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

Giving with one hand and taking with the other?

Despite the disagreements about the implications of Article 13.4, the FTA framework provided another opportunity through which to create clarity. Most free trade agreements contain a so-called “prudential carve-out” section that is designed to protect a country’s right to regulate its economy. The “Financial Services” Chapter of the FTA contains such a provision (see sidebar for full text).

The first sentence of the provision says that, despite the limitations imposed by the FTA, both the U.S. and South Korea will still be able to adopt any regulations they need to for prudential reasons, “including for the protection of investors, depositors, policy holders, or persons to whom a fiduciary duty is owed by a financial institution or cross-border financial service supplier, or to ensure the integrity and stability of the financial system.”

So, if the U.S. wanted to, say, ban certain kinds of derivatives, or limit the size of banks because they were too-big-to-fail, then, despite the provisions in Article 13.4, this sentence in Article 13.10 would seem to protect the right to impose those regulations if they were seen as necessary to “ensure the integrity and stability of the financial system.”

The USTR official made this argument explicitly: “Even if we wanted to impose a measure that would be inconsistent” with provisions of Article 13.4, the official told Remapping Debate, “if we believed that we needed to impose such a measure, we have the right to do that under the prudential exceptions.”

But the story is complicated significantly by the very next (and last) sentence of Article 13.10, which turns around and limits the availability of the prudential carve-out. When a financial regulation, it says, is inconsistent with the provisions of the financial services chapter — including Article 13.4 on market access — that regulation is not protected by the carve-out if it is being “used as a means of avoiding the Party’s commitments or obligations under such provisions.”

Public Citizen’s Tucker wrote in an email that the net effect was the prudential carve-out section was “self-cancelling.” True exceptions to trade agreements would, in contrast, “clearly allow countries reprieve from their obligations under the agreement if the exception’s requirements are met.”

The KORUS FTA’s limitation on the carve-out language would require in each case the resolution of the potentially difficult question of what is motivating a provision that does have the effect of contradicting one of the regulation-limiting provisions of Article 13.4. Is the provision designed to curtail systemic risk, avoid an FTA obligation, or both?

According to Joshua Meltzer, a Global Economy and Development fellow at the Brookings Institution, who has written in support of the FTA, the limiting sentence of Article 13.10 is merely designed to “make sure that you basically don’t use prudential regulation as a disguise to get out of your commitment.”

“[The first sentence] says that each country’s need to regulate their financial systems is more important than all the other provisions in the Agreement,” Meltzer said. “I’m not concerned that [the second sentence] is some kind of loophole.”

But how would a panel decide whether a prudential measures defense was a disguise, rather than a justifiable desire to ensure the stability of the system?

“It’s reasonable to say it’s a complex issue,” Meltzer said. “There’s a certain amount of what’s called ‘constructive ambiguity,’ because it’s nearly impossible to specify in detail exactly when a regulation starts becoming a trade restriction rather than generally aimed at a legitimate purpose.”

Ed Gerwin, a trade lawyer and senior fellow for trade and global economic policy at the think tank Third Way, has also written in favor of the agreement. When asked about the prudential carve-out language, he said that he was not able to explain it. For a detailed interpretation, he suggested asking someone at the Financial Services Forum.

When I put the question to John Dearie at the Forum, he said, “A trade attorney would be able to answer that question better than me.”

According to Robert K. Strumberg, Professor of Law at Georgetown University Law School focusing on international and trade law, the language in the second sentence is probably intentionally imprecise.

“It’s confusing as hell,” Strumberg said. “It’s incredibly vague. And this isn’t a trifling matter — these are some of the most important regulations that there are in terms of how our economy works.”

Strumberg added that it would be up to the dispute panel that heard the first case to decide what the meaning of the carve-out is.

“It’s pretty clear that [the provision] is designed not to be clear, and that the dispute panel will have to make up a meaning,” he said. “That’s a very strange way to set the most important international economic policy.”

A missed opportunity?

The disputes as to interpretation of the agreement may give the impression that the only policy possibilities in a trade agreement are to limit the ability of the signatories to impose regulatory controls, or to leave the parties free to impose such controls. There is actually a third possibility — use the agreement affirmatively to encourage the parties to adopt more robust regulatory controls — but that route was not taken.

The KORUS FTA was modeled on past FTAs, especially the North American Free Trade Agreement (NAFTA), and largely uses the same framework, albeit with different language. Some opponents of the agreement, however, believe that the U.S. financial crisis provided lessons about the perils of under-regulation that that Administration should have heeded when it renegotiated the deal.

Aldo Caliari, director of the Rethinking Bretton Woods Project at the Center of Concern, a faith-based advocacy organization for economic justice, says the KORUS FTA reflects “a model that was developed before the financial crisis” that “assumes that deregulation is going to lead to benign results.” But, he continued, “It does not really take on board what we are learning right now about the problems embedded in that model, [the assumption] that financial actors are going to self-regulate and that they will do it in the best interests of society.”

Kevin P. Gallagher, Associate Professor of International Relations at Boston University, who has written in opposition to the agreement, agrees, and describes the re-negotiation as a “missed opportunity” to reform the NAFTA-style model.