitate criminal and terrorist money laundering. In 2012, Panama – a leading tax haven and target of these policies – complained to the WTO. The three WTO panelists assigned to the case (Pierre Pettigrew of Canada, Gonzalo de las Casas of Peru, and Rodrigo Valenzuela of Chile) sided with Panama, finding that Argentina’s policies violated the WTO’s most-favored nation (MFN) rules.

The good news: the panelists found that – at least in theory –  defenses in the WTO’s rules allow a country to go after tax havens even when these violate MFN. Some of these defenses – like one covering prudential policies in financial services markets – had seemed to be worded so as to be useless. Pettigrew and company brought some welcome clarity and strength to those vaguely worded provisions.

The mixed news is that Argentina did not qualify for these defenses.The reason? In an effort to improve diplomatic relations and defuse the trade fight, Argentina launched negotiations with Panama in November 2013 to sign a tax cooperation agreement. Under Argentine law, countries that make these good faith efforts are removed from the sanction list. The WTO panel concluded that Argentina’s lenience with Panama had weakened the sanction regime, meaning it couldn’t qualify for the defense. I guess nice guys do always lose!

This is just the latest in a string of WTO cases that try to balance trade promotion and regulatory sovereignty, and come up with a weird mix. In 2012, the US lost a case over anti-smoking policies because it both hampered trade too much and protected health too little. These rulings gives regulators hope that trade law won’t interfere with their work. But they also cause headaches. WTO panels – perhaps to find a way to give complaining countries a win – have found something to dislike in the specific way a country regulated. The result is legal and policy-making uncertainty.

I’ll have more things to say about the case in the coming days.