I'm just back from a relaxing vacation of kayaking, eagle-watching, gun-shooting and salmon-eating, and I've got a bit of a long post stored up in me. So, you've been warned.
Before there was the New Great Depression, or whatever the latest term of art is for the current economic meltdown, there was a series of financial crises that wracked developing countries in the 1990s. And there's one NAFTA case that followed from these government responses to crises that provides a unique insight into how trade and investment treaties limit policy space in response to financial crises.
Going back to 1994, we saw Mexico's Peso Crisis, which came mere months after NAFTA went into effect. As a response, the incoming Ernesto Zedillo administration launched the Programa de Capitalización y Compra de Cartera, a financial rescue plan very similar to the packet of policies launched by the U.S. government in response to our crisis: the government bought non-performing loan portfolios from troubled banks in return for interest-generating government notes redeemable 10 years later. As a condition for participation in the program, banks had to raise additional capital from outside sources.
One of the 11 banks that participated in the program was BanCrecer, a subsidiary of a bank-holding company called Grupo Financiero BanCrecer (GFB). One of the outside sugar-daddies GFB saddled up to for capitalization was the Fireman's Fund Insurance Company (FFIC) of Novato, California. FFIC is owned by Allianz of America, a Delaware corporation owned in turn by Allianz AG of Germany. Allianz of America also owns Allianz Mexico, which in the mid 1990s was trying to ramp up some insurance business in Mexico.
So, to get Allianz's foot in the door, FFIC lent (via dollar-denominated mandatorily convertible five-year subordinated debentures issued by GFB) $50 million to GFB in September 1995. But GFB continued to have financial difficulties, and by 1998-99 was working with JP Morgan and Allianz to find a foreign corporation willing to buy BanCrecer, in coordination with Mexican regulators.
Allianz throughout was looking out for its own financial position, and by summer of 1999 was looking for an emergency parachute from the crumbling BanCrecer empire. It's best possible option appeared to be a reimbursement for the debentures along the lines of what some Mexican investors had gotten for their peso-denominated debentures around the same time period. But in August 1999, the Mexican Central Bank denied one of FFIC/ Allianz's parachute plan, and over 2000-01, BanCrecer was auctioned off to another Mexican bank and GFB began to be liquidated, in coordination with Mexican regulators.
By October 2001, FFIC had launched a NAFTA investor-state case against Mexico, claiming that its investment was expropriated by Mexico, among other claims. There are lot of ins and outs to the case (which you can read about on Todd Weiler's website here), but there are a few points (which I draw primarily from the July 2006 award) that are instructive for anyone thinking about how trade and investment treaties limit governments' policy space in crisis situations:
- Foreign subsidiaries can bring NAFTA investor-state cases against financial sector policies. In this case, a U.S. subsidiary of a German company (which, for undisclosed financial reasons, made the Mexican investment rather than the German company's Mexican subsidiary, even though it was part of the latter's expansion plans) was allowed to bring a case under a U.S.-Mexico pact. To read the tangled case history, it's clear that Allianz and FFIC were using their resources fairly interchangeably in Mexico. Yet neither Mexico nor the tribunal challenged FFIC's right to bring a NAFTA case on the grounds that it was a German subsidiary. Allianz could have also brought a case under the Germany-Mexico bilateral investment treaty (BIT), although it would have likely been for different aspects of Allianz's treatment in Mexico. In other words, corporations have a green light under current trade/investment pacts to launch cases via whatever piece of its corporate structure is most likely to win the dispute.
- At no point did the tribunal state that, as a principle, governments' crisis mitigation measures (including treatment during resolution / liquidation proceedings) are categorically off limits from investor-state panels. The tribunal did state that, as a result of economic conditions, FFIC's investment was virtually worthless, and that the specific government actions did not rise to the level of expropriation. But there was no statement of principle that investors have no right to launch cases related to these matters - on the contrary, the tribunal noted that investors do have this right, and moreover, speculated that the U.S. government (had it launched a case on FFIC/Allianz's behalf) would have won.
- This gets to the next point. The United States considered bringing a state-state case another country's financial regulations, and the tribunal speculated that it could have won such a case. It is sometimes said that governments would hold back from launching a financial regulation case because of the so-called "glass house" effect, where Country X wouldn't challenge Country Y's regs because of the possibility that Y would do the same to X. Well, the award shows that the U.S. did consider such a case, even though it would have only benefited a single, German-owned firm. Moreover, it appeared to pain the tribunal that investors couldn't bring investor-state cases for national treatment or minimum standard of treatment (NT/MST) violations under financial services chapter disciplines, because they went out of their way to say that governments could and that the tribunal would be sympathetic to such a claim.
- The NAFTA tribunal states that it believes that Mexico "did not behave appropriately" and that Mexico's actions are "a clear case of discriminatory treatment of a foreign investor." For the first "crime," the tribunal cites the fact that the Mexican government (including several non-political agencies) did not do enough to dispel a rumor that JP Morgan had circulated that the government was going to approve a certain bailout plan. In other words, Mexico's failure to put out a press release rebutting JP Morgan's claims constitutes "inappropriate" behavior, which I presume the tribunal would find as violating the MST. So, not only did the tribunal feel it was fair to apply NAFTA rules to complex financial proceedings, but went so far as to find fault with a government's decision not to put out a press release! Speaking purely from my own perspective, if I were held liable for every time I didn't put out a press release on a matter relevant to my job, I would not have a job. It seems ridiculous to judge governments, especially in developing countries, by this standard.
- Most U.S. trade and investment pacts that contain financial sector chapters have some version of a "prudential carve-out," meaning that governments can invoke prudential considerations as a defense against an investor-state or state-state case brought against government financial sector policies. The problem with this carve-out in the WTO and most U.S. bilateral investment treaties (BITS) and FTAs is that, even with the so-called carve out, prudential measures are only allowed if they are consistent with the terms of the agreement (this is often called a non-avoidance clause), which, as we have noted, are quite restrictive.
- The prudential carve-out in NAFTA is often argued to be different, and stronger, in the sense that it would read as if it could be invoked as a defense against a NAFTA case even if the prudential measure in question fell afoul of other NAFTA provisions (which, I should mention, was one reason that U.S. financial regulators cited for their support for the agreement).
- Not so, said the Fireman's panel. With absolutely no textual guidance (other than the memoirs of a U.S. negotiator who went on to work for AIG), the panel reads in a non-avoidance clause. They go on to say that investors can challenge prudential measures as expropriations, that panels can determine the reasonableness of prudential measures and decide whether they constitute expropriations or other NAFTA violations, and that the prudential carve out is not self-judging. (For good measure, the tribunal adds that, if governments don't request the formation of a Financial Services Committee, a NAFTA tribunal can automatically pick up the case.) So, the prudential carve-out of NAFTA - generally considered among the more deferential towards prudential concerns of U.S. pacts - does not really protect policy space, which suggests that agreements that more explicitly limit governments' prudential options would be even more restrictive.
In the end, Mexico won, but they had to spend years and millions of dollars defending measures they considered prudential against a German-owned firm that launched a case under a U.S.-Mexico agreement demanding over $50 million, more than the market value of their investment. Did I mention the tribunal forced Mexico to pay half the tribunal costs?
The full record of the case shows that the U.S. would have probably won if they had brought the case in a state-state panel, and that Allianz/FFIC could have won if they had bought debentures from a Mexican car company rather than bank. With countries with which we have a Model BIT, but no FTA, I think such a claim would have been successful, because there would be no financial services chapter to muck up the claim. (That is, I should mention, what mucked up FFIC's case, that their investment was in a bank and counted as regulatory capital, so it fell under the financial services chapter, rather than the bulk of the investment chapter, with its NT/MST disciplines.)
It'll be very interesting, in the ongoing debate over U.S. and other countries' bailouts, whether investor cases get triggered as a way to milk taxpayers for bad corporate luck.