The Doha Round and Financial Services Negotiations

The gravid of Qatar Round and Financial go Negotiations AEI STUDIES ON serve championship NEGOTIATIONS Claude Barfield, series editor THE metropolis of Qatar ROUND AND monetary function NEGOTIATIONS Sydney J. delineate INSURANCE IN THE GENERAL AGREEMENT ON vocation IN run Harold D. Skipper Jr. LIBERALIZING GLOBAL swap IN ENERGY run pricking C. Evans REDUCING THE BARRIERS TO INTERNATIONAL TRADE IN ACCOUNTING function Lawrence J. White The heavy(p) of Qatar Round and Financial work Negotiations Sydney J. mention The AEI Press Publisher for the the Statesn endeavour Institute WA S H I N G T O N , D . C . 2003Available in the joined States from the AEI Press, c/o Client Distri scarcelyion go, 193 Edwards Drive, Jackson, TN 38301. To order, c exclusively toll forego 1-800-343-4499. Distributed turn forbiddenside the coupled States by arrangement with Eurospan, 3 Henrietta Street, London WC2E 8LU, England. Library of Congress Cataloging-in-Publication in ricochetat ion aboriginal, Sydney J. The peachy letter of Qatar refreshen and pecuniary go negotiations / Sydney J. Key. p. cm. Includes bibliographical tie inences and index. ISBN 0-8447-4182-5 (pbk. ) 1. Financial expediency indus filter outLaw and legislation 2. unkn feature handicraft wind legislation. I. Title K1066.K49 2003 343&8242. 087dc 22 2003063553 3 5 7 9 10 8 6 4 2 Printed in 2003 by the American grounds Institute for Public Policy Research, Washington, D. C. The views expressed in publications of the American Enterprise Institute atomic number 18 those of the writers and do non inescapably reflect the views of the staff, consultive panels, officers, or trustees of AEI. The views expressed by the author in this publication should non be interpreted as representing the views of the Board of G overnors of the Federal Reserve body or whatsoeverone else on its staff. Printed in the United States of America Contents QFOREWORD, Claude Barfield ACKNOWLEDGMENTS 1 2 I NTRODUCTION INTERNATIONAL TRADE IN FINANCIAL SERVICES E-Finance 6 Modes of Supply 7 Services Provided across Borders 8 Foreign Direct Investment 9 front end of Natural Persons 9 loosening AND regularisation Three Pillars of Liberalization 12 National Treatment and grocery store place Access 13 Nondiscriminatory Structural Barriers 15 Freedom of Capital Movements 18 Strengthening home(prenominal) Financial Systems 20 Minimum Standards and Codes of Good Practices 22 Surveillance 23 The Prudential Carve-Out in the GATS 24 NATIONAL banter AND MARKET ACCESS Binding Existing and Ongoing Liberalization 28 IMF Conditionality 30 Permanence of GATS Commitments 31 Foreign Direct Investment 32 Remaining Barriers to Entry and Operation 33 MFN Exemptions 34 Barriers innermostly the reaching of the Prudential Carve-Out 35 Cross-Border Services 37 Binding Gaps versus Remaining Barriers 38 Un truety somewhat WTO Jurisprudence 39 v vii thirteen 1 4 3 11 4 27 vi CONTENTSMore Liberal Appr oaches for Wholesale Services 39 Evolving Regulatory Responses to Retail Cross-Border Services 40 Negotiating Goals 41 5 NONDISCRIMINATORY STRUCTURAL BARRIERS Regulatory Transp arncy 44 Rules round Developing and Applying Rules 44 Sound Financial Systems 46 useful Market Access 47 General Anticompetitive Measures 49 Necessity and domestic help Regulation 50 Recognition of Prudential Measures 51 Harmonization 52 Facilitating Access 52 The Intra-EU Approach 53 Remaining Second-Pillar Barriers 54 applicability of the Intra-EU Approach 55 CONCLUSION 43 6 57 61 87 101 107 NOTES REFERENCES INDEX ABOUT THE AUTHOR Foreword Q In advanced industrial economies, the run sector accounts for a substantial destiny of each nations gross theme help product.Despite the change magnitude splendour of mess in function, the General Agreement on mint in Services (GATS), which was negotiated during the 198694 Uruguay Round and put downed into force in January 1995, marked the premiere ti me that rules for up to(p)ing securities industrys in operate were implicated in the deuce-way employment placement. The GATS called for currentic negotiating declamatorys, beginning no later than 2000, to progress to tho repose of plow in go. Serious respective(prenominal) sector negotiations, however, did non shift into high gear until a comprehensive unfermented travel of multilateral cunning negotiations was launched at the November 2001 ministerial meeting of the World Trade Organization (WTO) in Doha, Qatar. The American Enterprise Institute is employed in a research project to focus on the latest round of flip negotiations on serve up.Mounted in conjunction with the Kennedy School of Government at Harvard University, the Brookings Institution, and the Coalition of Service Industries Research and Education Foundation, the project entails analysis of idiosyncratic economic sectors pecuniary operate accounting indemnity electronic job energy air freig ht and air cargo airline passenger serve and entertainment and culture. Each study identifies major barriers to bargain loosening in the sector below scrutiny and assesses policy options for work negotiators and fire private sector participants. AEI would like to ack straight offledge the following donors for their generous house of the craftsmanship-in-service project American Express Comp some(prenominal) American Inter case crowd CIGNA Corporation FedEx Corporation Mastercard Inter field of study the Motion Picture Association of America and the Mark Twain Institute. I emphasize, however, that the vii viii FOREWORD conclusions and recommendations of the item-by-item studies argon solely those of authors.Issues for the Financial Services Negotiations In this study, Sydney J. Key analyzes the sh atomic number 18 of the GATS and the WTO in the relaxation method and regulation of the fiscal go sector and identifies hexad spacious goals for the fiscal run negotiat ions in the Doha round. What fuck offs her analysis preposterous is that she integrates the ii very diverse perspectives of dispense policy and monetary regulative policy. Throughout the study, Key emphasizes the accompanimentary and mutually reinforcing relationship between efforts to open employments under(a) the GATS and the intensive ongoing worldwideistic work on confirm house servant pecuniary systems, including prudent regulation and superintendence.The study reads the role of the GATS and the WTO in relation to what Key characterizes as the trio keystones of ease necessary to achieve worldwide contestability of market places (1) opening markets to inter content go and service suppliers by GATS commissions to picture national give-and-take and market memory approach shot (2) implementing internal structural reforms that would communicate nondiscriminatory structural barriers to trade in pecuniary serve and (3) liberalizing capital mo vements. Key explains that the GATS deals with 3rd- column loosening only inso farther as it affects countries specific commissions to liberalize trade in run in usual, liberalization of capital movements is a offspring of concern for the International Monetary Fund (IMF).Key emphasizes the magnificence of foc using on storageamental first-pillar liberalization in the Doha round fiscal operate negotiations and gets forth four first-pillar goals first, screening in the GATS existing and ongoing liberalization that allows market access and national discussion second, removing remaining barriers to national discourse and market access and binding the resulting liberalization 3rd, narrowing or withdrawing the broad exemptions that some countries prevail taken from the virtually favored nation (MFN) responsibleness of the GATS and, fourth, using an incremental approach for cross-border run that combines arming GATS allegiances and achieving great liberalization in practice. CLAUDE BARFIELD ix How far should the Doha round fiscal service negotiations extend into the echtm of second-pillar liberalization?Like some former(a) authors in this series, Key grapples with the role of the GATS with regard to the domestic structural reform learned to humble or eliminate nondiscriminatory structural barriers to trade in serve. Key believes that the Doha round pecuniary work negotiations should proceed selectively by concentrating on the atomic number 18as in which the GATS and the WTO have a comparative advantage. She singles out two itemly all eventful(p) second-pillar goals for the Doha round pecuniary function negotiations ontogenesis stronger GATS disciplines on regulative transp argonncy and removing barriers to effective market access and binding the resulting liberalization.Key argues that GATS rules on transp bency in developing and carrying regulations, unitedly with the closely associate principle of procedural fairness in ap plying regulations, would non only divine service eliminate barriers created by opaque and unfair re stringentive procedures but to a fault help check that a province does non use its restrictive cargon for to undermine its commitments to national manipulation and market access. Key explains how GATS rules on transparency in financial serve regulation could both(prenominal)(prenominal) complement and build upon the work on transparency that is part of international efforts to strengthen domestic financial systems. The other second-pillar goal set forth by Key entails anticompetitive domestic regulative measures that can non be plainlyified on prudential grounds and serve primarily to keep inappropriate financial firms from competing in force-landed estate markets by fashioning adit impractical or too high-pricedthereby denying them effective market access. Key explains that identifying barriers to effective market access that could be negotiated in the Doha round requires a awkwards trading partners to determine whether, in practice, a soldiery pastorals measures keep strange firms from competing in its markets and whether a overcritical mass of regulators believes that the measures are in fascinate for prudential purposes. She points out, however, that scour if the prevalent regulatory view is that the measures cannot be justified on prudential grounds, phalanx-country regulators requisite be persuaded to accept it. What about barriers to trade in financial services that are created by rule-governed prudential measures? Key explains the importance of the prudential carve-out for domestic regulation in the GATS Annex on Financial x FOREWORDServices it hold backs the GATS will not interrupt with the ability of national politics to exercise their responsibilities for prudential regulation and management to protect consumers of financial services and to promote the integrity and stability of the financial system. She notes that while prudential measures sometimes impose assetal requirements on orthogonal firms, they may likewise create barriers simply because they differ among countries that is, financial firms in operation(p)(a) on a global priming may often knock it burdensome to comply with a multitude of different national rules. Key identifies two approaches for dealing with barriers created by prudential measures.One would have home-country regulatory regime convince swarm-country authorities that their prudential concerns can be addressed with little sweeping requirements. These efforts could take place bilaterally or in mixed international fora, including the financial services negotiations under the auspices of the WTO, where finance ministries behave a major role. A second approach would have home- and hostcountry authorities negotiate a actualization arrangement. Although the GATS Annex on Financial Services hastens unilateral or mutual recognition of prudential measures by permit ting a departure from the MFN obligation of the GATS for much(prenominal) arrangements, Key explains why the WTO is not the appropriate forum for their negotiation.In conclusion, Key summarizes the forces touch on the outcome of the Doha round financial services negotiations and the importance of that outcome to the operation of financial sector liberalization Success in achieving the financial services goals discussed in this study depends significantly on factors beyond the scope of the negotiations. As the GATS explicitly recognizes, liberalization of trade in financial and other services is an ongoing process. For financial services, this process is being driven in large part by market forces and brand-new technologies. It is in any case being driven by the growing recognition among policymakers that market opening can benefit host-country consumers of financial services and, at the same time, contribute to the resiliency of domestic financial systems.The development of i nternational minimum standards and codes of reasoned practices for healthy financial systems and their implementation by individual CLAUDE BARFIELD xi countries provide a strong foundation for moving forrader with nevertheless liberalization of trade in financial services. The negotiations in the Doha round can play an important role in circumstances to accelerate the process of liberalization as well as lot its results in the form of binding commitments put forward to the WTO dispute settlement mechanism. CLAUDE BARFIELD American Enterprise Institute for Public Policy Research Acknowledgments Q The author greatly appreciates the financial aid of the galore(postnominal) individuals who read all or part of the hologram and provided valuable chin-waggings and suggestions in their areas of expertise.She would like to thank Alistair Abercrombie, Claude Barfield, Nicholas Bayne, Stijn Claessens, Steven Fabry, Bernard M. Hoekman, Cecilia Klein, Masamichi Kono, Robert D. Kramer, Patrick Macrory, Ann Main, Marilyn L. Muench, Kathleen M. ODay, Patrick Pearson, Mary S. Podesta, Amelia Porges, incision E. W. Russell, Hal S. Scott, Richard E. Self, Jonathan D. Stoloff, and T. Whittier Warthin for reading the manuscript in its entirety. She would also like to thank Peter Berz, Barbara J. Bouchard, James M. Boughton, David T. Coe, Kenneth Freiberg, Ralph Kozlow, Ross B. Leckow, Michael D. Mann, Juan A. Marchetti, Peter K. Morrison, William A. Ryback, David Strongin, Mark W. Swinburne, Andrew Velthaus, and Obie G.Whichard for reading drafts, and often redrafts, of particular(a) sections. Finally, the author would like to thank Juyne Linger for her work in editing the manuscript. xiii 1 Introduction Q The General Agreement on Trade in Services (GATS), the first global trade add upment to cover financial and other services, is an important new element in the international manikin for liberalization and regulation of the financial sector. Participation in the GAT S, however, does not necessarily mean that a country has made strong commitments to open its markets to overseas services and service providers. Indeed, the strength of commitments varies substantially among countries.The GATS whence requires periodic negotiating rounds on financial and other services to improve commitments and thus achieve a progressively higher level of liberalization. 1 The GATS was negotiated in the Uruguay Round, which was launched in 1986 and officially concluded in April 1994. 2 Financial services, however, was one of several sectors for which negotiations on specific commitments were extended, and final agreement was not reached until December 1997. 3 In 2000, in accordance with the deadline established by the GATS for initiating a new round of services negotiations, work began again on financial and other services. This occurred contempt the failure of the Seattle ministerial meeting of the World Trade Organization (WTO) in December 1999 to launch a com prehensive new round of trade negotiations.Subsequently, at the Doha ministerial meeting in November 2001, WTO shares reached agreement on an agenda for comprehensive multilateral trade negotiations that incorporated the so-called entire agenda for financial and other services. 4 The ministerial declaration set January 1, 2005, as the deadline for completing the Doha round the declaration called for the next ministerial meeting, later on scheduled for September 2003 in Cancun, to assess progress and provide any necessary policy-making guidance. 5 1 2 THE DOHA ROUND AND FINANCIAL SERVICES NEGOTIATIONS For financial services liberalization, four aspects of the GATS and the WTO are peculiarly significant First, the WTO is a multilateral forum in which the primary quill goal is lessen or eliminating trade barriers to promote competitive markets and thereby support economic evolution and development.The new prominence of this goal at the multilateral level complements the intensi ve work on strengthening domestic financial systems in a variety of other international fora, ranging from institutions such as the International Monetary Fund (IMF) to specialized bodies such as the Basel delegacy on Banking Supervision. 6 Indeed, the efforts to liberalize trade in financial services and the efforts to strengthen domestic financial systems, including prudential regulation and supervision, are mutually reinforcing. In addition, the WTO is a forum in which all members have the opportunity to participate on an equal floor. Multilateral trade agreements are negotiated in the WTO without the conditionality that links IMF or World Bank financial assistance to the implementation of specific policy measures by a borrowing country. In principle, therefore, GATS commitments to liberalization have domestic self-possessionthat is, they reflect a countrys recognition of the need for policy reforma type that the IMF has found to be a crucial determinant of the success of its programs. 8 Second, the GATS provides a mechanism for parties to undertake legally binding commitments subject to enforcement under the WTO dispute settlement mechanism. A GATS commitment is permanent in that it cannot be withdrawn without compensation of trading partners. Failure to honor a commitment could open a country to a dispute settlement minutes and, ultimately, WTO-sanctioned retaliatory measures by its trading partners. Thus, backsliding in the face of protectionist domestic political pressures could be extremely costly. As a result, binding even the status quo is extremely important.Moreover, for negotiations that stretch over many years, the status quo in the final phase is often different from that at the outset of the negotiations, in part as a result of the negotiating process itself. Third, the GATS is based on the most-favored-nation (MFN) principle, which precludes discrimination among international countries. Under the MFN obligation of the GATS, a WTO member must accord to services and INTRODUCTION 3 service suppliers of any other member discussion no less favorable than the discussion it provides to like services and service suppliers of the most favored immaterial nation. 9 The reach of the MFN obligation is very broad ecause it applies to all measures affecting trade in services that are covered by the GATS, not just those for which a member has made specific commitments to liberalization. 10 Although the GATS does allow members to enter into economic integration agreementssuch as the Treaty establishing the European alliance (EC Treaty)11 and the North American Free Trade Agreement (NAFTA)without extending the benefits of the agreements to all WTO members, it establishes slopped criteria for an agreement to qualify for this exception. 12 If a WTO member undertakes liberalizing measures in connector with services obligations in an agreement that does not meet the criteria, it must apply the measures to all WTO members on an MFN basis. 3 Fourth, the GATS negotiating process can itself have a positive electric shock on domestic policymaking, particularly in rising market economies and other developing countries. Governments that participate in the negotiations are squeeze to account to their trading partners for the barriers they impose and to explore the possibility of overcoming domestic political constraints to reduce or eliminate those barriers. A continuing challenge for the trading partners is to use the GATS negotiating process to provide support for and to harness political and market forces that are creating pressures for liberalization within a host country. In this regard, a countrys readiness for reform is critical. Thus, the outcome of the GATS process depends heavy on factors beyond its purview.The next chapter of this study presents a brief discussion of the international preparedness of financial services and their reporting by the GATS. The third chapter provides a framework for analy zing the role of the GATS and the WTO in liberalization and regulation of the financial sector. The fourth chapter focuses on the barriers to national treatment and market access that need to be addressed in the financial services negotiations in the Doha round. The fifth chapter examines nondiscriminatory structural barriers and identifies authorized areas of domestic structural reform that could usefully be dealt with in the GATS negotiations. The final chapter presents the conclusions of this study. 2 International Trade in Financial Services QThe financial sector is a critical particle of a nations economy It not only contributes this instant to output and employment but also provides an essential infrastructure for the execution of the entire economy. The financial system serves as a channel finished which savings can be mobilized and use to finance enthronement and, at the same time, facilitates dealings necessary for internal and external trade. It also helps to have sex finds and reduce so-called information asymmetries between providers and users of funds. 1 For these reasons, a choke and businesslike financial system is imperative for economic growth and development. A sound financial system also appends the resiliency of a nations economy, thereby dowery it to withstand external shocks such as movements in exchange rates or a major increase in global interest rates.International trade in financial servicestogether with enhanced prudential regulation and supervision and other basic structural reformscan play an important role in helping countries build financial systems that are to a greater extent(prenominal)(prenominal) competitive and efficient, and therefore more stable. Financial services trade can enhance capital market efficiency improve the quality, availability, and pricing of financial services stimulate macrocosm by dint of the dissemination of new technologies, know-how, and skills and promote the use of international go od practices in areas such as accounting, risk management, and disclosure of financial information. 2 The rapid growth of trade in financial services in recent years reflects a combination of economic, scientific, and regulatory factors. These include new and expanding markets in developing and transition economies, technological advances, and progress in reducing or eliminating a variety of host-country barriers (see chapter 3). 4 INTERNATIONAL TRADE IN FINANCIAL SERVICES 5 Trade in services, as outlined in the GATS, includes services provided across borders and with irrelevant musical moderate enthronisation. The cross-border provision of servicesfor example, the provision of financial services from an office located in one country to residents of another country is broadly analogous to trade in goods. 4 By contrast, distant aspire investment involves the mental hospital of a technical aim, such as a branch or subsidiary company, within a host country. 5 The GATS appro ach of defining international trade to nclude services provided to host-country guests with the foundation and operation of a commercial battlefront differs from the approach use for balance-of-payments purposes, in which once a topical anesthetic branch or subsidiary has been established, the services it provides to host-country customers are treated as domestic. 6 In this study, the term financial services refers to financial services other than redress policy, which is the subject of another study in this series. 7 Although the GATS comment of financial services shroudes both insurance and insurance-related services and banking and other financial services (excluding insurance),8 they have been negotiated and listed in the financial services schedules as separate subsectors. 9 These subsectors are, however, closely linked.Many of the major commercial and investment banks operating internationally are part of financial conglomerates that also include firms engaged in insu rance underwriting, and banks often engage directly in insurance brokerage activities. Moreover, the development of new types of products and instruments is blurring the distinctions between financial subsectors. Major financial firms now provide a wide range of financial services to customers in other countries. These include commercial banking activities such as bestow and deposit-taking investment banking activities, such as underwriting securities and advising on mergers and acquisitions trading activities, that is, brokering and dealing in securities and other financial instruments and asset-management activities, including management of mutual funds and pension funds.Other financial services provided internationally include financial information and data bear upon services investment advisory services payment and money transmitting services, including credit cards settlement and clearing for financial assets and financial leasing. 6 THE DOHA ROUND AND FINANCIAL SERVICES NE GOTIATIONS Many financial services provided internationally are wholesale in nature that is, they are provided to ripe customers such as corporations and institutions, other financial services firms, and wealthy individuals. 10 Both foreign direct investment and cross-border supply are important means of providing wholesale financial services.In the banking sector, when wholesale services are provided done disposal of a commercial presence, direct branches of the foreign bankif permitted by host-country regulationare usually a more efficient form of organization than subsidiaries. Unlike subsidiaries, branches are not separately incorporated in the host country and operate using the firms f employ worldwide capital (but see chapter 4 regarding lending limits based on branch capital-equivalency requirements). E-Finance Technological advances have long had a major impact on the sway of wholesale financial activities. Business-to-business electronic proceeding within the financial sector have been utilize for more than two decades, both domestically and internationally.Financial firms have also provided online services to nonfinancial firms over unlikeable proprietary vanes for a number of years. Widespread access to the open network technology of the Internet, however, offers a whole new range of possibilities to provide services to a much broader base of customers at substantially lower costs. As a result, online services provided to wholesale customersboth within and across national bordersare growing rapidly. This growth includes not only traditional financial services but also new types of services knowing to facilitate business-to-business e-commerce activities. 11 The same technological and cost-saving possibilities exist for the provision of electronic banking and other financial services to sell customers.Within some countries, the provision of some types of financial services over the Internet and by dint of web-enabled technologies, such as brisk telephony, is expanding dramatically. Prominent examples include discount brokerage and mutual funds in the United States, and banking services in Finland, Norway, and Sweden. 12 The cross-border provision of INTERNATIONAL TRADE IN FINANCIAL SERVICES 7 financial services to retail customers over the Internet, however, is still in its infancy. In general, the international provision of retail financial services still takes place primarily through locally incorporated subsidiaries. 13 Indeed, a number of banks are now using their host-country subsidiaries as a base from which to provide electronic banking services to host-country retail customers.The lack of widespread development of cross-border retail banking and other financial servicesthrough the Internet or more traditional methodsreflects host-country regulatory requirements aimed at ensuring adequate consumer protection, consumer preferences, and measure considerations. Some countries actually require the establishment of a commercial presence to provide retail financial services. take down when regulatory requirements for cross-border services involve nondiscriminatory application of host-country prudential standards, firms operating on a global basis may have elusivey meeting a multitude of different national requirements. Perhaps even more important, consumers may prefer dealing with a local commercial presence, particularly because change against a local establishment is usually readily available through the domestic legal system.In addition, in a number of countries, consumers receive more favorable tax treatment on financial products that are provided through locally incorporated entities. 14 Modes of Supply In an effort to include all of the ways in which services are provided internationally, the GATS defines trade in services in terms of four so-called modes of supply. Mode 1 and mode 2 cover services provided across borders for financial services, the distinction between these two mod es is not always clear. Mode 3 covers services provided through establishment of a commercial presencethat is, through foreign direct investment, a term that is not used in the GATS.Mode 4 covers services provided through the temporary presence of inherent persons, which includes nonlocal employees of a foreign service provider. The GATS uses modes of supply not only to define the scope of its coverage but also as the basis for specific commitments to liberalization that WTO members undertake. 8 THE DOHA ROUND AND FINANCIAL SERVICES NEGOTIATIONS Services Provided across Borders. In this study, the term cross-border services is used broadly without attempting to assign a geographical location to the transaction. Thus, this study does not attempt to determine whether a transaction takes place in the country of the service provider or in the country of the customer.For example, a cross-border financial services transaction could be carried out in a number of different ways (a) a exe mplar of, say, a foreign bank dexterity visit the country of the customer to arrange a loan (b) the customer cleverness travel afield to visit the office of the foreign bank or (c) the transaction might take place via telephone, fax , or, increasingly, the Internet, which, in this context, is simply another technological means of delivering the service. 15 The GATS, however, appointes between services provided to nonresidents from the country of the service supplier (mode 1 or crossborder supply) and services provided in the country of the service supplier (mode 2 or consumption abroad). Usuallybut as before long defined by the GATS, not necessarilymode 2 involves material movement of the consumer, such as the movement that occurs in tourism. 6 For financial services, however, the line dividing these two modes of supply is not always clear, curiously in the case of example (c) in the previous paragraph. Indeed, because financial services are intangible, assigning a geographic site to their provision across borders is difficult and often arbitrary and will become more so as the importance of e-finance increases. From a regulatory perspective, a major issue is whether, and to what extent, the rules of the host countrythat is, the country of the customerare applied to the cross-border transaction. 17 Suppose, for example, that employees of a foreign bank visit the host country to arrange cross-border loans.Even when the host country does not have a regulatory framework in place for cross-border banking services, host-country bank regulators sometimes look at factors, such as the frequency and duration of visits and the permanence of the host-country infrastructure for the visiting employees, to determine whether, for regulatory purposes, the cross-border activity rises to the level of a host-country office. 18 Or suppose that a foreign broker-dealer solicits host-country customers to purchase securities. Securities regulators often use solicitation in addi tion to the actual conduct of business with domestic residentsas INTERNATIONAL TRADE IN FINANCIAL SERVICES 9 criterion for determining whether the foreign firm is subject to hostcountry broker-dealer registration requirements. 19 In response to the increasing use of the Internet by the securities industry, a number of regulators also examine factors such as whether a web site is being used to target host-country customers (see chapter 4). 20 Besides regulatory jurisdiction, another important territorial issue arises in the event of a dispute here the heading is which countrys courts have jurisdiction to try the case and which countrys laws apply. 21 Foreign Direct Investment. The inclusion of foreign direct investment in the GATS reflects its importance as a way of providing services internationally. 2 By contrast, the General Agreement on Tariffs and Trade (GATT) does not cover foreign direct investment for goods, there is only a relatively narrow agreement, negotiated in the Uru guay Round, on trade-related investment measures (TRIMs). 23 Although the GATS includes establishment of a commercial presence as a mode of supply, it does not have a separate framework for investment like that of the NAFTA or the widely used bilateral investment treaties (BITs). 24 These agreements cover portfolio investment as well as direct investment in both goods and services. Moreover, unlike the GATS, they include provisions to ensure the protection of investmentsspecific rules governing body expropriation and compensation, for exampleand also provide for arbitration of disputes between private investors and host-country governments. Presence of Natural Persons.The fourth mode of supply in the GATS, the temporary presence of natural persons, includes the temporary presence in the host country of employees of firms providing services across borders or through a commercial presence. For example, for financial services, this mode of supply covers the presence of nonlocal staff of a host-country branch or subsidiary of a foreign financial firm as well as agents of the firm visiting the host country to facilitate the provision of cross-border services. 25 Although the presence of natural persons is listed as a mode of supply in the GATS, and members can negotiate sectorspecific commitments, countries usually make commitments for the temporary presence of natural persons as horizontal commitments that 10 THE DOHA ROUND AND FINANCIAL SERVICES NEGOTIATIONS apply to all services sectors. 6 For the financial services sector, however, most countries that belong to the Organization for Economic Cooperation and Development (OECD) have incorporated into their schedules a set of commitments allowing the temporary entry of senior managerial personnel and authorized types of specialists in association with the establishment of a commercial presence. 27 3 Liberalization and Regulation Q Policymakers, particularly in emerging market economies, are increasingly recognizi ng that opening markets to foreign financial firms can benefit both consumers of financial services and the domestic economy as a whole. As noted in chapter 2, the presence of foreign firms can create more competitive and efficient markets for financial services, thereby supporting economic growth and development and contributing to a more resilient domestic financial system.At the same time, however, ensuring adequate prudential regulation and supervision of financial firms and markets, together with other fundamental domestic structural reforms, is essential to obtain the uttermost benefits of liberalization while minimizing the risks. Basic structural reforms include increasing transparency and accountability in both the private and public sectors introducing effective risk management techniques and developing the institutional infrastructure, such as insolvency laws and appropriate discriminative procedures. Because measures to promote competitive markets and to strengthen dom estic financial systems are complementary and mutually reinforcing, the relationship between financial sector liberalization and regulation has two distinct dimensions. On the one hand, liberalization requires reducing or removing anticompetitive regulations that pose unnecessary barriers to trade in services. On the other hand, liberalization requires increasing the strength and quality of plastered regulations and, in some areas, introducing new regulations. Thus the process of liberalization involves, inter alia, reaching a consensus on where to draw the line between regulations that are simply anticompetitive barriers to tradeand should therefore be eliminatedand regulations that serve legitimate purposes. For financial services, the GATS contains a prudential carve-out for domestic regulation. 2 In the GATS, the term prudential is used broadly 11 12 THE DOHA ROUND AND FINANCIAL SERVICES NEGOTIATIONS o encompass not only measures to promote the integrity and stability of the fi nancial system (as the term has traditionally been used in banking regulation) but also measures designed to protect consumers of financial services. The prudential carve-out, discussed later in this chapter, is designed to ensure that any obligations undertaken or commitments made in the GATS will not interfere with the ability of national authorities to exercise their responsibilities for prudential regulation and supervision. Whether a particular measure is prudential or simply being used to avoid a countrys obligations and commitments under the GATS is, however, an issue that could be brought before a WTO dispute settlement panel. All countries impose certain rules that are clearly prudential.Even if a measure is prudential, however, it may create a barrier to trade in financial services. This could occur because a host country imposes additional prudential requirements on foreign financial firms love seat their domestic counterparts. such(prenominal) barriers could also be cr eated simply because prudential rules differ among countriesthat is, even if each host country applies the same rules to foreign and domestic firms, financial services firms operating on a global basis often find it burdensome to comply with a multitude of different national prudential rules. A critical question is whether such barriers could be addressed without jeopardizing prudential goals.Specifically, in what areas and under what conditions might financial services regulators be able and willing to recognize each others regulations and supervisory practices as being as effective as their own? The GATS is permissive with respect to such recognition arrangements. However, as will be explained in chapters 4 and 5, the WTO is not the appropriate forum for financial services regulators to negotiate recognition of prudential measures. Three Pillars of Liberalization International contestability of markets refers to the foot of markets that are competitive and efficient on a global b asisa goal that can be achieved by removing all types of barriers to foreign participation in hostcountry markets. International contestability is, in effect, based on three pillars of liberalization (1) national treatment and market access (2) the slackening AND REGULATION 13 removal of nondiscriminatory structural barriers, that is, domestic structural reform and (3) license of capital movements. For financial services, the GATS has so far dealt mainly with the first pillar. An important question for the Doha round is how far the negotiations should extend into the second pillar. The GATS deals with the third pillar only insofar as it affects countries specific commitments to liberalize trade in services in general, liberalization of capital movements is a event of concern for the IMF 4 . National Treatment and Market Access. The first pillar of international contestability of markets is liberalization aimed at opening markets to foreign services and service suppliers and ensur ing that they enjoy substantially the same treatment as their domestic counterparts. Such liberalization requires reducing or removing barriers that discriminate against foreign services and service suppliers with regard to entry and operation in a host-country market. A host country might, for example, discriminate against foreign financial firms by refusing to grant licenses for their branches or subsidiaries majestic limitations on their ownership position in domestic firms or on their aggregate market share or repealing them from engaging in certain activities that are permissible for their domestic counterparts.First-pillar liberalization also requires removing various quantifiable limitations on the overall provision of services in a host-country market. Although these barriers may not, on their face, be overtly discriminatory, they are typically used to block entry by foreign services and service suppliers. A country might, for example, limit the number of service supplier s in a particular market by restricting the number of new licenses that may be issued or by relying on an economic involve test, which involves an assessment of needs in the market by host-country authorities. 6 Because these measures have the effect of imposing some type of quantitative limitation on foreign entry, they are similar to the more overtly discriminatory barriers.To deal with these first-pillar barriers, the GATS uses the principles of national treatment and market access. clause XVII (National Treatment) relies on a generally original definition of national treatmentthat is, it 14 THE DOHA ROUND AND FINANCIAL SERVICES NEGOTIATIONS requires a host country to treat foreign services and service suppliers no less favorably than like domestic services and service suppliers. 7 Barriers to entry or operation that discriminate against foreign services or service suppliers vis-a-vis their domestic counterparts would therefore be at variance(p) with national treatment. The G ATS does not attempt to define market access.Instead, Article XVI (Market Access) provides a list of restrictive measures, primarily quantitative, that are typically used by host countries to deny entry to foreign services or service suppliers. A country that does not maintain any of these measures is regarded as providing full market access. 8 The list includes seemingly nondiscriminatory quantitative barriers to entry that apply to both domestic and foreign firms, such as limitationsin the form of numerical quotas or economic needs testson the number of service suppliers or their total assets. It also includes quantitative barriers to entry that are clearly discriminatory and thus are also at variance(p) with national treatment, such as limitations on foreign ownership interests in domestic firms.As a result, some overlap exists in the national treatment and market access provisions of the GATSthat is, certain measures may be inconsistent with both national treatment and market a ccess. 9 The list of measures in Article XVI also includes restrictions on the type of legal entity through which services may be suppliedfor example, requiring establishment of a subsidiary as opposed to a branch. In the GATS, national treatment and market access are specific commitments as opposed to general obligations. 10 As a result, national treatment and market access do not apply across-the-board to all services sectors instead, they apply only to sectors, subsectors, or activities that a WTO member specifically lists in its schedule of commitments. 1 If a member is making only a partial commitment to national treatment or market access within a listed sector, subsector, or activity, any limitations must be listed in its schedule. 12 The use of specific commitments for national treatment and market access instead of obligations applicable to all services sectors is in some respects a structural failing of the GATS. 13 Under a more ambitious approach, such as that used in th e NAFTAs services and investment provisions, national treatment and market access would apply in each sector unless an exception was specifically listed in a countrys schedule of slackening AND REGULATION 15 commitments or one of the public policy exceptions, such as the national security exception, applied. 14 Nondiscriminatory Structural Barriers.The second pillar of liberalization required for international contestability of markets is aimed at removing nonquantitative and nondiscriminatory structural barriers. Such barriers are associated with national measures that do not discriminate between domestic and foreign services and service suppliers. A secondpillar barrier could arise because a national measure is primarily anticompetitive or fosters anticompetitive behavior by private parties. In some cases, the barrier could be associated with the inadequacy or absence of domestic regulationfor example, the lack of an adequate domestic legal framework for insolvency. A second-pill ar barrier could also arise because of differences in national rules, including prudential rules, that make it difficult to conduct operations on a global basis.Removing second-pillar barriers goes far beyond achieving national treatment and market access. Those principles ensure that foreign services and service suppliers can enter a host-country market as presently structured and enjoy equality of competitive opportunities vis-a-vis their domestic counterparts. By contrast, second-pillar liberalization represents an effort to create maximum potential competitive opportunities in a host-country market. Achieving this could require major domestic structural reform. This would necessarily involve some degree of convergence of national regulatory systems, either de facto or through negotiated harmonization. A longstanding U. S. rohibition on affiliations between banks and insurance companies in the United States, which was repealed in 1999, created a major second-pillar barrier for m any years. 15 Indeed, the European Union had found it difficult to accept that a European financial conglomerate that included both a bank and an insurance company could engage in only one of these businesses in the United States. Regardless of whether this nondiscriminatory restriction was primarily anticompetitive or could have been justified as a prudential measure, it nonetheless constituted a barrier to trade in financial services. Significant second-pillar barriers are often associated with national regulatory regimes for asset-management services. 16 These include 6 THE DOHA ROUND AND FINANCIAL SERVICES NEGOTIATIONS across-the-board prohibitions on delegation of functions, such as portfolio management and administrative operations, by the host-country office to a foreign affiliate extremely strict asset-allocation requirements for a domestic mutual fund or pension fund and rules that prohibit such funds from investing in foreign securities. 17 While asset management activitie s raise legitimate prudential concerns about ensuring adequate protection of hostcountry customers, these types of measures often serve primarily to restrict rivalry, particularly competition from foreign firms (see chapter 5).Nondiscriminatory structural barriers to trade in financial services are not limited to financial sector regulation. Barriers in other areas that are particularly important for the effective functioning of the financial services sector, such as lack of adequate frameworks for corporate governance or insolvency, are part of the international work on strengthening domestic financial systems, which is discussed later in this chapter. Ineffective or nonexistent competition policy regimes, which could foster anticompetitive behavior by private parties, can also create major second-pillar barriers. Differences in national tax systems are still another source of second-pillar barriers.Discriminatory treatment of foreign firms under national tax or competition rules , however, would be a first-pillar barrier. 18 Second-pillar barriers can also arise from a countrys administrative proceduresin particular, a lack of regulatory transparency and procedural fairness. For example, a country might fail to publish all of its laws, regulations, and administrative decisions administer them in an indifferent manner establish a meaningful procedure for interested parties to comment on proposed regulations act on applications for licenses within a reasonable period of time or provide a mechanism for independent review of administrative decisions.Because regulatory transparency and procedural fairness can be extremely effective in ensuring that commitments to market access and national treatment are fully implemented, they constitute an important underpinning of first-pillar liberalization. The European Unions single-market program represents the most far-reaching effort to date to remove nondiscriminatory structural barriers among a group of nations. Pred icated on political agreement on goals for economic liberalization, that effort is being carried out in the context of repose AND REGULATION 17 the unique supranational legislative, judicial, and administrative structure of the European Community. 9 Even within the European Union, however, important nondiscriminatory structural barriers to trade in financial services among the member states are still in place (see chapter 5). The GATS addresses certain types of second-pillar barriers. Article III (Transparency) imposes a general transparency obligation on WTO members to publish all measures of general application that are relevant to trade in services. 20 Article VI (Domestic Regulation) addresses, in fairly general terms, barriers created by domestic regulations. It requires countries to apply such regulations in a reasonable, object glass and impartial manner to avoid undermining commitments to market access and national treatment. 1 Moreover, countries must have appropriate leg al procedures to review administrative decisions affecting trade in services. 22 Article VI also mandates that work to develop disciplines to ensure that licensing requirements or technical standards do not constitute unnecessary barriers to trade in services. Pending the completion of this work, countries must refrain from adopting licensing rules or technical standards that are so burdensome, restrictive of trade, or lacking in transparency that they undermine the benefits that could reasonably be expect from their commitments to national treatment and market access. 23 The GATS deals with additional second-pillar barriers for individual sectors in members schedules of commitments.The most far-reaching example is in basic telecommunications, where a substantial absolute majority of the countries that have made commitments to national treatment and market access in that sector have incorporated into their schedules using the additional commitments columna reference paper setting forth procompetitive regulatory principles. 24 designed for a sector where dominant suppliers often control essential host-country facilities, these principles look for to ensure that a countrys national treatment and market access commitments will not be undermined. Countries committing to the principles undertake, among other things, to maintain measures to ensure network interconnection on nondiscriminatory terms and to prevent certain anticompetitive practices. 25 In the financial services sector, most OECD countries addressed nondiscriminatory structural barriers in their 1997 schedules of commitments 18 THE DOHA ROUND AND FINANCIAL SERVICES NEGOTIATIONS imply by making a general best efforts commitment to remove or eliminate any significant adverse effects of such barriers. 26 In addition, the United States and the European Union used the additional commitments column of their schedules to make best efforts commitments to remove specified nondiscriminatory barriers. For examp le, the U. S. administration committed to try to work with the Congress to remove Glass-Steagall Act restrictions, a goal that was subsequently accomplished, while the European Union pledged that its member states would try to process applications for licenses for banking and insurance subsidiaries within specified periods of time.Japan, under great pressure from its trading partners, went further and made binding commitments regarding removal of certain second-pillar barriersincluding restrictions on asset-management services and lack of regulatory transparency and limitations on lines of business in insurancethat were covered in its bilateral financial services agreements with the United States (see chapters 4 and 5). Freedom of Capital Movements. The third pillar of liberalization involves achieving freedom of capital movements across national borders. Such movements comprise international capital proceedingsthat is, the creation, transfer of ownership, or liquidation of capital assets, including financial assetsand the payments and transfers associated with such proceeding. 27 Restrictions on international capital movements are usually imposed on the underlying transactions as opposed to the related payments and transfers. 8 For example, if a country wished to restrict foreign direct investment in the banking sector, it could prohibit foreign financial firms from acquiring significant ownership interests in host-country banks it would be unusual to try to achieve this result by permitting the acquisition of the ownership interests while using exchange controls to block payment for them. 29 Although the free movement of capital plays a critical role in allowing efficient allocation of resources on a global basis, the Asian financial crisis of 199798 revived a long-standing debate over the appropriateness and effectiveness of capital controls, particularly on short flows. 0 Nevertheless, all parties to the debate agree that capital controls can never be a substitute for sound macroeconomic policies and fundamental reforms of domestic financial and legal structures. Indeed, the Asian crisis itself punctuate that weaknesses in domestic financial systems can create significant vulnerabilities LIBERALIZATION AND REGULATION 19 as capital movements are liberalized. At present, accomplished wisdom holds that, although cunning of new capital controls should, in general, be avoided, the imposition of limited, temporary capital controls to deal with massive temporary inflows or outflows of short-term debt might be useful in some cases. 1 Moreover, it is now widely recognized that removal of existing controls must be carried out with great care. Of particular importance are the pace and appropriate sequencing of liberalization of different types of capital flows and of liberalization of capital movements vis-a-vis structural reforms to strengthen domestic financial systems. 32 Freedom of capital movements per se is not within the purview of the GATS international capital movements and international trade in financial services are, however, closely related. Establishment of a commercial presence in a host country by a foreign service supplier involves both trade in services under the GATS and international capital transactions.For example, a commitment in the GATS to liberalize financial services trade by allowing foreign financial firms to establish completely owned subsidiaries is essentially a commitment to allow foreign direct investment that involves the acquisition of 100 percent of the shares of existing or de novo hostcountry financial firms. 33 In theory it is possible that, once established, the subsidiary could conduct its ongoing activities without engaging in additional international capital transactions however, its activities would need to be limited to transactions with host-country residents involving domestic financial assets. 34 Establishment and operation of branches, which are not separately incor porated in the host country, virtually always involve international capital transactions between the banks head office and the branch. 5 These transactions include both foreign direct investment and portfolio investment. 36 For branches conducting a wholesale business, ongoing activities would typically also involve international capital transactions with unaffiliated parties. For cross-border financial services, international capital transactions are typically either integral to, or closely associated with, the provision of the service. For example, international capital transactions are an integral part of accepting deposits from or making loans to nonresidents. In addition, international capital transactions are usually, although not necessarily, associated 20 THE DOHA ROUND AND FINANCIAL SERVICES NEGOTIATIONS ith financial services such as securities trading or asset management on behalf of a customer residing in another country. 37 By contrast, certain crossborder financial ser vices, such as investment advisory services and financial information services, can be provided without an associated international capital transaction. The usefulness of investment advice might be limited, however, if the customer were prohibited from investing in foreign assets. In general, it is difficult to realize fully the benefits of liberalization of trade in financial services without freedom of capital movements. Financial services trade absolutely requires, however, the liberalization of only those capital movements that are necessary for the trade transaction to occur.In recognition of this relationship, Article XI of the GATS (Payments and Transfers) prohibits WTO members from imposing restrictions on capital transactions or associated payments and transfers that would be inconsistent with their specific commitments to liberalization of trade in services. 38 A footnote to Article XVI (Market Access) provides greater detailnamely, a country that has made a specific commi tment to market access must allow (a) capital movements that are essential for the provision of a service in mode 1 (cross-border supply) and (b) inward capital movements that are related to a service supplied through establishment of a commercial presence. 39 The bottom line is that if a country makes a commitment to liberalize trade with respect to a particular financial service in the GATS, it is also making a commitment to liberalize most capital movements associated with the trade liberalization commitment.The country is not, however, making an across-the-board commitment to freedom of capital movements. The GATS provisions dealing with capital movements, like GATS specific commitments to liberalize trade in services, are subject to a balance-of-payments safeguard. 40 Both the capital movements and balance-of-payments safeguard provisions of the GATS refer to and are consistent with the IMFs responsibilities in these areas. 41 Strengthening Domestic Financial Systems The financ ial services sector has an elaborate and intensively used framework of international fora that are used, both separately and in combination, LIBERALIZATION AND REGULATION 21 o address overall financial and regulatory policy issues to promote cooperation and coordination among supervisors to set voluntary but widely accepted international minimum standards and codes of good practices and, most recently, to provide surveillance of domestic financial systems. This surveillance includes monitoring and helping to build institutional capacitance for implementation of the international standards and codes. The international fora dealing with these issues include the Group of cardinal (G-7), the Group of Ten (G-10), the Group of Twenty (G-20), the Financial Stability Forum, the Basel Committee on Banking Supervision (Basel Committee), and the International Organization of Securities Commissions (IOSCO), as well as the IMF and the World Bank. 2 The international framework for the financial services sector, which has been constructed over the past quarter century and is still evolving, is a response to two major factors the internationalization of banking and other financial activities and the special characteristics of the financial sector, especially the phenomenon of systemic risk. Because of systemic risk, problems with one financial firm can be transmitted to unrelated financial firms, both within and beyond a single country. For example, a chain reaction of problems could be triggered through onomatopoetic runs on banks as depositors lose confidence in a banking system, through default on domestic or international interbank obligations, or through domestic or international payment systems.Problems in a countrys financial sector can also affect the real economy, both domestically and internationally, through declines in output and shifts in trade flows. In addition, the existence of global financial firms, with activities falling within many different national jurisdictions, requires cooperation and coordination among home- and host-country authorities to prevent gaps in supervision. Increasingly, these global firms are financial conglomerates, which means that supervisory cooperation and coordination are necessary across financial subsectors as well as national borders. For these reasons, countries have a interest group in the quality of each others regulation and supervision of the financial sector and also in ensuring cooperation and coordination among supervisors.In this regard it is useful to distinguish between prudential regulation, which includes, for example, capital and other requirements designed to ensure the pencil eraser and 22 THE DOHA ROUND AND FINANCIAL SERVICES NEGOTIATIONS soundness of financial institutions, and supervision, which is aimed at making certain that financial firms adhere to such requirements. The importance of strong, effective supervision cannot be overemphasized without it, the best prudential rules c an be meaningless in practice. The extent to which both experience and good apprehension are required for such supervision also needs to be emphasized. Indeed, the role and nature of supervision make it particularly difficult for supervisory authorities to reach recognition agreements based on the harmonization of prudential rules (see chapter 5).While regulation and supervision must be strong and effective, a further complication is that a poorly designed regulatory systemfor example, an excessively generous deposit-insurance schemecan create an unacceptable degree of object lesson hazard that is, it may encourage excessive risk-taking by regulated firms. Accordingly, national regulatory and supervisory systems must be designed to complement and support, but not to substitute for, market discipline. Thus, achieving widespread transparency in both the public and private sectors, including accurate and timely disclosure of financial information, is critical