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Financial services talks as contentious as overall Doha talks

Geneva, 14 Oct (Chakravarthi Raghavan) - The general wariness and greater unwillingness of developing countries to accept negotiating agendas over whose formulations they have little influence - such as on investment and other Singapore issues - and that led to the difficulties at Cancun Ministerial, are also present in current negotiations on Trade in Financial Services, and may prove to be as contentious and bound up with the fate of the Doha negotiations as a whole.

This assessment is in a discussion paper, written in June and just published, by the UN Conference on Trade and Development. The paper, ‘The WTO Negotiations on Financial Services: Current Issues and Future Directions’ is by Mr. Andrew Cornford, Research Fellow at the Financial Markets Center, and formerly a Senior Economist and Expert on International Financial Markets at UNCTAD.

Cornford notes that during the Uruguay Round negotiations, trade in financial services was included in the WTO as part of the extension of the previous remit of the GATT. But the agreement on the financial services trade was reached only at end of 1997.

Cornford notes in his paper that the Cancun ministerial broke down following disagreements, mainly between the industrialized and developing countries - over protectionism in agriculture and inclusion on the agenda of the socalled Singapore issues.

But the difficulties at Cancun reflect factors which help to explain the more general wariness of many developing countries towards several of the negotiating initiatives coming from the major developed countries as well as the increased frequency of flashpoints during ministerial negotiations.

These factors include placing the major burden of structural adjustments required for liberalization on developing countries and exerting negotiating pressures on such regarding what for them are politically sensitive or controversial subjects, while keeping off the table subjects which could be a source of political problems in developed countries.

“In the context of negotiations on financial services in the WTO,” Cornford says, “these features of the negotiating stance of major developed countries are evident with respect to the issue of liberalization of capital-account transactions and certain other limitations on national policy autonomy towards the financial sector.  Thus greater unwillingness of developing countries to accept negotiating agendas over whose formulations they have little influence may also eventually involve financial services as well as the subjects which have proved most publicly contentious so far.”

Cornford notes that the December 1997 WTO agreement on financial services, was generally viewed as having contributed more to transparent policy regimes in WTO member countries than to opening of markets to foreign suppliers.

Reviewing the statistical data bearing on trends in market access of foreign banks since 1997, Cornford finds that there has been no increase in the presence of banks from developing countries in the markets of developed countries, but a large rise in the presence of banks from developed countries in the markets of developing countries - though this may reflect less the impact of the 1997 agreement than a more general movement in the direction of financial openness taking place anyway and which helped shape the agreement.

In the new round of negotiations, he notes, the ‘watchwords’ in the submissions of major developed countries include expanded market access and removal, from commitments of countries, of limitations affecting several financial activities (horizontal limitations). These submissions have also drawn attention to the need for greater regulatory transparency in the treatment of foreign banks, objectives similar to those pursued in the negotiations that ended in 1997.

At that time, there was an asymmetry in negotiating objectives between the developed countries and several developing countries. The developed countries, especially those with large financial sectors, saw their interests primarily as exporters of financial services and aggressively pursued market opening objectives. They were backed in these efforts by a powerful lobby of economists and other commentators working for official and private institutions, who trumpeted the case for cross-border financial liberalization undertaken over a fairly short horizon, with only limited safeguards.

On the other hand, developing countries were more defensive. Few were exporters of financial services on a large scale. Several had just undergone painful experience of bouts of financial instability where difficulties affecting domestic banking systems were accompanied by balance-of-payments crises, requiring macroeconomic retrenchment and resulting in major setbacks to economic growth and living standards.

[A study by the IMF staff, including the now retired chief economist, Mr Rogoff, in effect found that none of the vaunted benefits of financial sector liberalization has been achieved in developing countries.  Nevertheless that paper still advocated persevering with such liberalization - resulting in some sharp critiques by former World Bank Vice-President Joseph Stiglitz and US academic David Felix, both of whom separately have advised developing countries against such liberalization.]

At the WTO, as in many policy fora, developing countries continue to express their concerns about vulnerability to destabilizing capital movements. And although the rules of the GATS were designed to decouple liberalization of trade in financial services from that of capital account transactions, they have not succeeded in alleviating the misgivings of several developing countries.

Also, the developing countries, in the financial services talks, have drawn attention to the need for greater harmonization of different limitations in commitments of countries at the national and local government levels, and greater participation of developing countries in the setting of international standards with a bearing on market access and national treatment.

Both the developed and developing countries have also raised other issues, though from divergent viewpoints.

Both have raised the need for clarification of the distinctions between modes of delivery of financial services specified in the GATS where these have been blurred by recent technological changes.

However, concerns on the side of the developed and developing countries are from different perspectives.

Both sides have also focussed on the connections between work on financial services in the WTO and that on different aspects of the international financial system elsewhere.

The developed countries favour managing these connections in a mutually reinforcing way. Some of the developed countries have asked in this regard for further scrutiny of the relation of the WTO work with that in other bodies such as the IMF and the World Bank and standard setting institutions, dealing with different aspects of the functioning of the international system.

But developing countries are more circumspect owing to apprehensions over the multiplication of factors incorporated in IMF surveillance and conditionality, and consequent constraints on national policy autonomy.

There are also questions about prudential carve-out of the Annex on Financial Services. The developed countries appear to favour a tighter definition of its permissible scope. However, the developing countries prefer to keep the carve-out broad and unconstraining.

Both groups of nations have expressed support for more uniform classification of financial services in the commitments of countries.  But there is less consensus as to problems linked to statistics for different modes of delivery.

Cornford notes that progress in the new negotiations on financial services has been slow, reflecting that in the Doha talks as a whole.  The responses to the deadlines set - initial requests by mid-2002 and formal offers as part of the negotiation of commitments by March 2003 - have fallen short of expectations. The submissions and discussions so far indicate the principal concerns of many countries, and the features they would like to see in the final outcome.

In terms of trends in commercial presence of foreign banks, the Cornford paper brings out that there has been substantial contractions in presence of banking entities from developing countries in London and New York since 1996 - in London it has come down from 153 in 1996 to 122 in 2002; in New York it has fallen from 118 in 1996 to 90. In the EU, other than London, it has remained almost same - 144 in 1996 and 145 in 1999.

However, there has been a large increase in the presence of banks from the developed countries in East Asia, Latin America and Central and Eastern Europe.

The Consolidated Banking Statistics of the Bank for International Settlements (BIS), which provide data on their local lending, show a much faster increase in local claims in local currency in developing countries of the foreign offices of BIS reporting banks than in their international claims. Local claims in all developing countries were about 10% of international claims in 1990, and 68% in 2002.

The data on the effects of the WTO negotiations on market access, Cornford says, are inconclusive. A more conclusive evaluation of the effects of WTO negotiations in developing countries would require studies of the way their commitments have been implemented at country level.

But in view of the rather limited amount of expanded market access in these commitments, the growth in the internationalization of the banking sectors of countries classified as emerging financial markets since 1990s, is likely to reflect less the impact of the WTO 1997 agreement than a more general movement in the direction of financial openness which helped shape the eventual agreement.

On some of the issues in the new negotiations, Cornford says that countries making market opening commitments would also be making an open-ended commitment to the liberalization of such transactions - under the obligation to permit financial services suppliers of any other Member established in its territory to offer any new financial service.  Although commitments to the market opening for financial services carry associated obligations to liberalization of capital transactions, the country making them will have to depend on guesswork for the estimation of the size of the capital movements which are likely to ensue.

The difficulty of reaching estimates is increased by the pace of changes in the financial sector (such as E-banking) which is adding to the range of possible transactions under different modes of delivery under GATS.

That the discretion left to countries under the GATS regarding liberalization of capital account transactions has failed to alleviate concerns of developing countries would appear to be linked to the pressures to undertake substantial further market opening during the new round of negotiations and to the uncertainties of its effects.

While this discretion should give countries scope to avoid entering into commitments whose consequences they judge to be potentially risky or unfavourable, there may well be apprehension that such a negotiating stance will prove untenable as momentum builds up for substantial concessions on market access dictated by the pressures to achieve a successful outcome of negotiations.

On prudential regulations, governments in theory have been given by GATS considerable freedom of action to ensure the integrity and stability of their financial systems through prudential regulations.

However, as in the case of East Asian crisis of 1997, the restructuring exercise may take place over extended periods of time. Can all the actions involved be classified as covered by the reference to systems integrity and stability? Also, the restructuring may also be accompanied by substantial injections of government money in forms that may be considered as distorting competition and discriminating against foreign suppliers.

There has so far been no WTO case law to provide guidance. However, in the Korean restructuring involving substantial injections of government money to deal with non-performing loans and for replenishment of capital of the banks - the subject of discussions between Korea and the IMF - the Korean action was challenged as a violation of the Agreement on Subsidies and Countervailing Measures in the relevant WTO bodies, but not in terms of violation of the prudential measures rules. This also raises questions about the connections between work in the WTO and in the IMF and their mutual coherence, Cornford points out.

In its current submissions, Switzerland while conceding the need for ample room for manoeuvre on prudential measures, has argued that prudential regulation could be disproportionate to the problems against which it is directed, and may involve limitations on participation of foreign institutions in a country’s financial sector. It wants greater recourse to the financial standards developed by the Basel Committee on Banking Supervision, the International Association of Insurance Supervisors, the International Organization of Securities Commission, and the Joint Forum on Financial Conglomerates. These, in the Swiss view, should serve as a basis for definition of exceptional measures that may be taken for prudential reasons, regardless of other GATS provisions.

The implications of the Swiss proposal, Cornford says, is not very clear. These standard setting organizations are not responsible for the vetting of the implementation of their recommendations.

One effect of the Swiss proposal could be use of the work of these bodies in defining non-actionable prudential measures. Another, and with more far-reaching implications, would be the vetting of prudential regulation and supervision regimes of countries as a precondition for providing broad latitude on prudential measures.

The implications of linking relations between work at the WTO with that on international initiatives on financial standards however raise a number of questions, according to Cornford. Many developing countries will have reservation over an approach along these lines. Even acceptance of such financial standards is not universal. Objections focus not only on the content of these standards, but also on resources and time required for implementing them.

[That even some advanced countries have problems in applying the Basel-II standards, is brought out by the fact that while the US Federal Reserve (with jurisdiction over holding companies of banking and financial enterprises, and thus the large transnational banks) has agreed to implement Basel-II with its internal rating systems of risk assessment for capital adequacy, the US Controller of Currency with jurisdiction over all the state and regional banks, and who has inspectors in each of these banks, has advised the US Congress that the costs of implementing Basel-II and managing it is too much for these banks, and hence he would advise application of the old standards.]

Also, developing countries have limited participation in the standard setting exercise, and may raise these issues. As a corollary is their limited role in the governance structure of the IMF and the World Bank - where many developing countries feel their voice as too little weight in decision-making.

The efforts to establish links between the work at the WTO and in other international organizations relating to financial services - a proposal advanced by the developed countries - may in the area of prudential measures actualy furnish developing countries with an argument for shifts in imbalances in existing structure of financial governance, according to Cornford.

The Cornford paper also raises questions about classification and statistics. He notes that the latter currently is inadequate to enable countries to value their commitments. However, the recently issued UN Manual on Statistics of International Trade in Services is intended to meet this gap, using the data and statistics for Foreign Affiliates Trade in Services (FATS) which can cover the value of activities associated with supply through commercial presence.

[At a consultation meeting at UNCTAD on the services data issue, some of the experts involved seemed to concede that when they drew up and agreed on the manual they had no interaction with trade negotiators who would be using these data and what their needs would be.]

Cornford however says that in countries with still a small presence of foreign banks, FATS may not provide an adequate basis for assessment exercise. Also there is a long lag between availability of results under FATS. This and other difficulties calls for a rethinking of how the value of assessments could be made.

On the issue of harmonization of national and local regulations, Cornford notes that these may raise legal or political problems for Members with federal structures, specially if significant power over international trade is devolved constitutionally to provinces or states.

The Cornford paper also raises issues relating to Global Policy Coherence, but notes that financial services are not the only topic with respect to which the WTO agenda poses questions as to global policy coherence. Nevertheless the interaction between the real economy and of money and finance have long been a fruitful source of issues under such services and their importance lie not only in their links with production and trade, but also the functioning of international financial system more generally.

The Doha Declaration, as a followup, has provided for the establishment of a working group to examine ways in which the multilateral trading system could contribute to a durable solution to the external indebtedness of developing countries and to the strengthening of coherence of international trade and financial policies in order to safeguard the system from the effects of monetary and financial stability.

However, past experience and realism about willingness of major actors to envisage changes in international economic governance, argues against expecting too much from this working group, Cornford says. But the more general issue of international financial stability, which is connected

in several ways to issues of global coherence, will significantly influence the actual sectoral negotiations in the current round, such as those on financial services. – SUNS5667

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