Could US-Korea trade agreement deter enhanced regulation of financial services?

Original Reporting | By Mike Alberti |

Limitations on more robust regulation of the financial services sector?

The Office of the U.S. Trade Representative has called the “Financial Services” chapter (Chapter 13) of the agreement “a groundbreaking achievement, providing more extensive provisions related to financial services than ever before included in a U.S. FTA.”

Chapter 13, article 4

A Party shall not adopt or maintain, with respect to financial institutions of the other Party or investors of the other Party seeking to establish such institutions, either on the basis of a regional subdivision or on the basis of its entire territory, measures that:

(a) Impose limitations on:

(i) The number of financial institutions whether in form of numerical quotas, monopolies, exclusive service suppliers, or the requirements of an economic needs test;

(ii) the total value of financial service interactions or assets in the form of numerical quotas or the requirement of an economic needs test;

(iii) the total number of financial service operations or on the total quality of financial services output expressed in terms of designated numerical units in the form of quotas or the requirements of an economic needs test; or

(iv) the total number of natural persons that may be employed in a particular financial service sector or that a financial institution may employ and who are necessary for, and directly related to, the supply of a specific financial service in the form of numerical quotas or the requirement of an economic needs test; or

(b) Restrict or require specific types of legal entity or joint venture through which a financial institution may supply a service.

Christine Ahn says that the financial services industry was deeply involved in the negotiation of the agreement and, in fact, “was one of the main drivers” of that negotiation. Ahn asserts that comments from the financial services industry show that the industry is “salivating” over the prospect of the FTA’s ratification and implementation.

According to John Dearie, the Executive Vice-President for Policy at the Financial Services Forum — a coalition of the 20 largest financial services institutions in the U.S. — “The agreement has been referred to as a ‘gold standard agreement’, meaning that South Korea went far beyond its WTO obligations, permitting market access across virtually all service sectors.”

Article 13.4 of the agreement (see sidebar for full text of the Article) prohibits either country from adopting or maintaining a variety of limitations on the “financial institutions of the other Party or investors of the other Party seeking to establish such institutions.” That means that the U.S. would not be able to enforce such limitations on Korean companies, and visa versa. But, as a practical matter, the provisions would also effectively discourage the impositions of such limitations on domestic institutions operating in each country as well, since neither country would want to put its own companies at a disadvantage relative to the other country’s financial institutions.

One provision of Article 13.4 prohibits limitations on the “total value of financial service interactions or assets” in respect to the other party. Todd Tucker, the research director of Public Citizen’s Global Trade Watch, claims that, if U.S. regulators or Congress were to decide to limit the size of a bank’s assets or market share in order to avoid situations where banks become too big to fail, the Korean government could challenge that law under the FTA.

An official at the Office of the U.S. Trade Representative, who was not authorized to speak on the record, vigorously disputes this contention, and asserts that such regulation would not be prohibited. That official argues that the “obligations” of Chapter 13 refer to sector-wide limitations (that is, all institutions in a country), not limitations on individual institutions.

But at least one provision of Article 13.4 — paragraph (a)(4) — does appear to refer to both restrictions applicable to either the entire financial sector or an individual financial institution, and the other provisions do not specify “financial sector” only.

Ian Fletcher, a research fellow at the Business and Industry Council, argues that the FTA restricts one country from applying “provisions against financial firewalls between financial activities [or] regulation on derivatives” on the financial institutions of the other country. He cites the the provision of the FTA that prohibits either the U.S. or Korea from restricting or requiring “specific types of legal entity or joint venture through which a financial institution may supply a service.”

USTR official: “We don’t need to clarify this part of the agreement. We understand, and our trading partners understand, how the agreement operates as a whole. We don’t think it’s necessary to do anything different here.”

The firewall that existed under the Glass-Steagall Act, for example, prohibited depository banks from offering investment banking services, until it was repealed in 1999. (The repeal of the law has been criticized on the grounds that it allowed some banks to become too big to fail.)

A proposal to regulate derivatives by limiting what kinds of institutions could trade in them would also raise issues of how to interpret the FTA’s provision precluding requirements on the “specific types of legal entity” that could provide the service.

Tucker also claims that the agreement would prohibit any regulatory bans — such as on credit default swaps or flash trading — because they could be interpreted as a “quota of zero” (see bottom box), and therefore violate paragraph (a)(iii) by limiting the total quantity of financial services output.

Though the U.S. would not be barred from imposing such regulations on its own institutions, it is difficult to imagine that it would decide to enact a limitation that could only be applied only to U.S. banks and not to Korean-registered banks operating in the U.S., of which there are currently several.

In an email response to further inquiry, a USTR official insisted to Remapping Debate that “the obligations in the financial services chapter do not prevent government actions to address systemically important financial institutions, create ‘firewalls’ among sector-specific financial services suppliers, or otherwise regulate financial products.”

So if the FTA is not intended to block regulations addressing systemic risk, why not add language to the agreement to make that clear? (Nothing would prevent, for example, the inclusion of an illustration of the type of regulation the parties intend to permit under the FTA.)

“We don’t need to clarify this part of the agreement,” the official said. “We understand, and our trading partners understand, how the agreement operates as a whole. We don’t think it’s necessary to do anything different here.”

What’s a quota in the context of a trade agreement?

Each of the provisions in Article 13.4 is qualified by the phrase “in the form of numerical quotas.” The agreement does not define what constitutes a “numerical quota,” however, and Public Citizen’s Tucker points out that, in the past, regulatory bans have in fact been interpreted as quotas.

In 2003, the government of Antigua and Barbuda challenged a U.S. regulatory ban against internet gambling, claiming that it violated market-access provisions in the General Agreement on Trade in Services (GATS) that are very similar in language to those in the KORUS FTA. The Office of the U.S. Trade Representative argued that bans are not quotas.

The WTO Appellate Body ruled in 2005 that regulatory bans are considered a “quota of zero,” and found in favor of Antigua and Barbuda and against the U.S.

Although the WTO jurisprudence is not binding on the KORUS FTA, Tucker said that if a similar case came up based on Article 13.4, the panel deciding the case would be likely to consult it.

Send a letter to the editor