US-China BIT:Implications for China’s Capital Account

Kevin P. Gallagher Global Economic Governance Initaitive, Boston University www.bu.edu/gegi

Four Points

• US BITS require full opening of capital account with the United States.

• Unlike the WTO and the BITS of most other industrialized countries, US-BITS do not have exceptions for capital account regulations to prevent and mitigate crises.

• TPP countries, members of US Congress, and economists have been urging the US to reform, with some success.

• It is vital for the US-China BIT to leave policy space for sequencing liberalization and the need to regulate capital flows to prevent and mitigate financial instability.

US BITs

• Definition of ‘investment’: “every asset that an investor owns or controls, directly or indirectly”

• Scope of investment: “all transfers relating to a covered investment to be made freely and without delay into and out of its territory”

• Governance: private sector led “Investor-State-Dispute Settlement”

Comparing WTO and US Treaties

WTO-GATS• Covers only ‘financial

services’• Positive ‘list’

‘limitations’• Balance of Payments and

Prudential safeguards• State-to-State dispute

settlement

US FTAs and BITS• Covers all cross-border

transfers and investment• Negative ‘list’• No BOP safeguard and

restricted Prudential exception

• Investor-state dispute settlement

*NAFTA has BOP exception

GATSArticle XII

Restrictions to Safeguard the Balance of Payments

• 1. In the event of serious balance-of-payments and external financial difficulties or threat thereof, a Member may adopt or maintain restrictions on trade in services on which it has undertaken specific commitments, including on payments or transfers for transactions related to such commitments. It is recognized that particular pressures on the balance of payments of a Member in the process of economic development or economic transition may necessitate the use of restrictions to ensure, inter alia, the maintenance of a level of financial reserves adequate for the implementation of its programme of economic development or economic transition.

GATS: Annex on Financial Services

• Article 2 (a): Notwithstanding any other provisions of the Agreement, a Member shall not be prevented from taking measures for prudential reasons, including for the protection of investors, depositors, policy holders or persons to whom a fiduciary duty is owed by a financial service supplier, or to ensure the integrity and stability of the financial system. Where such measures do not conform with the provisions of the Agreement, they shall not be used as a means of avoiding the Member's commitments or obligations under the Agreement.

Prudential Exception-US BITS/FTAs• 1. Notwithstanding any other provision of this Chapter or Chapter Ten

(Investment), Fourteen (Telecommunications), or Fifteen (Electronic Commerce), including specifically Articles 14.16 (Relationship to Other Chapters), and 11.1 (Scope and Coverage) with respect to the supply of financial services in the territory of a Party by a covered investment, a Party shall not be prevented from adopting or maintaining measures 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. Where such measures do not conform with the provisions of this Agreement referred to in this paragraph, they shall not be used as a means of avoiding the Party’s commitments or obligations under such provisions.

• *It is understood that the term “prudential reasons” includes the maintenance of the safety, soundness, integrity, or financial responsibility of individual financial institutions or cross-border financial service suppliers.

US Inching Forward?

• 2003: US-Chile FTA: Special Dispute Procedure—arbitration after one year

• 2006: US-Colombia FTA: Special Dispute Procedure--arbitration after one year

• 2012: US-South Korea FTA: Annex ‘carving out’ South Korean regulation (with limits)

TPP: Chile ProposalChile reserves the right of the Central Bank of Chile (Banco Central de Chile) to maintain or adopt measures in conformity with Law 18.840, Constitutional Organic Law of the Central Bank of Chile (Ley 18.84, Ley Organica Constitucional del Banco Central de Chile) or other legislation, in order to ensure currency stability and the normal operation of domestic and foreign payments. For this purpose, the central bank of Chile is empowered to regulate the supply of money and credit in circulation and international credit and foreign exchange operations. The Central Bank of Chile is empowered as well to issue regulations governing monetary, credit, financial and foreign exchange matters. Such measures include, inter alia, the establishment of restrictions or limitations on current payments and transfers (capital movements) to or from Chile, as well as transactions related to them, such as requiring that deposits, investments or credits from or to a foreign country, be subject to a reserve requirement (encaje).]

TPP: Malaysia Proposal

Nothing in this agreement shall be construed to prevent a Party from adopting or maintaining temporary safeguard measures with regard to payments or transfers relating to the movement of capital:•(a) in the event of serious balance of payments or external financial difficulties or threat thereof; or•(b) where, in exceptional circumstances, payments or transfers relating to capital movements cause or threaten to cause serious difficulties for macroeconomic management, in particular, the operation of monetary policy or exchange rate policy.

US Counter Proposal

• Regulations on outflows only.• Exempts equity markets from safeguard.• Regulations must be price-based.• Subjects regulation to a ‘necessity test.’• Regulations may only last one year.

IMF on safeguards

•“these agreements in many cases do not provide appropriate safeguards or proper sequencing of liberalization, and could thus benefit from reform to include these protections”

International Monetary Fund (2012a), Liberalizing Capital Flows and Managing Outflows, Washington, IMF.

.

Ensuring Financial Stability in the US-China BIT

• Reform ‘prudential exception’ to explicitly:– allow for proper sequencing of capital account

opening,– allow for regulation of inflows to prevent

instability.

• Include strong ‘balance of payments safeguard’ to explicitly allow for regulation of outflows to mitigate instability.

THANK YOU!Kevin P. Gallagher

Global Economic Governance Initiative

Pardee School of Global StudiesBoston University

www.bu.edu/gegi

BostonUniversity

Global Economic Governance Initiative

GATS and Cross-Border Financial Regulation

• (Article XVI: footnote 8 GATS): WTO members must allow cross-border (inward and outward) movements of capital if these are an essential part of a service for which they have made commitments. – accepting deposits from or making loans to nonresidents

(mode 1).– securities trading on behalf of a customer residing in

another country (mode 1). – The establishment of a commercial presence (mode 3) in a

host country by a foreign services supplier involves both trade in services and international capital transactions.