The financial industry’s demands for a “modernized” financial services chapter of the North American Free Trade Agreement (NAFTA) have been overlooked by both agricultural policy advocates and those who are seeking to prevent the regulatory death by a thousand cuts of the reforms initiated in the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act of 2010 (Dodd-Frank). These demands come from an industry whose members received $19 trillion in below-market rate loans in 2007-2010 from the Federal Reserve Bank to stave off bankruptcy. If their demands are incorporated into NAFTA, they will provide a new platform for attacking U.S. financial law.
Given the dozens of financial lobbyist-drafted deregulation bills tracked by Americans for Financial Reform (of which IATP is a member) in a March 2018 report, not adding NAFTA to the workload of greatly overworked Dodd-Frank defenders is understandable. With the multiple trade-related causes of the current U.S. farm income crisis, the National Farmers Union demand to eliminate in NAFTA alleged “currency manipulation” by foreign central banks that increase the price of dollar-denominated exports is a more achievable objective than that of preventing currency manipulation by U.S. banks or their foreign exchange partners. (The just announced U.S.-South Korean Trade Agreement contains a “side deal” on currency manipulation, but it is non-binding.)
However, the revision of NAFTA would provide Wall Street with new means to attack Dodd-Frank reforms, not only via their allies in Congress and regulatory agencies, but by filing lawsuits against U.S. financial regulations launched from their subsidiary operations in Canada and Mexico. For example, Canadian banks complained in 2012 that a Dodd-Frank provision to prevent investment banks from using taxpayer-guaranteed funds to trade derivatives contracts would discriminate against Canadian-affiliated mutual funds under the terms of NAFTA. Under 2017 financial service industry objectives for NAFTA, the banks would have a way to claim, and win, damages from U.S. taxpayers.
In a July 2017 op-ed, the chief lobbyist for the Securities Industry and Financial Markets Association (SIFMA) summarized its objectives for the NAFTA negotiations. Among the four objectives was this: “NAFTA should ensure that the financial sector has the same broad coverage of investor protections and investor-state dispute settlement (ISDS) as the enforcement mechanism, as afforded to other sectors.” SIFMA’s demand for financial investor protection would also prohibit governments from requiring that the data servers of financial investors be located in the country in which digital financial trade is transacted.
Data localization is a form of commercial presence that enhances the ability of governments to investigate suspicious financial activity and prosecute financial crime, e.g. the May 2017 conviction of SIFMA member Citigroup and its Mexican subsidiary for money laundering resulting in a $97 million fine and no admission of guilt. (The amount of the fine and no admission of guilt amounts to a Trump administration slap on the wrist, compared to the $1.9 billion that HSBC paid with an admission of guilt during the Obama administration to settle a case in which the bank laundered billions of dollars for Iran.) If investors engage in legally suspect financial activity in a country in which they have no physical or data localization presence, will ISDS offer them protection against enforcement activities that they claim to be discriminatory and an indirect expropriation of their investment?
ISDS is a private system of mandatory arbitration before a panel of three lawyers that enables a very broadly defined “investor” to sue governments for legislation, regulations, court rulings, enforcement actions and other measures that plaintiffs believe will impair the past and future profits from and/or value of very broadly defined investments. In September 2015, the European Commission sent to the European Parliament a proposal to include the financial services sector in the ISDS of the proposed Transatlantic Trade and Investment Partnership Agreement (TTIP). The definition of “investment” included “shares, stocks and other forms of equity participation in an enterprise; bonds, debentures and other debt instruments of an enterprise.”
These instruments include the credit defaults swaps and collateralized debt obligations, derivatives contracts that hid corporate debt in the form of off balance sheet tradeable “assets.” These investment vehicles triggered 2007-2009 “Too Big To Fail” and smaller bank defaults by firms that did not hold enough capital to cover their losses. The EU proposal includes an exemption from ISDS for “prudential regulation” to ensure the “safety and soundness” of financial institutions. But as Public Citizen showed in its analysis of the financial services chapter of the Trans Pacific Partnership Agreement, there are ways to circumvent the exemption.
The Obama administration opposed including mandated financial regulatory cooperation in TTIP, fearing that refusal to accept any EU financial rule as complying with U.S. law would provide an evidentiary path to a very, very expensive for taxpayers ISDS lawsuit. While the European Commission financial services proposal included a government “right to regulate,” (Article 1), governments must demonstrate that there is a “legitimate policy objective” to any regulatory measure that causes a foreign investor to believe that its investment is “impaired.” Demonstrating that a government policy achieves a “legitimate policy objective” and does not negatively affect an investment is a steep burden of proof in today’s financial technology environment. Many financial service investments are traded by algorithms that direct hyper-speed order placement, cancellation and transaction in Automated Trading Systems (ATS) whose source codes the financial service industry does not divulge to regulators.
SIFMA opposes a proposed Commodity Futures Trading Commission (CFTC) ATS rule, including a provision to allow CFTC to access source codes to be able to efficiently reconstruct the causes of market disruptions, (pp. 19-20). (IATP supported in 2016 much of the CFTC proposed ATS rule, in part because of the 38 percent growing share of agricultural commodities derivatives contracts traded by ATS algorithms in 2013, and due to the dozens of price distorting and market disruptive mini-flash price crashes recorded in CFTC research. It is very likely that the Trump administration CFTC will support the SIFMA position to allow the industry to self-regulate ATS activity.) In defense of forbidding government access to source codes, SIFMA cites intellectual propriety concerns and the possibility that a CFTC source code repository could be hacked.
U.S. trade policy often seeks to “harmonize” such prohibitions against regulation, while supporting a general right to regulate made unenforceable by those prohibitions. SIFMA does not make a NAFTA demand regarding regulator access to ATS source codes under NAFTA. However, the Internet Association of computer technology and internet service providers (Google, Apple, etc.) insists that, “NAFTA should prohibit governments from requiring access to encryption keys and source code as a condition for market access.” SIFMA’s members and other cross-border financial data service providers would benefit by the prohibition against timely access of regulators to source codes. (SIFMA members and other CFTC regulated entities also will benefit by the agency’s new enforcement policy of relying on industry self-reporting of violations of CFTC rules.)
Expanding market access, with or without commercial presence in Mexico, Canada or any other country, is a major goal of the Internet Association and SIFMA members. Denial of access to source codes to government authorities, would place enforcement of algorithmic-mediated market disruptions and data privacy invasions in the hands of the investors, their self-regulatory organizations and three lawyers on ISDS panels. The U.S. International Business Council (USCIB) is alone among ISDS proponents in allowing an exemption for law enforcement to the general prohibition against government access to the source codes of data flows, (p.15). However, this is exemption is contradicted by a USCIB demand in the same letter to USTR to prohibit government access to source codes pertaining to food safety, product labeling and other Technical Barriers to Trade issues, (p. 9)
All of this financial service industry demand for inclusion under ISDS will be for naught, if the Trump administration decides to exclude ISDS from NAFTA. But—when ISDS beneficiaries not only pay for a large share of electoral campaigns, but also provide careers for politicians and other government officials once they leave government service—will it?
USTR Robert Lighthizer stated in October 2017 that investors can buy political risk insurance to protect their investments, rather than having governments pay for that risk insurance in ISDS. The U.S. has proposed that it be allowed to “opt out” of ISDS in NAFTA, generating panic among corporate lobbyists. Removing ISDS would be a huge victory for civil society organizations that have campaigned against the mechanism for years. IATP has long opposed ISDS, most recently in a December 2017 report documenting ISDS lawsuits against the public provision of water and sanitation services.
However, ISDS proponents have many supporters in the U.S. Congress, particularly in President Trump’s party. On March 20, more than one hundred Republican Members of Congress wrote to Ambassador Lighthizer that they would oppose a renegotiated NAFTA if it did not contain ISDS, claiming that taxpayer-guaranteed protection for investors would “provide certainty for U.S. companies in all sectors.”
Including a NAFTA provision to enable the U.S. to opt out of ISDS would still hold open the possibility that a future administration, or even the Trump administration a year or so down the road, could opt back in. If the underlying language in a new NAFTA investment chapter is “modernized” to allow for ISDS lawsuits over cross-border financial investments, the U.S. could opt back in to enable lawsuits coordinated by the cross-border financial services industry.
Taxpayer-funded compensation paid to financial investors would dwarf the largest ISDS payouts to date. Consider that in 2013, Michel Barnier, then-EU Commissioner for Internal Markets, complained that Federal Reserve Bank capital reserve requirements for U.S. banks unfairly discriminated against the European subsidiaries of those banks. (From 2007-2010, the Federal Reserve loaned the European Central Bank $8 trillion, (pp. 11-12), in addition to hundreds of billions of dollars loaned to European banks to save them either from insolvency or a liquidity crisis.) Suing the Federal Reserve Bank for having a capital reserve requirement that is higher than of the European Central Bank could result in a payout to European banks of tens of billions of dollars, corresponding to lost anticipated profits of having to hold capital in reserve against losses, rather than investing that money in lucrative contracts.
Opting out of ISDS in NAFTA would be a great start to resolving trade and investment disputes in a public venue, with clearer rules of due process and the ability of all parties affected by the dispute to contribute friend of the court briefs. Adding the hyper-speed financial transactions of investors—some with a history of being bad actors in financial markets—to NAFTA will further entrench protection for a largely self-regulated industry, still unreformed after the 2007-2010 “Too Big To Fail” crisis.