LOLR Exception, LOL?

I got several comments and questions following yesterday's post on capital requirements and WTO obligations. One commenter asked about whether Federal Reserve actions are carved out of the GATS, and another pointed out that the WTO has put out a 1998 document further classifying regulatory measures into a taxonomy by GATS applicability. Both questions highlight the uncertainty surrounding overly intrusive WTO/ GATS obligations.

The first commenter noted that, according to GATS Annex Article 1(b)(i), "activities conducted by a central bank or monetary authority or by any other public entity in pursuit of monetary or exchange rate policies" are unlikely to be covered by GATS obligations.

Here's my take on this:

1. It's debatable whether many of the policies the Fed has been pursuing are strictly related to exchange rate or monetary policy. In the instances of Bear Stearns and AIG bailouts, we're straying pretty far from directly influencing the monetary base. From the perspective of the JP Morgans of the world, the policies from 2007-present were as much as anything about eliminating their competition, and expanding market share.
2. The Obama administration appears to be aware that Fed prudential banking regulation (as opposed to Fed monetary base-affecting policies) could be covered by trade and other pacts. In the recent recovery plan document, the administration instructed the Fed that they “should also consider the implications of [certain regulatory] determinations for international agreements negotiated by the executive branch”.
3. Some of the bailout programs are run through the Fed, but many are run out of the political agencies, like Treasury. In particular, the Troubled Asset Relief Program and various guarantee programs - which have the heaviest subsidy component of any of the 30-odd bailout programs - are run by FDIC and Treasury. In my read, there is no broad carveout in the GATS, Annex, Understanding, or U.S. schedule for these aspects of the bailout. (Indeed, the U.S. horizontal reservation for subsidies is fairly limited for Mode 3, and the policies that are reserved wouldn't seem to apply to Treasury subsidies under the TARP.) Now, the Annex's Article 1(b)(iii) carves out "other activities conducted by a public entity for the account or with the guarantee or using the financial resources of the Government" except if they are supplied in competition with the private sector. The issue here is that Treasury has been doing precisely what many private firms do: investment, lending and guarantees. Since both Treasury and private firms were performing the same types of functions at the same time, it'd be hard to say this wasn't a form of competition.
4. The Understanding Article C(1) imposes an obligation to offer access to official funding facilities on a national treatment basis:

"Under terms and conditions that accord national treatment, each Member shall grant to financial service suppliers of any other Member established in its territory access to payment and clearing systems operated by public entities, and to official funding and refinancing facilities available in the normal course of ordinary business.  This paragraph is not intended to confer access to the Member’s lender of last resort facilities." 

It's not clear where the line between "official funding and refinancing facilities available in the normal course of ordinary business" ends and " lender of last resort facilities" begins. Some of the bailout programs may fall on one side, others on another. I would say that Treasury and FDIC-run programs would probably not be LOLR facilities. It's possible that some of the Fed programs would not be considered such either.

While I've discussed past bailout programs, the same general points would apply to future proposals. However, Geithner and company may be making a calculation that putting more programs in the Fed would make it more likely that they would qualify for an Annex 1(b)(i) exception - whether or not these programs are central to the Fed's mandate. (There are of course many other arguments for and against centralizing power in the Fed, which I won't get into here.) Many progressive groups in the U.S. are pushing for fewer of the programs to be put in the Fed's exclusive jurisdiction, so these are muddy waters indeed. We'll have more to say on this at a future date.

As for the second intervention, let me just quote from the 1998 document in question, which says there are:

four types of government intervention or involvement that could have an impact on the financial services sector, which were (i) macroeconomic policy management, (ii) prudential regulations, (iii) non-prudential regulation to pursue various public policy objectives other than that falling under (iv), and (iv) trade restrictions concerning market access or national treatment.  Under the GATS, item (ii) is dealt with by paragraph 2 of the Annex on Financial Services, and (iii) by Article VI.  Item (iv) is dealt with by Articles XVI and XVII.

These secretariat documents should not be construed as binding interpretation, but they do provide some interesting fodder for contemplation. I see several main issues:

1. Regardless of which category a measure falls under, there is no guarantee that a tribunal would still not see it as violating GATS obligations.
2. The limit cases are what is tricky: where does macroprudential regulation fall? How would a tribunal rule about higher capital requirements in a certain jurisdiction? These could have market access or national treatment implications, or could be considered as nullifying other GATS commitments under GATS Article VI.
3. The schema of four types of regulation above is not put through the filter of the Understanding on Commitments in Financial Services. Just taking the Standstill, New Financial Services, Non-Discriminatory Measures and National Treatment obligations there, you could easily multiply the taxonomy from 4 to upwards of 28 different (overlapping?) categories of domestic regulation, i.e. "prudential regulations" that fall under Understanding B(10)(a), those that fall under Understanding B(10)(b), etc.

Again, not to be obtuse, but there is just no way to know how a WTO panel would consider these questions and terms, many of which are not fully defined. We're stuck yet again with the best case scenario that there is a lot of uncertainty, and the worst case scenario that various financial rescue packages could be successfully challenged under the WTO (or various bilateral pacts). Since we're talking about cleaning house at the BIS, IOSCO and other international bodies, why is the WTO being curiously exempted from the reform discussion?

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Finally, just for the sake of fun, let me point out some of the other nutty things in the 1998 document I referred to re: the second commenter:

"35.    There would be little objection to considering that, in banking, for example, capital adequacy ratios, limits on risk concentration and risk management system requirements, liquidity requirements, prohibitions on insider trading and transactions giving rise to conflicts of interest, rules on the classification of and provisioning for non-performing assets, "fit and proper" tests for directors and managers, as well as transparency and disclosure requirements constitute prudential measures.  At the margins, however, there may be differences of views as to whether certain measures can be considered as prudential, and therefore, not subject to scheduling under the GATS. [Footnote: Traditional line-of-business restrictions, such as the segregation of banking, securities and insurance businesses such as those existing in the U.S. and Japan, have prudential objectives, but they can be perceived as having non-prudential elements from the point of view of European countries with a tradition of universal banking.  Another example may be portfolio allocation rules for investments of financial institutions, where a shift appears to be occurring towards the adoption of prudent-person rules providing flexibility in investment decisions instead of numerical restrictions traditionally adopted in many European countries.  This does not necessarily mean, however, that the traditional rules are trade restrictions limiting market access or national treatment.]


37.    Non-prudential regulatory measures such as lending requirements to certain sectors or geographical regions, restrictions on interest rates or fees and commissions, and requirements to provide certain services may also exist.  Services related to the issuance of public debt are often subject to special rules and standards.  Some of those measures may be subject to scheduling under the GATS as limitations on market access, or as limitations on national treatment, particularly when they are applied in a discriminatory manner.  They may also necessitate MFN exemptions, if applied in a discriminatory manner between trading partners...

41.    Financial regulators have been generally cautious towards introducing competition in the financial sector, due primarily to prudential concerns, but also because many countries have adopted policies to develop domestic financial industries and markets.  Based on those concerns, licensing and authorization requirements in financial services are often restrictive, and the conditions or requirements sometimes extend beyond prudential objectives such as soundness and competence of applicants.  This appears to be the reason why many of the licensing requirements or restrictions on the number of licenses granted were inscribed in the Schedules of Members as limitations on market access and national treatment.   As such licensing requirements are liberalized and are made purely prudential, they may no longer need to be scheduled as trade restrictions, but there may still be an issue of whether they constitute unnecessary barriers to trade in financial services [Footnote: Although technically, Article VI:4 and 5 may not be applicable to prudential measures, questions may remain as to whether they are based on objective and transparent criteria, or are not more burdensome than necessary.]...

44.    Other forms of market access restrictions include limitations on the number of licenses granted, either in the form of numerical quotas or economic needs tests.  Some countries impose a moratorium or a freeze on new bank licenses.  A restriction on new licenses may have prudential connotations, if countries seek to prevent "over-banking" or excessive competition in the financial sector for the purpose of reducing systemic risk and ensuring uninterrupted service.  However, it may not qualify as a prudential measure within the meaning of the Annex, since it does not directly aim to protect investors and depositors or address instability; its primary objective is to restrict competition, including that from a sound and superior competitor.  Similar considerations may apply to restrictions on the number of operations such as branches or ATMs, as well as limitations on the value of transactions or assets (such as limitations on the share of banking assets allowed to be held by foreign banks).

45.    Concerning national treatment, special authorization requirements for foreign institutions, limitations on the ownership of land, and nationality and residency requirements for members of the board are very common.  Taxes and subsidies also cause national treatment concerns.  Taxation is often a determining factor in the decision of the location of financial transactions and can  substantially alter the conditions of competition between financial service suppliers.   Subsidies are also not uncommon, but they may take the form of preferential loans from the central bank or governmental entities, which may be difficult to identify.  Governmental assistance to the banking sector provided in the context of a financial crisis may have national treatment implications, but could constitute prudential measures if the objective is to protect depositors or to restore the stability of the financial system.   National treatment and MFN are important issues in government procurement of financial services, especially when it relates to issuance of public debt.         

46.    It has been stated by observers that, in the OECD countries, restrictions on market access and national treatment in financial services have been substantially reduced thanks to reform,  and most of the progress, in particular for commercial presence, has been reflected in the commitments made by those countries in the most recent negotiations.   As a result, the focus of governments in addressing barriers to trade in financial services appears to have shifted to non-discriminatory measures in domestic regulation including prudential measures and licensing requirements and procedures which may have the effect of creating difficulties for foreign suppliers to make headway in the market.   Transparency and efficiency of the administrative process are increasingly taken up in this context.  Competitive safeguards, or appropriate measures to create fair competition in newly opened markets, become increasingly important with liberalization.

47.    The scheduling of Additional Commitments for a number of countries  in the most recent negotiations containing regulatory principles or guidelines on the procedures for licensing and authorization of new activities and products would appear to be a reflection of such shifts in focus.   As non-OECD countries also bring down trade restrictions under the GATS, remaining obstacles to free trade in financial services for those countries are also expected to stem from various differences in prudential or non-prudential domestic regulation across countries."