1. Introduction
International rules established by the Agreement on Subsidies and Countervailing Measures (SCM Agreement) are intended to regulate subsidies granted by public bodies to private industries/entities that may negatively affect international trade (Adamantopoulos, Reference Adamantopoulos, Wolfrum, Stoll and Koebele2008: 425). Pursuant to Article 1.1 of the SCM Agreement, a government measure will be deemed to constitute a subsidy if a ‘financial contribution’ by such government or by ‘any public body’ is made,Footnote 1 and ‘a benefit is thereby conferred’.Footnote 2 Conversely, if no financial contributionFootnote 3 is made or no benefit is conferred thereby, a government measure will not be treated as a subsidy and thus will not be subject to the SCM Agreement, without regard to its negative impact on international trade.
In order to determine whether a benefit is being conferred through a financial contribution, the Dispute Settlement Body (DSB) of the World Trade Organization (WTO) has traditionally applied the mandatory/discretionary distinction. Under the mandatory/discretionary distinction, measures of WTO Members are classified as a ‘mandatory measure’ if such measure by its terms mandates public bodies of a Member to violate the Member's obligations under the Marrakesh Agreement Establishing the World Trade Organization and its annexed multilateral trade agreements (collectively, the WTO Agreement),Footnote 4 and as a ‘discretionary measure’ if such measure by its terms affords discretion to public bodies of a Member to violate the Member's obligations under the WTO Agreement.Footnote 5 Pursuant to the mandatory/discretionary distinction, only a mandatory measure can be challenged ‘as such’, while a discretionary measure can only be challenged after the relevant public bodies have actually applied the measure in a way that is inconsistent with the WTO Agreement (i.e., ‘as applied’ challenge).Footnote 6
This paper will demonstrate, through the analyses from both legal and economic perspectives, that applying the mandatory/discretionary distinction vis-à-vis Article 1.1(b) of the SCM Agreement would allow Members to systematically circumvent the SCM Agreement. Thereafter, this paper will argue that, in order to prevent such undue circumvention, Article 1.1(b) of the SCM Agreement should be construed to cover any benefit accruing as a consequence of an underlying financial contribution, without being limited by the ‘mandatory/discretionary distinction’.
2. Case study: the mandatory/discretionary distinction and Article 1.1(b) of the SCM Agreement
There are a number of cases in which the DSB applied the mandatory/discretionary distinction to determine whether particular measures of Members are consistent with the SCM Agreement.Footnote 7 In applying the mandatory/discretionary distinction to Article 1.1(b) of the SCM Agreement, i.e. ‘a benefit is thereby conferred’, the panel report in the case of Canada–Aircraft Credits and Guarantees Footnote 8 provides one of the most comprehensive and elaborated jurisprudences yet.
In Canada–Aircraft Credits and Guarantees, Brazil challenged Canada's export credits provided by the Export Development Corporation (EDC), an export credit agency of Canada.Footnote 9 One prong of Brazil's challenge was that certain export credit programmes maintained by the EDC constituted export subsidies that are prohibited ‘as such’ under Article 3.1(a) of the SCM Agreement.Footnote 10 The panel applied the mandatory/discretionary distinction, noting that the mandatory/discretionary distinction is ‘an established principle of GATT and WTO jurisprudence’ and that no objection was raised by the parties to the case over the applicability of the mandatory/discretionary distinction.Footnote 11 While the panel's review was conducted within the context of Article 3 of the SCM Agreement, the panel applied the mandatory/discretionary distinction to both Articles 1.1 and 3.1 of the SCM Agreement, taken together.Footnote 12
To establish an ‘as such’ challenge under the mandatory/discretionary distinction, Brazil was required to demonstrate that Canada's EDC export credit programme mandated grant of ‘export subsidies’ prohibited by Article 3.1(a) of the SCM Agreement.Footnote 13 Before examining the programme under Article 3.1(a) of the SCM Agreement, however, the panel first reviewed whether Canada's EDC export credit programme fell within the scope of a subsidy under Article 1.1 of the SCM Agreement. The main issue in this regard was whether the export credits extended by Canada through the EDC export credit programme constituted ‘mandatory subsidizations’.Footnote 14 Specifically, Brazil was required to demonstrate that the legal instruments governing establishment and operation of the EDC export credit programme mandated the EDC to extend export credits that confer benefits on its customers.Footnote 15
It is now ‘well established’ that a ‘benefit conferred’ within the meaning of Article 1.1(b) of the SCM Agreement means an ‘advantage given’ vis-à-vis a relevant market. In other words, a financial contribution will confer benefits only if the financial contribution is provided on terms more favorable than terms a recipient thereof could have otherwise obtained from the market.Footnote 16 None of the provisions contained in the EDC legal instrument mandated the EDC to confer any benefit to its customers within the meaning of Article 1.1(b) of the SCM Agreement, but Brazil argued that export credit agencies like the EDC benefit from certain competitive advantages over their private sector competitors (for example, export credit agencies do not pay tax) and are thus capable of offering more favorable terms when compared to their private competitors.Footnote 17 Brazil contended that the EDC will provide export credits to its customers on terms more favorable than those available in the market because doing so is the raison d’être, or the reason for being, of the EDC export credit programme.Footnote 18 Brazil's argument, however, fell short of clearing the mandatory/discretionary distinction hurdle. The panel in Canada–Aircraft Credits and Guarantees found that in order to satisfy the element of ‘conferral of benefit’ under Article 1.1(b) of the SCM Agreement for the purpose of raising an ‘as such’ challenge, a complainant must demonstrate that the measure being challenged ‘requires conferral of a benefit, not that it could be used to do so, or even that it is used to do so’ (emphasis added).Footnote 19
In this respect, the panel elaborated:
That an entity enjoys certain fiscal advantages does not in and of itself prove that that entity is required to pass on those advantages to its clients in the form of subsidies within the meaning of Article 1 of the SCM Agreement … the fact that [export credit agencies] may have a competitive advantage that allows them to undercut private sector competitors does not mean that they are necessarily required to do so.Footnote 20
The panel, by applying the mandatory/discretionary distinction, eventually ruled that the EDC export credit programme did not fall within the scope of subsidies covered by the SCM Agreement.Footnote 21 Thereafter, the panel found that it does not need to address the question of export contingency under Article 3.1 of the SCM Agreement (i.e., whether the EDC export credit programme constitutes a prohibited export subsidy) with respect to Brazil's ‘as such’ challengeFootnote 22 because the EDC export credit programme does not constitute a subsidy which is subject to the SCM Agreement.Footnote 23
The reasoning introduced in Canada–Aircraft Credits and Guarantees is not an isolated body of logic. Rather, this reasoning is consistent with the prevailing WTO jurisprudence adopted in a series of cases such as Brazil–Aircraft (Article 21.5 – Canada II) Footnote 24 and Korea–Commercial Vessels.Footnote 25 The panel in Brazil–Aircraft (Article 21.5 – Canada II), even after finding that Brazil's certain interest rate equalization scheme (denoted by that panel as ‘PROEX III’)Footnote 26 is expected to confer benefits absent ‘some limitations placed by Brazil on the degree of concesssionality of export credit supported by interest rate equalization’Footnote 27 and that Brazil ‘most likely would’ confer benefits in some if not most cases in which PROEX III is applied, because ‘the very logic of PROEX III would be undermined if Brazil were to limit the provision of PROEX III interest rate equalization to cases where no benefit was conferred’,Footnote 28 ruled that PROEX III cannot be subject to an ‘as such’ challenge because Brazil is not required to violate the SCM Agreement under PROEX III.Footnote 29 In Korea–Commercial Vessels, the panel, in striking down several ‘as such’ challenges raised by the European Communities against certain statutes, decrees, and programmes of Korea, also focused on the fact that those statutes, decrees, and programmes do not require or mandate conferral of benefits (in some cases the panel took note of the fact that the relevant statutes, decrees, and programmes do not impose specific terms of financing).Footnote 30
In sum, under the prevailing WTO jurisprudence, even if a Member's measure has the effect of enabling the Member's public body to confer benefits within the meaning of Article 1.1(b) of the SCM Agreement and the public body has substantial motivations to ‘pass on’ such benefits to intended end-recipients, by virtue of the mandatory/discretionary distinction, such measure will not be subject to an ‘as such’ challenge unless such measure requires or mandates conferral of benefits to the end-recipients.
3. Vulnerability of the mandatory/discretionary distinction when applied to Article 1.1(b) of the SCM Agreement
The panels in the cases of Canada–Aircraft Credits and Guarantees, Brazil–Aircraft (Article 21.5 – Canada II), and Korea–Commercial Vessels have all applied the mandatory/discretionary distinction to Article 1.1(b) in order to determine whether the subject measures were consistent with the respondent Members’ obligations under the SCM Agreement. Because no measure can be found to be inconsistent with the SCM Agreement unless the measure constitutes a subsidy within the meaning of Article 1.1, any ‘as such’ challenge raised under the SCM Agreement must first pass the mandatory/discretionary distinction scrutiny with respect to Article 1.1 before challenging the measure under the next level of scrutiny, i.e. whether the measure is contingent upon ‘export performance’ or ‘use of domestic over imported goods’ pursuant to Article 3 of the SCM Agreement (for a prohibited subsidy), or, whether the measure entails ‘specificity’ and ‘adverse effects’ pursuant to Articles 1.2, 2 and 5 of the SCM Agreement (for an actionable subsidy).
So long as the mandatory/discretionary distinction is applied to Article 1.1(b) of the SCM Agreement, an ‘as such’ challenge may be raised only when a subject measure requires conferral of a benefit. Hence, if a measure does not require conferral of a benefit, the measure cannot be subject to an ‘as such’ challenge. If a measure cannot be challenged ‘as such’, the measure, under the mandatory/discretionary distinction, can be challenged only ‘as applied’Footnote 31 if a public body in fact exercises its discretion inconsistently with the SCM Agreement.Footnote 32
This is where a loophole inevitably kicks in because a Member may institute the WTO's dispute settlement proceeding pursuant to the Understanding on Rules and Procedures Governing the Settlement of the Dispute (the ‘DSU’) only against measures taken by another Member (more precisely, by a public body of a Member), ‘as such’ or ‘as applied’, as the case may be. Because a private entity's decision to confer a benefit is not an exercise of discretion by a ‘public body’, voluntary conferral of a benefit by a private entity cannot be challenged ‘as applied’. This is the case even when a private entity ultimately ‘passes on’ the benefit it originally received from a public body to another recipient, as long as such a private entity enjoys full discretion as to whether or not to pass on the benefit. After all, the subject of an ‘as applied’ challenge is the exercise of discretion by a public body of a Member and not the exercise of discretion by private entities. Therefore, no ‘as applied’ challenge can be raised under the SCM Agreement if a benefit is being conferred on an intended end-recipient voluntarily by a private entity.
Of course, as long as an intermediary private entity enjoys absolute full discretion as to whether or not to pass on benefits it receives from a public body to end-recipients, this loophole may not materialize because the private entity may opt to completely absorb any fiscal advantage arising from underlying financial contributions for its own profit and not to pass on the benefits at all to intended end-recipients. After all, as the panels have explained, the fact that a financial contribution ‘could be used’, ‘most likely would’ be used, or ‘even that it is used’ to confer benefits does not necessarily mean that the conferral is required. However, as demonstrated in the following section, under certain market conditions, private entities will be practically forced to pass on benefits to end-recipients and such market conditions can be manipulated by public bodies.
4. The loophole materialized: systematic circumvention of the SCM Agreement
4.1 Construction of a ‘Systematic Subsidy’
This section will demonstrate how public bodies can indirectly confer benefits on their intended recipients without invoking either an ‘as such’ or ‘as applied’ challenge through systematically implemented subsidization. There can be many variations, but for ease of reference, this paper will use the EDC export credit programme, examined in the case of Canada–Aircraft Credits and Guarantees, as the primary example with certain embellishments. Let us assume that there is a particular financing programme that mandates a public body (e.g., export credit agency) to extend loans, not directly to their intended recipients (i.e., private producers or exporters of goods), but to private ‘financial institutions’ at an interest rate significantly lower than what is available in the market for the same private financial institutions (such loans and the underlying programme are hereinafter collectively referred to as the ‘Systematic Subsidy’).
As the panel in Brazil–Aircraft (Article 21.5 – Canada II) Footnote 33 recognized, the SCM Agreement, being an Annex 1A agreement on ‘trade in goods’, does not regulate subsidies granted to financial institutions unless the subsidies are ‘passed through’ to producers or exporters of certain goodsFootnote 34 (as the panel in the case of Mexico–Olive Oil found, recipients of benefits can be different from recipients of underlying financial contributionsFootnote 35 ). Therefore, the Systematic Subsidy will not be subject to the SCM Agreement unless its end-recipients are in some way directly related to trade in goods. Now, let us further assume that the Systematic Subsidy that is offered to the financial institutions is subject to a condition that the financial institutions must use the Systematic Subsidy to extend export credits to producers or exporters of certain goods. Such conditioned Systematic Subsidy, if received and so used by the financial institutions, would constitute financial contributions made by the public body to the end-recipients (e.g., producers or exporters) even though the underlying financial contributions are not extended to the end-recipients directly by the public body. This is true not only because the relevant ‘practice’ of the public body (i.e., the Systematic Subsidy) involves giving of direct loans to the recipients as contemplated by Article 1.1(a)(1)(i) of the SCM Agreement,Footnote 36 but also because the financial institutions are acting as a ‘funding mechanism’ or even a ‘proxy’ of the public body as prescribed by Article 1.1(a)(1)(iv) of the SCM Agreement.Footnote 37
However, for the tricky part, let us further assume that the conditions for receiving the Systematic Subsidy do not require the receiving financial institutions to pass on the benefits it receives from the public body to the end-recipients, but instead give the private financial institutions full discretion to decide on the terms of export credits extended to the end-recipients (in other words, the private intermediaries are not required to offer terms more favorable than what is otherwise available in market for a comparable export credit). What distinguishes such a Systematic Subsidy from the various financing programmes examined in the cases of Canada–Aircraft Credits and Guarantees, Brazil–Aircraft (Article 21.5 – Canada II), and Korea–Commercial Vessels is the addition of private financial institutions as an extra link between the public body and the end-recipients. The financial institutions that receive such a Systematic Subsidy will enjoy certain ‘competitive advantages’ over other financial institutions that do not receive such a Systematic Subsidy. In other words, these ‘competitive advantages’ will enable the receiving financial institutions to ‘undercut competitors’ by extending export credits under terms and conditions more favorable than those otherwise available to the end-recipients in the market. Under such a Systematic Subsidy, it is these private intermediary financial institutions that enjoy discretion to confer benefits to the end-recipients, not the public body.
As previously examined, the Systematic Subsidy will not be subject to an ‘as such’ challenge under the mandatory/discretionary distinction, because the underlying programme only mandates the public body to make the financial contribution to the end-recipients through the private intermediaries (i.e., the financial institutions), but does not require conferral of any benefit on the end-recipients. The Systematic Subsidy will also not likely be subject to an ‘as applied’ challenge, because full discretion on conferral of benefits will be exercised exclusively by the private intermediaries and not by the public body.Footnote 38
Normally, an export credit programme implemented by a Member needs to pass the Annex I(k) scrutiny of the SCM Agreement.Footnote 39 However, the Systematic Subsidy, despite its nature as a trade financing regime, which could very well be regarded as a prohibited subsidy under Article 3 of the SCM Agreement, does not need to be troubled by the Annex I(k) scrutiny. This is because, under the prevailing WTO jurisprudence, the Systematic Subsidy does not confer any benefit on the end-recipients within the meaning of Article 1.1(b) of the SCM Agreement, and thus is not subject to the SCM Agreement.
Adoption of a form of Systematic Subsidy by a WTO Member is not unrealistic. In recent years, the international community has witnessed an increased use of the so-called ‘market window’ and its hybrids,Footnote 40 which often triggered debates among the members of the Organization for Economic Cooperation and Development (the ‘OECD’).Footnote 41 In general, market windows are government-backed financial institutions operating on the basis of commercial terms when extending various financings to their customers. Because they operate under market-oriented principles and seek to generate profit from transactions that they engage (by only processing commercially viable deals), financings extended by the market windows are not usually considered as ‘official supports’ subject to the OECD Arrangement.Footnote 42 Nevertheless, these market windows undercut their private counterparts because their government backingsFootnote 43 allow them to generate profit even when they offer financings at below-market rates (Levit, Reference Levit2004: 104). The working mechanism of the Systematic Subsidy is not entirely identical with that of conventional market windows, because the Systematic Subsidy may only be used for extending export credits and may be granted only to purely private financial institutions. However, the international community has already learned from its experiences with market windows that even a market-oriented operation can be manipulated to confer benefits.Footnote 44
The next section will provide an economic analysis substantiating how the Systematic Subsidy can create a market condition that will force intermediary financial institutions to pass on benefits to end-recipients.
4.2 ‘Forced’ by market: private intermediaries will ‘pass on’ benefits to intended end-recipients
The Systematic Subsidy can be defined as a financial scheme that subsidizes its intended end-recipients indirectly through private financial institutions acting as intermediaries. Suppose that the objective of a public body in providing the Systematic Subsidy is to extend loans to its intended end-recipients at an interest rate that is lower than what is available in market. In this regard, let us denote the ‘interest rate available in market without Systematic Subsidy’ (the ‘Market Rate’) as
$\overline r $
and the ‘interest rate subsidized by the Systematic Subsidy’ (the ‘Subsidized Rate’) as r. In a situation where the public body extends the Systematic Subsidy to a financial institution without giving any instruction or direction on the level of r, the public body will have successfully subsidized its intended end-recipients, or the borrowers of loans, through an intermediary financial institution if the financial institution extends loans to the intended end-recipients at an interest rate lower than the Market Rate, that is
$r \lt \overline r $
. Denoting the ‘quantity of loan demand at interest rate r’ as q(r), the foregoing analysis can be summarized as the following economic definition: ‘an intermediary financial institution passes on benefits conferred to the end-recipient whenever q(r) > 0 and
$r \lt \overline r $
’.
Let us denote
${\underline r}$
as the interest rate at which the financial intermediary can borrow, and assume for convenience that the intermediary can borrow any desired amount at this rate. The profit (π) that the financial intermediary makes as a result of lending q(r) at r and borrowing the same amount at
${\underline r}$
can be restated as:Footnote
45
$$\pi = (r - \underline r )q$$
A natural observation from equation (1) above is that the financial intermediary will not set r below
${\underline r}$
, or the borrowing rate, because doing so will incur a loss on its part. On the other hand, the financial intermediary will not set r above
$\overline r $
, the Market Rate, either, because doing so will merely result in the loss of its customers.
A natural assumption is that the intermediary financial institution will try to maximize its profit through the interest accrued on loans extended to the end-recipients.Footnote
46
One might think that the financial intermediary will maximize its Subsidized Profit (i.e., π) by making r as high as possible, that is
$r = \overline r $
. This will be the case when the intermediary financial institution fully absorbs benefits originally conferred by the Systematic Subsidy without passing on any of the benefits to its customers, the end-recipients. This possibility must have formed at least some part of the panels’ rationale in the cases of Canada–Aircraft Credits and Guarantees, Brazil–Aircraft (Article 21.5 – Canada II), and Korea–Commercial Vessels. A much more likely outcome, however, would be that the financial intermediary would reduce r in order to expand q: the so-called ‘the law of demand’ is that as the interest rate (i.e. r) gets lower, demand for loans gets greater, which we may denote as
$\displaystyle{{\partial q} \over {\partial r}} \lt 0$
. That is, although the financial intermediary will realize slightly less profit for each unit of loan (because r <
$\overline r $
), the collective amount of profit it realizes through the increased loan demand based on ‘r‒
${\underline r}$
’ will more than offset such reduced per-unit profit.
The foregoing can be demonstrated a little more formally as follows. The financial intermediary will aim to maximize its profits as given by equation (1), choosing r given its borrowing rate (
${\underline r}$
) and the demand function that it faces (q(r)). This leads to the so-called first-order condition:
$$\displaystyle{{\partial \pi} \over {\partial r}} = q + (r - \underline r )\displaystyle{{\partial q} \over {\partial r}} = 0$$
The first term in the middle of equation (2) above captures the return for each unit of the loan while the second term captures the degree of quantitative increase in the loan demand if the financial intermediary lowered its interest rate slightly. The ‘=0’ at the end of equation (2) states that these two forces just offset each other at the chosen point. By making a simple manipulation of equation (2), it can be demonstrated how the ‘profit-maximizing interest rate’ set by the financial intermediary will depend on two underlying variables, i.e. the cost of borrowing (
${\underline r}$
) and the elasticity of demand for loans (denoted as ‘ε’), as follows:Footnote
47
$$r = \displaystyle{1 \over {(1 + 1/\varepsilon})} {\underline r} $$
Equation (3) shows that given
${\underline r}$
, the intermediary financial institution seeking to maximize its profit will set r higher as the elasticity of demand for loans (ε) gets smaller in absolute terms (i.e. closer to zero; that is, as demand becomes less responsive to the interest rate).Footnote
48
It also shows that the financial intermediary will never set r below the borrowing rate,
${\underline r}$
.
Equation (3) defines the market outcome prior to the Systematic Subsidy: given
${\underline r}$
, financial intermediaries charge r and make q(r) of loans. The Systematic Subsidy now offers funds to financial intermediaries at an interest rate below
${\underline r}$
. From equation (3), it is immediately clear that a financial intermediary will reduce the rate of interest (r) that it charges its borrowers.
The foregoing analysis effectively establishes the following economic proposition:
If the objective of an intermediary financial institution before and after the introduction of the Systematic Subsidy is to maximize its profit, and the demand for loans demonstrates some sensitivity to interest rates, the intermediary financial institution will pass on at least some of the benefits conferred by the Systematic Subsidy to the end-recipients (the ‘Proposition’).Footnote 49
The Proposition stands irrespective of the fact that the intermediary financial institution enjoys full discretion in setting the Subsidized Rate, r.
It is worth noting that competition in the intermediary market will work to lower r, the Subsidized Rate. If an intermediary financial institution enjoys a certain degree of market power, it faces little competition and the elasticity of demand that it faces for the loans that it makes is relatively small in absolute value. That is, the financial intermediary can charge higher lending rates and not lose too much business. If, on the other hand, there are a virtually infinite number of competitors in the relevant intermediary market, we would have what economists refer to as ‘perfect competition’ among lenders. Here, if any financial intermediary tried to charge an interest rate even slightly above that of its competitors, it would lose all relevant business to those competitors; that is, each intermediary would face an infinite elasticity, ε = −∞. In this respect, equation (3) shows that the result will be ‘
$r = {\underline r}$
’; that is, benefits accruing from the Systematic Subsidy will be completely passed on to end-recipients.
To conclude, if the mandatory/discretionary distinction is applied to Article 1.1(b) of the SCM Agreement, Members will be able to practically circumvent the SCM Agreement through a systematically designed subsidization scheme which neither mandates conferral of any benefit nor provides any discretion to confer benefits to public bodies, but which nonetheless creates a market condition under which benefits of a subsidy (even export subsidy) will be effectively passed on to the subsidy's intended end-recipients through private financial institutions acting as intermediaries of subsidization.
5. An ‘as such’ challenge should be made available against the systematic subsidy
5.1 The mandatory/discretionary distinction is not a mandatory requirement
As previously observed, raising an ‘as applied’ challenge against any specific transaction voluntarily implemented by a private intermediary would unlikely be allowed. Therefore, any WTO challenge on a Systematic Subsidy would have to be instituted against an underlying programme that fosters the problematic market condition, ‘as such’. This ‘as such’ challenge will not be available against a Systematic Subsidy as long as the mandatory/discretionary distinction is applied to Article 1.1(b) of the SCM Agreement.
The Appellate Body in US–Corrosion-Resistant Steel Sunset Review stressed that ‘the import of the mandatory/discretionary distinction may vary from case to case’ and that the mandatory/discretionary distinction should not be applied in a ‘mechanistic fashion’.Footnote 50 In this connection, it is noteworthy that the purpose of the mandatory/discretionary distinction is to determine whether a Member's measure is inconsistent with the WTO Agreement ‘as such’.Footnote 51 On the contrary, Article 1.1(b) of the SCM Agreement is not a prohibitive provision. The element of ‘conferral of benefit’ does not, in and of itself, trigger inconsistency with the WTO Agreement even if satisfied (or unsatisfied, for that matter). In this sense, applying the mandatory/discretionary distinction vis-à-vis Article 1.1(b) of the SCM Agreement does not seem to be mandatory, to say the least. Even if the mandatory/discretionary distinction is not applied to Article 1.1(b) of the SCM Agreement, the distinction's general utility would still be preserved simply by applying it to Article 3 (for a prohibited subsidy) or Articles 5 and 6 (for an actionable subsidy) of the SCM Agreement, as required.
Given the potential loophole that may render the entire SCM Agreement vulnerable against systematically implemented subsidizations such as the Systematic Subsidy, the mandatory/discretionary distinction should certainly not be applied to Articles 1.1(b) of the SCM Agreement in a ‘mechanistic fashion’.
5.2 Article 1.1(b) should be deemed satisfied as long as a benefit is conferred as a consequence of an underlying financial contribution
Article 1.1(b) of the SCM Agreement is one of the shortest provisions in the WTO Agreement: ‘a benefit is thereby conferred’. Because the term ‘conferral of benefit’ has already been defined by the several WTO dispute precedents, the only remaining riddle in Article 1.1(b) is the meaning of the word ‘thereby’.
It is an established international legal practice to refer to the interpretative rules and principles enshrined in the Vienna Convention on the Law of the Treaties (the ‘VCLT’) whenever meaning of a treaty language becomes an issue.Footnote 52 The DSB has also frequently referred to Article 31 of the VCLT, which states that, ‘a treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in light of its object and purpose’ (emphases added), to determine the meaning of various provisions of the WTO Agreement.Footnote 53
In order to find out the ordinary meaning of various treaty languages, the DSB has referred to prestigious dictionaries such as the Cambridge Dictionary or Oxford Dictionary.Footnote 54 As for the ordinary meaning of the word ‘thereby’, the Cambridge Dictionary defines the word as ‘as a result of this action’Footnote 55 and Oxford Dictionary defines the word as ‘as a result of that’.Footnote 56 A plain reading of Article 1.1(b) clearly shows that this is a provision the coverage of which is intended to be comprehensive.
In addition, Article 1.1(b) is attached to Article 1.1(a) by the adverb ‘thereby’. Thus the ‘conferral of benefit’ within the context of Article 1.1 is not an isolated event but must occur ‘as a result of’ a financial contribution established as per Article 1.1(a). As long as the result or consequence of a financial contribution confers benefit, whether directly or indirectly (and whether in law or in fact, for that matter), the requirement of Article 1.1(b) should be deemed satisfied, because nothing in Article 1.1(b) provides that the coverage of the said provision precludes certain methods of conferring benefit.
Applying the foregoing analysis would not pose a risk of opening doors for undue over-expansion of the SCM Agreement's applicability to the effect that even legitimate internal policies of Members are limited by the SCM Agreement. Article 1.1(b)'s applicability is subordinate to, and is restricted by, the scope of the financial contributions prescribed by Article 1.1(a) of the SCM Agreement, which was prudently tailored by the drafters of the SCM Agreement specifically so that not all government measures that confer benefits would be regulated by the SCM Agreement.Footnote 57 In this connection, the drafters stipulated in Article 1.1(a) an exhaustive, not illustrative, list of financial contributions.Footnote 58 In light of the object and purpose of the SCM Agreement, any measure that falls within that exhaustive list should be governed by the multilateral rules on subsidies – it makes perfect sense to consider the SCM Agreement as being applicable to Article 1.1(a)'s exhaustive list of financial contributions as long as any ‘benefit is thereby conferred’, whether directly by a public body or indirectly through an intermediary private entity.Footnote 59
Because all effective subsidization requires targeted channeling of resources, each underlying financial contribution would carry certain terms that effectuate such channeling (e.g., in the case of the Systematic Subsidy, private intermediaries are required to use underlying resources for extending ‘export credits’), and the DSB, being the judiciary of the WTO, would be able to determine whether benefit is or will be conferred consequentially by an underlying financial contribution.
5.3 Benefits ‘consequentially conferred’ by a financial contribution can be examined through various means, including the traditional ‘pass-through’ analysis
Under the Systematic Subsidy, benefits will be conferred to intended end-recipients indirectly through intermediary financial institutions. The WTO has a longstanding history of recognizing indirect conferral of benefit through the so-called ‘pass-through’ analysis based on Article VI:3 of the GATT and footnote 36 of Article 10 of the SCM Agreement. A pass-through analysis has been used to determine whether benefits have been indirectly conferred upon end-recipients of a subsidy where the subsidy has been granted to intermediary recipients. Through the pass-through analysis, an investigating authority conducting countervailing duty investigations can examine the ‘existence’, and the ‘extent’ or ‘amount’ of benefits indirectly conferred on end-recipients through intermediary recipients (Shadikhodjaev, Reference Shadikhodjaev2012: 627).
The ‘pass-through’ analysis has been classically used to examine benefits indirectly conferred through a stream of goods production, unlike the case of the Systematic Subsidy where benefits are indirectly conferred through a financial credit line. Therefore, end-recipients in a pass-through analysis are normally producers of processed or downstream products, while intermediary recipients in a pass-through analysis are normally producers of input or upstream products. Also, the pass-through analysis is in principle a test conducted for the purpose of countervailing duty investigation under Part V of the SCM Agreement but not for the purpose under other Parts of the SCM Agreement.Footnote 60 However, the panel in Brazil–Aircraft (Article 21.5 – Canada II) rationally hinted that subsidies granted to financial institutions may also be ‘passed through’ to the subsidies’ end-recipients who are producers or exporters of certain goods.Footnote 61 If the pass-through analysis can be utilized at the level of countervailing duty investigation, the pass-through analysis should also be utilizable for the purpose of finding the existence of a ‘subsidy’, which is fundamental to every analysis under the SCM Agreement, for a parallel purpose of determining whether benefits have been indirectly conferred to the end-recipients.Footnote 62
The classic pass-through analysis will need to be tailored to a certain extent if the same is to be applied with respect to the Systematic Subsidy. For example, under the relevant WTO jurisprudence, a pass-through analysis is required in circumstances where ‘(i) a subsidy is provided in respect of a product that is an input into the processed, imported product that is the subject of the countervail investigation; and (ii) the producer of the input product and the producer of the imported product subject to the countervail investigation are unrelated’.Footnote 63 At the very least, the requirement under (i) above should be expanded to cover subsidies provided to lenders of loans that are ultimately extended to the end-recipients. For the requirement under (ii) above, in the case of the Systematic Subsidy, a pass-through analysis should be conducted even between related parties because a financial pass-through of subsidization cannot normally be presumed unless there is an explicit act of financing (e.g., lending and borrowing).Footnote 64
In any case, Members have long been examining conferral of benefits made indirectly through intermediaries of subsidization. Similarly, there should be many fair and effective methods of examining and measuring the ‘existence’, and the ‘extent’ or ‘amount’ of benefits passed on to the end-recipients of the Systematic Subsidy.
6. Conclusion
The ‘rational objective’ of the mandatory/discretionary distinction is to allow ‘as such’ challenges against measures that will necessarily result in actions that are inconsistent with the WTO obligations ‘before’ such actions actually take place.Footnote 65 This paper does not purport to undermine this general utility of the traditional mandatory/discretionary distinction. However, the mandatory/discretionary distinction, if applied to Article 1.1(b) of the SCM Agreement, may render the entire SCM Agreement vulnerable to measures such as the Systematic Subsidy under which private entities are systematically forced to act as intermediaries of subsidization. Given the increasingly active and comprehensive roles played by private entities in contemporary international trade, mechanistic and exclusive application of the mandatory/discretionary distinction vis-à-vis Article 1.1(b) of the SCM Agreement may introduce unintended loopholes into the WTO's regulatory system.
In a situation where a Member's measure effectively creates a market condition in which private intermediaries are practically forced to pass on benefits that they receive from a public body to the intended end-recipients of the underlying financial contribution, an ‘as such’ challenge must be made available against such a measure by interpreting Article 1.1(b) of the SCM Agreement in accordance with its ordinary meaning without being limited by the mandatory/discretionary distinction.
As declared by the Appellate Body in the case of US–Corrosion Resistant Steel, ‘the disciplines of the GATT and the WTO, as well as the dispute settlement system, are intended to protect not only existing trade but also the security and predictability needed to conduct future trade’.Footnote 66 In light of the foregoing disciplines, the mandatory/discretionary distinction should be applied selectively on a case-by-case basis, with a view to protecting and promoting the security and predictability of the multilateral trading system.
