1. Introduction
This article explores the interface between international integration of financial services and domestic regulation. Financial services are traded internationally, but regulated on the national level. The tension between trade integration and national sovereignty is especially hard to reconcile in the area of financial services. This results from the multiple aims financial regulation seeks to achieve: alleviate information asymmetries, market failures, and negative externalities. A thin line exists between protectionist measures, which seek to stave off foreign competition for instance, and measures that serve legitimate objectives.Footnote 1 Determining the extent international trade law affects domestic financial regulation and, subsequently, challenging financial regulatory measures, is a delicate exercise. This contribution aims to highlight the benefits of striking a balance between the two disciplines and uses clearinghouses of over-the-counter (OTC) derivatives as a case study.
Clearinghouses, also known as central-counterparties (CCPs), are entities that mitigate systemic risk and increase financial stability by inserting themselves between the parties to derivative transactions. They act as the buyer to every seller and the seller to every buyer. Clearinghouses are used for the back-office processing or ‘plumbing’ of securities; this taking place after a trade is agreed and before it is settled. Their primary tasks are (i) confronting counterparty credit risk,Footnote 2 (ii) reducing systemic risk,Footnote 3 and (iii) developing loss-sharing structures.Footnote 4 Following the G20 mandate to increase transparency and reduce risks in OTC derivative markets,Footnote 5 clearinghouses have emerged at the center of policymakers’ post-crisis reform agendas. They are expected to harness international OTC derivative markets valued at 595 trillion US dollars in the first half of 2018.Footnote 6 This is why clearinghouses have been called ‘super systemically important’Footnote 7 institutions with their role being seen as pivotal in the post-crisis financial architecture.Footnote 8
Explaining the role of clearinghouses in global financial networks involves considerations of international standard-setting bodies and their regulatory proposals,Footnote 9 market structure analyses for different financial products, major financial centers’ legal regimes (like EU and US),Footnote 10 the operation of market participants, and WTO law among others. This contribution investigates the European clearinghouse regulation from an international economic law perspective. In addition, it touches on the surrounding issues but only to the extent that they serve its analytical framework.
The European Market Infrastructure Regulation (EMIR)Footnote 11 raises issues on how international integration in the field of clearing derivatives is to be achieved. I use it as a framework to test the conformity of its prudential rules with WTO law. One may wonder to what degree European financial regulation and its application encroach on the opportunities of ‘third-country’ clearinghouses which aim to provide their services in the European market. Additionally, the rationale behind financial regulation and international trade law often differs significantly despite the fact that they regulate the same activities. Clarifying their relationship is one of the paper's objectives.
An examination of clearinghouses is crucial due to (i) their importance to the post-crisis reform of financial markets, (ii) the failure of existing literature to assess their role in international economic law, and (iii) the transnational nature of clearing OTC derivatives. In practical terms, when an international clearinghouse enters a derivatives transaction with market participants from other jurisdictions, they will engage multiple sets of rules that will likely include the WTO's rules for trade in financial services. Trade in financial services constitutes a significant part of international trade (particularly for the EU and the US) and the WTO offers its own legal system that places national legislations under scrutiny, provided commitments have been assumed.
International integration in financial services is facilitated by the General Agreement on Trade in Services (GATS).Footnote 12 The research question I address is how may international trade law scrutinize the European rules on clearinghouses. On a broader level, I question the degree to which trade has the potential means to further financial services liberalization. Investigating this subject matter is of relevance to anyone interested in how international economic law (the GATS) and financial regulation (exemplified by the European rules) relate to each other. The analysis suggests that the two disciplines are in conflict and investigates whether a closer relation that furthers the interests of both is feasible. The writer answers in the affirmative, so long as WTO Members (hereinafter Members) re-evaluate their approach to trade norms.
The structure of the article is as follows: Section 2 examines the European regulatory framework for ‘third-country’ clearinghouses to set the scene. Section 3 ventures into testing the GATS consistency of the European regime to evaluate the tension between the two disciplines. To that end, the analysis builds on the principles of non-discrimination and transparency in the light of Domestic Regulation (GATS Article VI), MFN (GATS Article II), Recognition (GATS Article VII), and the prudential carve-out (Annex on Financial Services paragraph 2(a)). Examining the European regulation's conformity with the relevant GATS provisions is essential to establish how financial policy objectives can be reconciled with trade disciplines and, subsequently, contribute to international integration. Section 4 concludes.
2. The European Regime for Third-Country Clearinghouses
In response to the G20 agreement, the European Commission drafted a proposal for regulating CCPs since they have turned into ‘systemically relevant’ financial institutions.Footnote 13 Subsequently, EMIR came into play in 2012. The EMIR's provisions connected to international trade in clearing derivatives are discussed to set the scene for the subsequent WTO law analysis. Specifically, the rules associated with a clearinghouse established outside the European Union (EU) providing its service to European market participants. Not surprisingly, the European regulation and EU executive agencies exercise thorough checks and balances for assessing the eligibility of clearinghouses from third-countries. This is conducted through the EU rules on equivalence. As OTC derivatives markets rely heavily on the functioning of clearinghouses, it is sensible for financial authorities to evaluate whether foreign CCPs comply with their own prudential rules. Due to the transnational nature of derivatives markets, different regulatory frameworks can generate disruptions in international trade-flows by increasing transaction costs and undermining the efficient allocation of funds.Footnote 14 EMIR is currently under revision.Footnote 15 Some of the new proposed features, such as the location policy for third-country systemically important CCPs, present interesting angles for future analyses. However, since EMIR II is still in the making, this is reserved for another occasion.
2.1 The ‘Equivalence’ Rules
Clearinghouses from non-European countries can provide clearing services in the EU after they have been recognized by the European Securities and Markets Authority (ESMA). The main criteria to be fulfilled are: (i) that the CCP shall be authorized in its home country, and ‘is subject to effective supervision and enforcement ensuring full compliance with the prudential requirements applicable in that third country’;Footnote 16 (ii) that the European Commission furnishes its equivalence assessment;Footnote 17 (iii) that the anti-money laundering and financing of terrorism laws in the third country are equivalent to the ones of the EU;Footnote 18 and (iv) that the regulatory authority of the third-country has concluded cooperation arrangements with ESMA.Footnote 19 In terms of procedure, the European Commission requests that ESMA provides technical advice with regard to third-country jurisdictions of major derivatives markets and clearinghouses that have applied for recognition. ESMA's assessments represent a factual comparison of the third-country provisions with the ones of the EU. They also provide advice to the Commission with respect to the possible effects of regulatory discrepancies and what should be incorporated in the Commission decisions. Equivalence determinations may be unilateral acts, but at the same time they are endorsed within a scheme of collaboration between the EU and third-countries. Notably, it should be underlined that there is no specific procedure under which third countries can apply to the European Commission for assessments of equivalence. Third countries, in principle, can express an interest in being assessed, which the Commission would duly consider without any further commitment.Footnote 20
These standards ensure that recognized third-country clearinghouses do not disrupt the orderly functioning of European financial markets and do not earn a competitive advantage against European ones.Footnote 21 The rationale behind extending recognition to CCPs from foreign jurisdictions, only if their regulatory frameworks are trustworthy and of similar standards as domestic regulations, is to avoid potential market failures in their own jurisdictions. During the EMIR legislative development, contentious discussions about the form of the equivalence regime took place in Brussels with WTO commitments supposedly being taken into consideration.Footnote 22 To date, seven years after EMIR's introduction, 32 non-European clearinghouses from 15 third-countries, established in Australia, Hong-Kong, Japan, Singapore, South Africa, Canada, Mexico, New Zealand, Switzerland, South Korea, the US, the United Arab Emirates, India, Dubai, and Brazil have been recognized by ESMA.Footnote 23 Notably, and after some troublesome discussions, the Dodd-Frank regime was deemed equivalent by the European Commission.Footnote 24
What does the number of recognized third-country regimes/clearinghouses tells us about the effectiveness of the EU equivalence regime? Similarly, as the ‘substituted compliance’ regime in the US,Footnote 25 it implies that it is a rather long process that lasts between two and four years.Footnote 26 However, when it attains its finalité, it can provide clarity and legal certainty to the clearinghouses doing business with Europe. But what about the third-countries, whose regimes are not qualified as equivalent? Are their clearinghouses afforded the same opportunities to determine their equivalence and provide their services in the EU? The forthcoming analysis filters the conformity of the European financial regulation under the GATS. The EU regime permits clearing trade flows with 15 jurisdictions outside Europe. Neither the European Commission nor EMSA have unlimited resources to engage in highly complex analyses of all third-countries’ clearinghouse regulations. Accordingly, CCPs from ‘third-countries’ that have not been deemed equivalent might find it more burdensome to furnish their services in Europe. For the sake of this argument, there are clearinghouses that have applied for recognition, while their domestic regime has not yet qualified as ‘equivalent’, and might need to wait for an undetermined number of years before they can provide their clearing services in Europe.Footnote 27
These regulatory frameworks on OTC derivatives seem to produce a new type of asymmetric compliance that can generate disruptions in the international derivatives clearing business.Footnote 28 Equivalence regimes that safeguard clearinghouses conducting transnational business are on a level – high standard – playing field. This would imply that their costs are comparable. As such, clearinghouses from one or the other side would not need to incur inflated compliance costs in foreign jurisdictions or conversely reduced conditions of competition. Nevertheless, even as market certainty for cross-border OTC derivatives clearing is promoted, liquidity is injected and no market disruptions occur if a third-country CCP is recognized under EMIR. The opposite can be said when an ‘equivalence’ agreement is not struck. This is for the minor jurisdictions which do not have an equivalence deal with the EU. Next, I examine EMIR through the GATS ‘looking glass’ to evaluate the tension between financial regulation and international trade law.
3. Testing the GATS-Consistency of the European Regime
The liberalization of financial services in the multilateral trading system is effected through the GATS disciplines and Members’ commitments.Footnote 29 This contribution reveals to what extent the GATS legal order challenges the European framework for conducting equivalence assessments of non-European clearinghouses. In that endeavor, I inquire whether clearinghouses from some third-countries might find it more burdensome to access the European market than other non-European clearinghouses. The relevance of this exercise lies not only in examining the tension between financial regulation and WTO law, but also in finding a mutually beneficial space for third countries. The analysis builds on the concepts of non-discrimination and transparency, and the GATS relevant provisions are put in context. It shall be mentioned that the limited jurisprudence on the GATS, alongside with the vast flexibility that the Agreement offers for financial services, makes this exercise somewhat delicate.
3.1 The GATS ‘Playbook’ – Scope of Application
The GATS is the first multilateral and legally enforceable agreement that covers trade in services. The dynamics that led to its ‘genesis’ came as the consequence of political compromise and vast flexibility is provided to Members.Footnote 30 Progressive liberalization constitutes the Agreement's compass.Footnote 31 Investigating how the European rules that affect international derivatives clearing may be scrutinized under this legal order contributes to understanding and challenging the balance between Members’ regulatory autonomy and integration norms. Furthermore, the EU is a full member of the WTO. In terms of scope, the GATS is applicable to ‘measures by Members affecting trade in services’.Footnote 32 The panel in EC–Bananas III has stated that the GATS has a wide scope to ‘ensure that the disciplines of the GATS would cover any measure bearing upon conditions of competition in supply of a service, regardless of whether the measure directly governs or indirectly affects the supply of the service’.Footnote 33 In addition, a distinction between the measures ‘as such’ and ‘as applied’ exists, and it can be maintained that not only the content of EMIR is under the GATS scrutiny, but also its application by the European executive agencies.Footnote 34 The definition of a ‘measure’ is very broad in the GATS, encompassing any type of action in any form taken by Members.Footnote 35 The scope of the GATS covers both the treatment extended to services and service suppliers of foreign Members.Footnote 36 In the same vein, a ‘measure’ by a Member ‘affecting trade in services’ includes measures regarding the purchase, payment, or use of a service, and the access to and use of, in connection with the supply of a service among others.Footnote 37
Moreover, the GATS Annex on Financial ServicesFootnote 38 (hereinafter Annex) provides further clarity on defining ‘financial services’Footnote 39 and ‘financial service supplier’.Footnote 40 The Annex includes in its indicative list, the services linked to clearing OTC derivatives; namely, ‘settlement and clearing services for financial assets, including securities, derivative products, and other negotiable instruments’.Footnote 41 The panel in China–Electronic Payment Services clarified the nature of this sector: ‘subsector (xiv) encompasses the clearing and settlement of financial instruments sharing essentially the same characteristics as securities, derivative products, and other negotiable instruments. More particularly, (xiv) covers the clearing and settlement of financial instruments which have investment attributes, grant ownership rights and yield financial returns’.Footnote 42
The GATS provides four modes of supply for the provision of services.Footnote 43 The most relevant for the purposes of this study are ‘cross-border supply’ (Mode 1) and ‘consumption abroad’ (Mode 2). This is because clearinghouses most commonly provide their services transnationally, without establishing commercial presence in third-countries. Possible inconsistencies between these two modes of supply for financial services are addressed below. It can thus be confidently inferred that the European equivalence regime and its application, touching on the conditions for the provision of cross-border clearing of OTC derivatives from non-European service providers, qualify as ‘measures’ that affect foreign clearinghouses.
Since the application of EMIR affects trade in financial services, it falls within the regulatory perimeter of the GATS. Next, I discuss the legal problem of distinguishing between Modes 1 and 2 in financial services trade. Following this, I consider how the GATS disciplines that promote transparency and prohibit discriminatory behaviours may assess the European equivalence rules. The analysis brings into the spotlight the tension between financial regulation and WTO law.
3.2 Modes 1 & 2: The Stakes for Financial Services
At the outset, the GATS modes of supply for wholesale financial services must be put in context. Importantly, I advocate that both Modes 1 and 2 can be admissible for the clearing of OTC derivatives based on the state-of-play of the Agreement and WTO jurisprudence. The analysis underscores that Modes 1 and 2 produce different legal effects depending on the context in which they arise. If different commitments are undertaken for Modes 1 and 2 in Members’ schedules, then the level of liberalization varies accordingly. However, in the domain of financial services there is an inherent challenge in distinguishing Mode 1 from Mode 2.Footnote 44 This can produce difficulties in the interpretation of scheduled commitments and in doing so give rise to legal uncertainty. Generally, for Mode 1 the supplier is not present in the territory where the service is provided, and telecommunications or international transport are textbook cases. In contrast, it is the ‘movement of the consumer’ that seems to be the benchmark for Mode 2,Footnote 45 although as shown later that is not necessarily the case. Notably, the panel in Argentina–Financial Services held that under the first two modes of supply, service providers ‘may be located outside the territory of the Member ‘importing’ the service’.Footnote 46 Below, I explain the intricacies in the supply of financial services and the legal interpretation challenges associated with it.
Fleshing out the GATS modes of supply conundrum requires an understanding of the mechanics of financial transactions. This is a complex exercise due to the breadth of activities financial services involve and the interconnectedness of financial markets. Some financial services operate on technical networks and as a result their supply is hard to capture from an international trade law perspective. Unsurprisingly, to understand how the reality of financial services translates into the clearing of derivatives under WTO law presupposes complex considerations, assuming there are diverging scheduled commitments for Modes 1 and 2. Unlike what occurred in US–Gambling,Footnote 47 this issue turns from a purely academic endeavour to a tangible one for the WTO system. This is because legal ambiguities are likely to emerge. I introduce an international clearing hypothetical to add concreteness to the subject.
A credit-default-swap (CDS) is consummated between two parties, A and B. Once the terms of the contract are agreed between the counterparties, the swap passes to the post-trade phase. There, the swap between A and B must be centrally cleared, to mitigate the counterparty risk exposures of the transaction. Since clearing services are required, another party steps in, namely the clearinghouse CCP. As explained, the CCP at this stage inserts itself between parties A and B. It is held that the clearing service supplied is none other than the service provided by the CCP to the parties that conclude the swap, namely A and B. For the sake of simplicity in this example, the two parties are from the same WTO Member and the parties’ relation to the clearinghouse is not examined.Footnote 48 Since the service supplier (CCP), the service consumers (A & B), and the service at stake (clearing of the CDS) are defined, the next step is to supplement the scenario with the international dimension features, so that the GATS modes of supply discussion becomes relevant. The level of liberalization, enshrined in the parties’ commitments, is added next.
A and B, are investment banks incorporated in Europe. They decide to clear their CDS with clearinghouse CCP established in the US. Generally, OTC derivative traders are large financial institutions that supply their services across frontiers. Clearinghouses are also international institutions selected for their efficiencies. That said, when it comes to Mode 1 – cross-border supply – things appear to be quite clear-cut. The clearing service in question is provided from the territory where the service supplier (the CCP) is situated into the territory where the contracting parties reside, accordingly from the US to the EU in our example. Traditionally, it is maintained that cross-border supply is the only GATS mode that does not require territorial proximity between the service supplier and the consumer, but this assumption is doubtful due to the emergence of new technologies and infrastructure.Footnote 49 Attention is drawn to the challenging state-of-play for Mode 2.
The role of international capital flows, global financial communication channels, and financial market infrastructure facilitates the transnational distribution of financial services. This narrows the gap – or even cuts the dividing line – between Modes 1 and 2 because the natural presence of consumers is not borne in mind. More accurately, ‘once the physical presence of the consumer ceases to be a benchmark for determining the place of delivery of a service, it becomes extremely difficult to determine in an unambiguous manner where a service is delivered’.Footnote 50 As a reminder, consumption abroad is the mode of supply that depends on the consumer's location. Notably, wholesale financial transactions, such as the derivatives clearing, are provided transnationally through financial infrastructure networks. Given that financial regulation has provided the green light, meaning that CCPs from third-countries are qualified under equivalence/substituted compliance regimes, this results in making the determination of a physical location for the supply of the service a ‘Gordian knot’. Thus, the issue becomes highly complex.
Conceptualizing Mode 2 in our hypothetical has a similar outcome as Mode 1 – the provision of clearing services from the US clearinghouse to the European banks, with the difference that the legal narrative of the transaction changes. It can be convincingly argued that clearing services are supplied by Mode 2 provided: (i) there is no solicitation on the part of the CCP to parties A and B and they initiate the transaction; and, (ii) A and B conclude the deal through their US offices which are governed by foreign law and are not constituted as separate legal entities under US laws.Footnote 51 If these conditions are fulfilled, clearing services can be provided through Mode 2. This transaction can qualify as consumption abroad because the European banks would clear an EU-bound CDS with a US CCP through their New York offices. The elements of this transaction that are of the essence for Mode 2 are (i) that the EU banks opt for a third-country CCP, one from the US in our case, and (ii) that they complete the transaction via their NY offices, which are not subject to US laws. This is not a domestic transaction for the reason that the European banks opt for sourcing European business into the US. However, the fact that both Modes 1 and 2 are plausible for the purposes of derivatives clearing begs the question of where does the transaction actually occur: in financial communication channels? For these transactions, it is extremely difficult to unambiguously determine the GATS mode of supply. The foregoing analysis highlights that clearing derivatives services can be supplied by both Modes 1 and 2. Nevertheless, it is obvious that there is not a clear line to define the difference between the two modes. To avoid legal ambiguities in the future, it will be necessary to have a conclusive benchmark to make such determinations.
Distinguishing the modes of supply and understanding the legal reality behind the provision of financial services has important legal consequences. In the case of cross-border supply, if a Member has not entered commitments for clearing services, its regulatory behaviour cannot be scrutinized by the GATS provisions. Conversely, if for Mode 2 full commitment is extended, the GATS scrutiny is significantly broader. As a result, it is evident that the modes in question can generate different legal effects depending on the interest of WTO Members. As the financial industry evolves, international trade law needs to keep up the efficacy of its legal instruments in order to avoid loopholes in its architecture. Since neither the WTO dispute settlement system nor its Members have clarified that score until now, this discourse has no definite answer and I argue that both the venues of Mode 1 and 2 can be used for clearing services.
The commitments for clearing derivatives in the EU ScheduleFootnote 52 are essential for the legal standards of Article VI analysed right below. These commitments underscore the existence of legal ambiguities that arise if different commitments are undertaken for Modes 1 and 2. Pursuant to the EU Schedule in place for financial services sectors: The Communities and their Member States undertake commitments on Financial Services in accordance with the provisions of the ‘Understanding on Commitments in Financial Services’(Understanding).Footnote 53 The Understanding bestows in fact ‘a sort of a formula approach to scheduling commitments under Articles XVI, XVII, and XVIII of the GATS with regard to financial services’.Footnote 54 When it comes to international trade, the Understanding's reach extends to both Modes 1 and 2 of the GATS.Footnote 55 However, for clearing services the Understanding offers commitments only for services under Mode 2.
Consequently, in the case of Mode 1, the EU has not assumed commitments for clearing derivatives, and as a result its regulatory behaviour cannot be filtered by the GATS provisions that require specific commitments. Conversely, for Mode 2 the GATS scrutiny is significantly wider because full commitment is extended, and accordingly the European financial regulation complies with higher WTO standards. Given the existing difficulty in distinguishing Mode 1 from Mode 2 in financial services, this article endorses the view that clearing OTC derivatives services between the EU and WTO Members are supplied through mode 2. The subsequent analysis of Article VI evolves on that premise. This approach is adopted because it is consonant with the GATS text and the existing WTO jurisprudence while it reflects how wholesale financial services are provided. At the same time, it serves the liberalization agenda to opening up markets.Footnote 56 Since the EU has undertaken commitments for Mode 2 clearing derivatives, the article proceeds by testing the GATS Article VI consistency of EMIR rules.
3.3 GATS Article VI
Domestic Regulation is a GATS hybrid provision because certain of its elements are intimately linked to the Members’ Schedules. Article VI introduces a mechanism that requires that Members’ regulations are not inequitable, excessively interventionist, or inhibit trade disproportionately to the desired outcomes.Footnote 57 Generally, liberalization in services is confined by non-tariff barriers that take the form of regulations.Footnote 58 This is especially the case for financial services, which is one of the most heavily regulated industries. Nevertheless, the Members’ regulatory autonomy is prescribed in the GATS,Footnote 59 and can serve as a valuable means of interpretation. It is assumed that governmental protectionismFootnote 60 can be entrenched in Members’ regulations and subsequently can be deemed, on a case-by-case basis, unlawful under WTO law.
Article VI scrutinizes how domestic regulations are designed, administered, and applied. It stipulates legally binding provisions of procedural nature,Footnote 61 a mandate to deploy a multilateral discipline for licensing requirements, and a substantive obligation of transitional nature. The application of Members’ domestic regulatory measures shall reflect on the principles embedded in the GATS, most importantly, on fairness, as an expression of non-discrimination, openness, in the form of transparency, and on negotiated commitments.Footnote 62 The panel delineated the scope of Article VI in US–Gambling, and stated that WTO Members’ regulatory sovereignty ceases when the GATS rights of other Members are infringed.Footnote 63 The analysis proceeds by testing the compatibility of the EMIR equivalence regime under Article VI:1 and VI:5.
3.3.1 EMIR Tested under GATS Article VI:1
When it comes to how the Commission conducts EMIR equivalence assessments of third country clearinghouse regimes, it is underlined that WTO rules cover how the measure is administered and the measure itself. The Commission's role is to examine the regulatory frameworks of third-countries, using ESMA's technical advice, and to determine the regime's equivalence with EMIR. Importantly, it is a stepping stone in the recognition process and highly impacts on the market access of third-country CCPs. Given that third-countries are largely WTO Members, it is vital to evaluate the measure's GATS-conformity for possible breaches.
At the outset, it is examined whether EMIR Article 25 constitutes a measure of ‘general application’ in the context of Article VI:1. It is important to understand that Article 25 puts forward the rules that the European Commission follows while discharging its equivalence assessment tasks. Carrying out equivalence assessments qualifies as a measure of general application firstly because it affects an unidentified number of economic operators;Footnote 64 namely, all CCPs established in third-countries on the one hand and all market participants within the EU receiving clearing services on the other. Secondly, within Article 25 a wide range of measures is included and the rules of conduct alongside the exercise of influence of certain authoritative bodies, such as the Commission, are scrutinized by this provision.Footnote 65 Consequently, the Commission's administrative conduct and decision-making function under the EMIR provision at issue can be characterized as of general application for the purposes of GATS Article VI:1.
The application of the equivalence assessments by the European Commission can be challenged as biased against the regulatory frameworks of smaller countries that are not financial hubs because: (i) even if Members have CCP regulatory frameworks of similar quality, some Members have received equivalence decisions while others have not, and (ii) there are no guidelines or rules on the sequence the European Commission carries out its equivalence assessments. Overall, the Commission seems to favour CCPs from jurisdictions that have stronger ‘regulatory leverage’ because it is more sensible from an economic standpoint to acquire the clearing services from WTO Members with stronger financial institutions rather than the opposite. The WTO dispute settlement mechanism is at the disposal of smaller countries that can initiate litigation. The argument that the European Commission's administration of equivalence assessments is discretionary is of procedural nature and the role of the Commission is examined to reveal whether the current state of affairs can be problematic from a WTO law perspective.
The Commission can be accused of not safeguarding the standards of due process for WTO Members. Notably, it has been characterized as inherently political.Footnote 66 This claim is substantiated by the fact that some financial rulebooks are selected to be assessed and are deemed equivalent by the European Commission, while the regulatory frameworks of other Members are not. As a result, some Members’ clearinghouses cannot be recognized by ESMA to supply services to European financial institutions abroad in countries other than to those with equivalence decisions, issued by the Commission. What is political in this process is the sequencing of the equivalence assessments. In the absence of guidelines setting out the order to be followed for carrying out equivalence assessments, some Members are given priority to the detriment of others. For instance, the regimes of Singapore, Australia, Japan, and Hong Kong, countries that represent international financial centres, acquired their equivalence decisions by the European Commission in 2014. Conversely, Members, such as Argentina, Russia, and Thailand are still on the waiting list. To that end, the two specific procedural aspects – mentioned above – of the general mandate for the administration of equivalence assessments by the European Commission, enshrined in EMIR Article 25, need to be examined closer.
The first Paragraph of VI, similarly to Article X:3(a) of the GATT,Footnote 67 stipulates the obligation of reasonable, objective, and impartial administration. This obligation hinges on Members’ assumed commitments in service sectors and mirrors the GATS asymmetric architecture. Interestingly, Article VI:1 presupposes that Members, when administering their domestic legal frameworks, shall conform to certain minimum standards of due process,Footnote 68 which include the notions of fairness and equity.Footnote 69 This provision reinforces the norms of consistency and predictabilityFootnote 70 and promotes good regulation standards for Members. The scarcity of GATS case law on this provision makes its GATT counterpart a valuable guide to investigate the WTO adjudicatory bodies’ stance.
Any measure that on the surface appears fair and just could come under the purview of this provision if it is de facto applied in an arbitrary, unreasonable, and biased fashion, as the Appellate Body noted in US–Shrimp.Footnote 71 This element of WTO judicial review is essential to avoid governmental circumvention based on the distinction between measures as applied/as such. Additionally, an infringement on the obligations mandated in VI:1 can occur as the result of an omission in a case where an obligation to act in a specific manner is imposed.Footnote 72 Differential treatment over time and relating to other trade operators is disallowed as well.Footnote 73 The WTO jurisprudence reveals that the obligation laid down in VI:1 circumscribes the administration of such measures or how these measures are applied in practice,Footnote 74 and does not scrutinize their substantial elements.Footnote 75 The administration of measures should have a significant impact on the holistic application of a Member's regulation, and not only on the course of a particular case.Footnote 76
EMIR has been in place since 2012. In that period, the European Commission has decided that 15 third-country CCP regimes are equivalent to the EU.Footnote 77 Accordingly, only clearinghouses from these 15 jurisdictions can provide, once they are recognized by ESMA, their services to European markets. It should be stressed that the way equivalence assessments are carried-out takes time. However, less trade-restrictive alternatives that do not jeopardize stability might be available, and are discussed infra. Moreover, due to financial integrity considerations and the intricacies of financial regulation, the process becomes additionally complex and cumbersome.Footnote 78 Nonetheless, the outcome limits the access of European market participants to third-country clearinghouses abroad from the abovementioned jurisdictions.
The way the Commission conducts its equivalence assessments raises questions of impartiality and objectivity. First, the European Commission seems to indulge in ‘cherry-picking’ of the jurisdictions that admittedly have bigger clearinghouses, such as the US, Hong Kong, Australia, and Singapore. This practise seems sensible from an economic perspective. Nevertheless, that is not the case from an international trade angle, provided that the GATS obligations and commitments are borne in mind. More interestingly, although the central-clearing frameworks of Argentina, Indonesia, and India are on the same regulatory implementation rating by the Financial Stability Board (FSB), only India has acquired an equivalence decision by the European Commission.Footnote 79 Nevertheless, an empirical study that exceeds the scope of this article is required to identify the patterns and consistently appraise the methodology the Commission uses to assess third-countries’ financial rulebooks. Second, priority is given to the countries that have ‘regulatory leverage’ in the sense that bigger countries with financial centres are assumed to craft better regulations. Thus, it seems easier for Europe to proceed with the examination of their regimes. Importantly, since there are no guidelines on what sequence the Commission shall follow to examine foreign jurisdictions, another question of compatability with Article VI:1 emerges. The absence of guidelines or standards in how the Commission decides to initiate its equivalence assessments begs the question of whether the administration of EMIR Article 25 is objective,Footnote 80 especially as CCPs from smaller Members apply, but are unable to supply their services to European financial institutions abroad due to the Commission's lack of Implementing Act. Notably, irrespective of the CCPs application for recognition date at ESMA, there is no procedural rule that sets a condition to the Commission relating to the order of third country equivalent assessments. Consequently, what might be in violation of GATS Article VI:1 is that the Commission prioritizes in its equivalence assessments some Members over others by discretionary deciding to evaluate some regimes, without providing the same opportunity to clearinghouses from other jurisdictions.
Arguably, the Commission and ESMA lack the unlimited resources to conduct simultaneously assessment of all WTO Members financial rulebooks. Considering the complexities of such determinations and the number of third-country jurisdictions it can be understandable. However, the Commission's discretionary behaviour in the administration of EMIR could be found in violation of the GATS Article VI:1. To remedy the current state-of-play would require either: (a) provision to all Members an equal opportunity to have their regulations evaluated for equivalence, something extremely difficult in practice; or, (b) further harmonization of regulatory standards among Members, or at least parts thereof, to permit trade-flows.Footnote 81 On a normative note, it can be argued that to encourage trade in financial services without facing the transaction costs and market access barriers raised by regulations, such as the regimes of equivalence/substituted compliance, it is essential for the WTO to provide a venue for its Members to discuss and if possible mitigate their regulatory divergences.
3.3.2 Transparency under EMIR & GATS Article VI:5
Transparency is one of the WTO fundamental disciplines that reflects the Members’ openness towards their counterparts. It is also one of the general obligations applicable to trade in services. Transparency, as it is enshrined in GATS Article III, relates to the Members’ mandate to furnish predictability in the multilateral trading system. Lex specialis resides in GATS Article VI Par. 5(a)(i) which encounters the concept of transparency in the domain of qualification procedures, technical standards, and licensing requirements. GATS Article VI:5 encompasses a substantive legal obligation of transitional character; this obligation is ‘pending the entry into force of the disciplines developed in these sectors pursuant to paragraph 4’, interestingly for 24 years. This provision accommodates a minimum qualitative set of standards of market access, only for the legal orders of Members that have entered commitments.
The criteria set by GATS Article VI:5 are: (i) a Member has a commitment in a specific services sector; (ii) this Member imposes licensing, or qualification requirements, or technical standards in this sector; (iii) the application of the measures nullifies or impairs the specific commitments assumed; (iv) the nullification or impairment transpires in a way that is not consonant with the conditions of transparency, objectivity, and necessity stipulated in Article VI:4(a-c);Footnote 82 and (v) such nullification or impairment could not have been reasonably anticipated by that Member when the specific commitment was undertaken.Footnote 83 Along these lines, the first two criteria are fulfilled because Europe has made commitments for clearing derivatives services for mode 2 pursuant to the Understanding and EMIR spells out the licensing requirements. EMIR's transparency considerations are drawn next to assess whether they could impair the EU's commitments. Surprisingly, Article VI:5 regardless of its pervasive nature has never been interpreted by WTO adjudicatory bodies. The only time a panel had the opportunity to shed light on the provision, in Mexico–Telecoms, it neglected to do so for reasons of judicial economy.Footnote 84
The EU in its attempt to design a robust regulation for clearinghouses has indulged in adopting measures that can be contested before WTO judiciary on the basis of transparency. WTO Members, whose CCPs have not acquired a recognition and are unable to supply their services in Europe, could contend that EMIR lacks objective and transparent criteria with respect to its licensing requirements. This can be substantiated by the fact that the main criteria on which ESMA and the Commission base their assessments on are not exactly clear. The third-country recognition procedure is driven by motives relating to the clearinghouse's jurisdictional ‘creditworthiness’. The Implementing ActsFootnote 85 that the Commission adopts reinforce the regulatory framework's lack of transparency exactly because of the nature of their determinations regarding: (i) ‘effective supervision and enforcement’ that the CCPs are subject to in third countries, and (ii) third-countries’ ‘legally binding requirements which are equivalent’ to EMIR.
These criteria prescribed in EMIR are abstract. The missing determinant is the way they are assessed by the European executive agencies because the requirements themselves leave considerable room for discretion in the appraisal phase. At first glance, these criteria, as they are articulated in the text of the Regulation, seem quite transparent. However, when read in conjunction with ESMA's advice and the Commission's Acts, they generate further questions. The discrepancy among Members’ financial regulatory frameworks requires further clarity with respect to how these legal aspects are assessed. The points on effective supervision and enforcement and legally binding requirements that are equivalent to EMIR are not clear because they are not benchmarks that third countries and their clearinghouses can rely on. Rather, they promulgate some criteria that the EU institutions can construe with a high margin of appreciation. Moreover, confusion can emerge from the discrepancies in the assessment of different jurisdictions.
EMIR's lack of transparency might be inconsistent with GATS Article VI Paragraph 5(a)(i) provision because it can impair or nullify the commitments EU assumed for clearing financial instruments in accordance with the Understanding. In particular, by hindering third-countries from acquiring a clear view of the system in place for the implementation of equivalence assessments, Europe could impair its commitments for financial services. More broadly, for violation cases there is a rebuttable presumption of nullification or impairment.Footnote 86 However, the special nature of this provision links the concept of nullification or impairment to a substantive infringement of WTO rules, displaying the negotiators’ reluctance in restricting their own regulatory autonomy.Footnote 87 The burden of proof of nullification/impairment rests with the Member seeking to demonstrate that the application of the equivalence assessment is in violation of Article VI:5. The application of EMIR rules can be characterized as trade restrictive in the sense that service suppliers from third-countries suffer the loss of opportunity to transact with European market participants abroad. The lack of transparency is evidenced in the absence of explicit guidelines that explain what third-countries effective supervision and enforcement might entail, and what would be the parameters for the equivalence assessment, given that financial regulations across the globe are inherently disparate. Conducting these analyses is not an easy task, due to the complexities of Members’ financial rulebooks. Nevertheless, more transparent criteria should be put in place for the sake of predictability and in order to inform Members about the precise steps EU institutions take. Transparency is intended to furnish openness to services’ trade, and the regulatory framework in question does not seem to facilitate multilateral trade in clearing derivatives.
3.4 MFN Treatment for Non-European Clearinghouses
Non-discrimination constitutes the cornerstone of the multilateral trading system and MFN is the most representative GATS obligation. Article II:1 can test the consistency of EMIR's equivalence regime and puts forward that service providers of any Member shall not receive less favourable treatment than like services and service providers of any other Member. To fall within the scope of MFN, two criteria must be satisfied, which are articulated for our discussion as: (i) that clearing services or clearinghouses from countries that have been deemed ‘equivalent’ by Europe are ‘like’ to CCPs from countries that have not; and, (ii) that the application of the EMIR equivalence assessments extends ‘less favourable treatment’ (LFT) to clearinghouses with specific origin in comparison to other countries. The forthcoming analysis assesses how the GATS Article II:1 conditions can filter EMIR Article 25, in the light of the Argentina–Financial Services. This dispute elaborates on the tension between trade and regulation because differential treatment is accorded to Members based on their regulatory frameworks.
3.4.1 ‘Likeness’
The determination of discriminatory behaviour in WTO law depends on the concept of likeness. Like service suppliers from different Members cannot be accorded differential treatment. However, if they are not considered alike, they can be treated differently. Extensive WTO jurisprudence on likeness exists in trade of goods,Footnote 88 but our focus lies with services. The panel in Canada–Autos held that ‘to the extent that the service suppliers concerned supply the same services, they should be considered like’.Footnote 89 This statement is drafted broadly, and seems to disregard the complex nature of services and the role of regulation. Additionally, it could restrict the right of Members to regulate the supply of services on the basis of national policy preferences. The GATS likeness determination differentiates from the standards set out by WTO jurisprudence for goods. Allowances must be made for Members’ regulatory framework divergences that can complicate the conditions of ‘likeness’. Recently WTO case law has broadened our understanding of how trade norms can filter WTO Members’ prudential frameworks. It has also provided guidance on how ‘likeness’ can be established between service providers from different jurisdictions. The question I address here relates to whether non-European CCPs from country x, which has been deemed to have an equivalent regime by the Commission, are ‘like’ to clearinghouses from country y, which has not.
The Appellate Body in Argentina–Financial Services held in respect of ‘likeness’ of the GATS Article II:1 that ‘the determination of ‘likeness’ of services and service suppliers must focus on the competitive relationship of the services and service suppliers at issue’.Footnote 90 The competition concept is adopted from the GATS Article XVII, and can prove to be a useful guide in the process of assessing whether service suppliers are like. Although the China–Electronic Payment Services panel inquired the determination of likeness for both services and service suppliers,Footnote 91 the Appellate Body understands these terms in tandem, and suggests they should not be examined in isolation.Footnote 92 Furthermore, the presumption approach refers to the case that the complainant can establish ‘likeliness’ by merely illustrating that the measure in question distinguishes between services and service suppliers based exclusively on origin. This ‘presumption’ has been accepted by numerous panels for trade in goods,Footnote 93 and recently adopted by the Appellate Body.Footnote 94 Nevertheless, the perimeter of the ‘likeness’ presumption is narrower for trade in services; this is due to inherent complexities of services sectors, distinctions between services and service suppliers, varying modes of supply,Footnote 95 and domestic regulations, which define the realm of operation of service suppliers alongside with consumers’ preferences, that all need to be borne in mind.Footnote 96 Interestingly, in Argentina–Financial Services the panel concluded that ‘it is not the origin per se which determines … but the regulatory framework inextricably linked to such origin’.Footnote 97 The Appellate Body reversed the panel's finding because its analysis erred in fulfilling the presumption of ‘likeness’ criteria.Footnote 98
These benchmarks for determining ‘likeness’ between service providers furnish clear filters for evaluating whether clearinghouses from third-countries are like or not. However, case-by-case analysis is required to establish if the conditions are met. It should be mentioned that the burden of proof always lies with the party that asserts an affirmative claim.Footnote 99 The role of regulatory frameworks has been stressed by WTO judiciary in the determination of ‘likeness’ for services/service-suppliers. Potential complainants that would challenge EMIR equivalence mechanism should either illustrate that differential treatment is extended between the clearinghouses of x and y exclusively on the basis of origin to adhere to the condition of the presumption approach, or encounter whether the regulatory divergence between CCP regulation does not alter the conditions of competition in the traditional ‘likeness’ determination. If it does not and the regulatory frameworks of x and y follow the same standards and implementation,Footnote 100 then their clearinghouse should be considered ‘like’. In the case where there are fundamental discrepancies between the countries’ clearing-derivatives regimes, then ‘likeness’ would be more challenging to prove.
3.4.2 LFT
LFT is embedded in both GATS Articles II:1 and XVII and WTO judiciary holds that both provisions employ the same standard.Footnote 101 Jurisprudence developed for goods agreements does not always chime with the mechanics of the GATS due to their structural differences.Footnote 102 Nevertheless, the GATS legal requirement for establishing LFT has been recently delineated by the Appellate Body for trade in financial services. A measure fails to confer ‘treatment no less favourable’ if it modifies the conditions of competition to the detriment of services or service suppliers of any other Member in comparison to like services or service suppliers of, respectively, any other country or the Member imposing the contested measure.Footnote 103 Thus, the driving force of LTF is the relation between the measure in question and whether this measure alters the conditions of competition between like service suppliers.Footnote 104
Regulatory frameworks admittedly affect trade in services. Evaluating whether a measure leads to modifying the conditions of competition at the expense of like service suppliers ‘must begin with scrutiny of the measure, including consideration of the design, structure, and expected operation of the measure at issue’.Footnote 105 However, this type of regulatory assessment will not go beyond the content of the GATS, and change its internal balances. The panel in Argentina–Financial Services attempted an alternative interpretation of the LFT, which resembles the approach devised by the TBT Agreement. The panel's analysis went beyond just taking account of the regulatory aspects relating to services that may affect the conditions of competition, and attempted to justify LFT on ‘certain regulatory distinctions’.Footnote 106 This stance disregards the broader GATS taxonomy, which favors Members pursuing their national policies and at the same time provides the prudential exception that financial regulations can be justified under.Footnote 107 Contrary, TBT has this regulatory distinction in the determination of LFT, but does not furnish exceptions as the GATS does. Ultimately, the Appellate Body did not endorse the panel's interpretation.Footnote 108 It stated that to the degree that evidence pertaining to the regulatory aspects has a bearing on the conditions of competition, it might be taken into consideration, subject to the specific characteristics of the case.Footnote 109The GATS Article II:1 LFT status quo provides clarity on how like service suppliers are to be treated. If national regulatory frameworks impact on the conditions of competition between like service suppliers, then differential treatment at odds with the MFN principle is extended. One may wonder to what degree the European clearinghouse regulation affects the opportunities of third-country CCPs planning to provide their services in the EU market. Applying the stated two-pronged test presupposes that the clearinghouses by country x, which has been deemed to have an ‘equivalent’ regulatory framework by the Commission, are ‘like’ to clearinghouses from country y, which has not. Then as soon as ‘likeness’ is established, LFT is extended by Europe because CCPs from x can supply their services to European financial institutions, while CCPs from y cannot. To illustrate, we first assume that the central-clearing regime of India, which has been deemed equivalent by the EU, and the regulatory framework of Argentina, which has not, are considered to provide similar standards. Accordingly, their clearinghouses would be deemed like by the WTO judiciary. Then, establishing LTF would only rely on proving that the EU regulation changes the terms-of-competition between the CCPs of India and Argentina, by disallowing the latter to provide their services in Europe. EMIR regime affects the conditions of competition because it favors clearinghouses from certain jurisdictions and forecloses the European market to others. Consequently, the EMIR regime might result in violation of the GATS Article II. Nevertheless, the GATS provides regulatory flexibility and Article VII, alongside with Annex paragraph 3, furnishes a safe harbour from MFN, as long as their conditions are satisfied.
3.5 Recognition Agreements for Financial Services
In response to the G-20 accord, regulators have devised their frameworks for clearinghouses. Subsequently, they carry out their own evaluations of third-country CCP rules to determine whether the regimes are equivalent to theirs. These assessments determine whether other Members’ clearinghouses can furnish their services or not. In a similar vein, EMIR promulgates that the Commission publishes equivalence decisions of third-country CCP frameworks. Accordingly, some jurisdictions are deemed equivalent while others are not. The clearinghouses of Members that are extended recognition of their regimes find it less burdensome to offer their services in Europe than clearinghouses from Members that are not. However, the GATS sets out that ‘a Member may recognize … requirements met, or licenses or certifications granted in a particular country’.Footnote 110 The rationale of Article VII lies in furthering trade integration through recognition, while disallowing discrimination.Footnote 111 In addition to Article VII and closer to our analysis, the Annex on Financial Services reads: ‘A Member may recognize prudential measures of any other country in determining how the Member's measures relating to financial services shall be applied.’Footnote 112 These recognition provisions stipulate that agreements can be concluded either mutually or unilaterally, and spell out specific conditions that shall be respected.
First, transparency in the form of notifying recognition measures to the Council for Trade in Services is prescribed in the GATS.Footnote 113 This obligation can potentially increase the WTO Members’ understanding of what are the driving forces of recognition agreements, and ultimately contribute to further integration.Footnote 114 However, for trade in financial services, openness through transparency is not attained because Members do not notify any of their recognition measures.Footnote 115 This does not imply that recognition in financial services sectors between Members is not accorded, but rather that the transparency obligation is not fulfilled. As a result, since the practice of states does not facilitate trade openness, it becomes more difficult to pursue recognition with WTO Members that are not ‘like-minded’ partners. Most importantly, this lack of transparency has implications on restricting future recognition agreements.
The second obligation requires that a Member ‘shall afford adequate opportunity for other interested Members to negotiate their accession to such an agreement or arrangement or to negotiate comparable ones with it’.Footnote 116 The Annex clarifies in that regard, that equivalent regulation, supervision, and enforcement are of vital importance for financial services. It should be understood that in practice Members that lack the regulatory expertise and the supervisory/enforcement resources are not necessarily offered adequate opportunity to conclude recognition agreements due to the complexities involved in these processes, as discussed above. Third, recognition agreements shall not be either discriminatory or constitute a disguised trade restriction.Footnote 117
At this stage, an interpretative comment on the relation between GATS Article VII and the Annex paragraph 3 is required to shed light on the applicable provisions for the recognition of prudential measures. At first, the Annex provision on Recognition is a lex specialis to the GATS Article VII. However, we should underscore that the existence of Paragraph 3 of the Annex does by no means lead to the inapplicability of the broader GATS provision. This can be convincingly substantiated by an a contrario interpretation of the Annex Paragraph 3(c) which explicitly stipulates that: Where a Member is contemplating according recognition to prudential measures of any other country, paragraph 4(b) of Article VII shall not apply. Notably, the founding fathers consciously discarded only the applicability of paragraph 4(b) of Article VII for financial services sectors; namely, the Members’ transparency obligation in relation to the notification of potential ongoing recognition procedures. As a result, it emanates from this reading that all the other GATS Article VII provisions still apply for financial services with the particular specificities attached to Paragraphs 3(a) and (b) of the Annex.
Given that most GATS Article VII obligations remain applicable for financial services, it is worthwhile briefly discussing the role of Article VII:5 in this context. This provision spells out a best-effort obligation for Members to negotiate common international standards and criteria for recognition in international fora. This provision is not excluded from the scope of financial services. In principle, Members, when appropriate, must adopt the standards put forward by international standard setting organizations. Perhaps the key condition enclosed to this provision is ‘in appropriate cases’, because it leaves considerable room for maneuver to WTO Members. Especially, the intricacies associated with financial regulation and the stability considerations enshrined in the prudential carve-out might strip this provision of meaning for financial services recognition agreements. Arguably, it would be a long shot to claim that Members have the obligation to adopt the standards promulgated by IOSCO for clearing services based on this GATS article.
EMIR equivalence assessments should fall under the unilateral recognition category of Article VII. Nevertheless, the collaboration between regulatory agencies should not be underestimated, as cooperation arrangements between ESMA and third-country regulators are required. In the light of the GATS Article VII obligations, clearinghouses from Argentina, for example, should, in principle, be afforded adequate opportunity to negotiate a recognition procedure as CCPs from India. However, problematic features regarding the process followed by the European Commission in the conclusion of equivalence decisions shall be underscored. First, the transparency obligation to notify recognition agreements in accordance with Article VII:1 is not fulfilled. Second, the potential discretionary nature of the equivalence assessments’ application in favor of Members with higher regulatory leverage and bigger clearinghouses seems to suggest that adequate opportunity to negotiate recognition agreements has not been extended evenly to Members. In the absence of formal criteria, the European Commission chooses on a discretionary basis the WTO Members with which it conducts equivalence assessments, irrespective of similar equivalent standards between third-countries.Footnote 118 Nonetheless, it would be for WTO judiciary to find whether EMIR's possible GATS-inconsistencies could be justified under Article VII on a case-by-case basis.
3.6 Prudential Carve-Out
The prudential carve-out (PCO) provides wide leeway to financial regulators.Footnote 119 The autonomy to legislate prudential rules for the sake of financial stability, among other objectives, is encouraged by the PCO, even if these rules do not conform with the GATS. However, despite the broad margin offered to regulators, the provision reads in the second sentence that prudential rules must not ‘be used as a means of avoiding’ trade disciplines.Footnote 120 This ‘anti-circumvention’ clause exists to delimit the range of regulatory space of Members in financial services. To date, our knowledge of what type of measures can be justified under the PCO is quite restricted. The prudential exception has been only interpreted once in Argentina–Financial Services. In the light of this dispute's findings, I discuss the PCO legal standards while investigating whether EMIR's possible GATS inconsistencies can fall within its scope.
The panel dealing for the first time with the prudential exception developed an analysis that employs three requirements for measures to fall under its remit.Footnote 121 The scope of the PCO constitutes the first requirement. It was hotly debated between Panama and Argentina whether all types of ‘measures affecting the supply of financial services’,Footnote 122 or only ‘domestic regulation’, in the sense of the GATS Article VI, fall under the purview of paragraph 2(a).Footnote 123 In response to it, the Appellate Body adopted the panel's interpretation and ruled that the PCO scope comprises all the measures that affect the supply of financial services.Footnote 124 Moreover, the second requirement introduced by the panel pertains to measures taken ‘for prudential reasons’. This criterion is further divided by the panel into two separate analyses for the purposes of judicial review. Firstly, it shall be determined whether the rationale behind Members’ regulatory measures are prudential ‘reasons’, in the sense that the measures act to prevent a risk, injury or danger that does not necessarily have to be imminent’.Footnote 125 Secondly, it shall be illustrated, based on the word ‘for’ in paragraph 2(a), whether there is a ‘rational relationship of cause and effect between the measure and the prudential reason’.Footnote 126 The rational link between the regulatory measure and the prudential reason lies with the ‘adequacy’ of the first, through its design, to attain the desired outcome.Footnote 127 Assuming that a rational relationship exists, the third requirement of the PCO is that the measure in question shall ‘not be used as a means of avoiding the Member's commitments or obligations under the Agreement’.Footnote 128
The prudential carve-out offers Members’ regulators extended room for maneuver. In principle, measures that seek to protect the safety and soundness of financial systems fall within its purview. However, as demonstrated by recent WTO case law, checks-and-balances exist for the prudential carve-out. These filters scrutinize the measures at issue. The ‘rational relationship of the cause and effect’ requirement, conceptualized by the panel, limits to a substantial degree the wide scope of the prudential exception. At the same time, the PCO scope is still wider than the exceptions of GATS Article XIV, which presupposes necessity. Thus, regulators, while crafting their prudential rules, should take into consideration that their financial regimes should not circumvent trade disciplines and should be fit for the purpose they aspire to achieve. If the European equivalence regime for third-country clearinghouses was found in breach of a GATS provision, one would wonder if it could be justified under the prudential exception.
The first step is to ascertain whether the measures for recognizing non-EU CCPs fall under the scope of the PCO. The discussion above verifies that the European regulatory measures undoubtedly affect the supply of financial services and the first PCO requirement is fulfilled. Contrary to the first, the second requirement is quite tricky. With regard to the first prong, the fact that the EMIR equivalence regime is crafted to promote OTC derivatives market stability is well-known. Accordingly, it would not be a problem for this regulatory measure to argue that it serves prudential reasons.Footnote 129 Nevertheless, the challenging task would be to demonstrate that there is a ‘rational relationship’ between the equivalence mechanism, the application of which might be characterized as discriminatory or ill-transparent, and the prudential objective. A case-by-case evaluation is necessitated to determine whether such a relationship exists and the WTO judiciary would have to address this issue based on the parties’ submitted evidence. The writer's view is that it would be difficult for the EU to draw a cause and effect link between this type of trade-barrier and the rationale of financial stability. Although EMIR equivalence regime undoubtedly safeguards the integrity of financial systems, it is contestable whether the application of equivalence assessments is the adequate instrument to meet this end. In principle, the design of regimes such as equivalence/substituted compliance promotes financial stability but their implementation might not be appropriate to achieve their goals. That said, if the European regulatory measure in question is found to be discriminatory or lacking in transparency by the WTO judiciary, it would be challenging to substantiate the existence of a rational link between the application of equivalence rules and financial stability. Furthermore, even if this relationship is established, the non-circumvention criterion is the last stop before the PCO conditions are satisfied. This requirement also heavily relies on a case-by-case analysis and a conclusive answer cannot be given in respect of EMIR measures. Given that the prudential exception has never been invoked in relation to regulatory measures touching on financial stability, it is very difficult to predict how the WTO judiciary would conduct its analysis in that regard. Consequently, the PCO is still an uncharted territory.
4. Conclusion
This contribution has sought to evaluate the tension between financial regulation and WTO law by taking the EU's clearinghouse regulation as a case study. Completion of this exercise allows for three significant deductions regarding the future liberalization of financial services within the GATS legal architecture. First, the analysis demonstrates that regulatory equivalence assessments of financial services’ foreign jurisdictions can negatively impact on the terms-of-trade and conditions of competition between WTO Members. Second, the findings indicate that smaller countries without regulatory leverage are less likely to gain access to the European market because of the structural problems of the rules on equivalence. Third, and perhaps more interestingly, this contribution has found that the Members’ vast flexibility to regulate financial services (provided by the GATS) does not make use of all avenues provided by the multilateral trading system to achieve further integration.
In all these cases, this study has evidenced that the most problematic issues arise with respect to the GATS principle of non-discrimination and transparency. Namely, in terms of transparency, problems arise not only in publishing substantial elements of the regulatory frameworks per se but also in disclosing recognition agreements. With respect to non-discrimination, both procedural and substantive GATS legal disciplines are potentially disregarded by EMIR equivalence rules and the application thereof. Specifically, the discretionary and politically driven application of rules seems to advantage some countries over others.
These findings can be explained by the absence of coordination and synergies between the trade and finance administrations of Members, such as the EU. In the aftermath of the crisis, it became clear that regulation of financial services, including the one of clearinghouses, was crucial to safeguard the integrity of global financial systems. That said, our example challenges whether the means employed by financial regulators always justify the end sought. As a result, the conformity of the GATS rulebook by domestic financial regulators is put in question. The outcome of the tension between financial services regulation and liberalization seems hard to reconcile.
Is it time to clear-house?
The importance of a right balance between financial regulation and liberalization extends far beyond a pure legal argument. Ultimately, combining financial regulatory capacity with the benefits of trade in financial services could and should translate into more integration for WTO Members.
A starting point towards this goal could be to explore less trade-restrictive means available at the WTO, such as the application of non-differential treatment in financial rulebooks. Additionally, international standards for the harmonization of transnational derivatives clearing frameworks in parallel with monitoring by international standard setting organizations and supervisory cooperation by regulators could be even more effective. These may usefully boost the unfulfilled potential of financial services liberalization and at the same time achieve the legitimate objectives set by financial regulators. By using these tools, Members do not derogate from their GATS financial services obligations and they re-start using the avenues available at the WTO.
This contribution did not intend to exhaust the question of available WTO tools capable of striking a fair balance between financial services liberalization and regulation. Rather, its purpose was to start a much-needed debate on an increasingly important, but scarcely discussed subject: the relationship between financial services regulation and WTO rules. I have shown that the current system of financial regulation leaves important gaps on the road to trade liberalization. I have also suggested that important avenues for tackling these gaps may be found within the WTO legal framework itself. The questions that remain are when and under which conditions these avenues will reach their full potential.
Acknowledgement
The author is grateful to Petros C. Mavroidis, Juan Marchetti, Bernard Hoekman, Carlo M. Cantore, Thomas Streinz and the participants of Columbia Law School's Visiting Scholars' forum and seminars/workshops at EUI and Humboldt for discussions and valuable comments to previous drafts. Additionally, special thanks go to L. Alan Winters and the anonymous reviewers of World Trade Review. The usual disclaimer applies.
