Implications of the global financial crisis on international trade and investment regimes.

Position:International Law in a Time of Change - Proceedings of the 104th Annual Meeting of the American Society of International Law - Discussion

This panel was convened at 12:45 p.m., Friday, March 26, by its moderator, Eckhard Hellbeck of White & Case LLP, who introduced the panelists: Chris Brummer of Georgetown University School of Law; Elizabeth Trujillo of Suffolk University Law School; Jeffery Commission of Freshfields, Bruckhaus, Deringer US LLP; and Padideh Ala'i of American University Washington College of Law.


Much has been written and said on the origins of the 2008 global financial crisis and its international implications. (1) My presentation today provides a broad overview as to the origins of the crisis, and the international and national responses that the crisis has provoked. I will highlight some of the changes in the global financial architecture, while still noting the importance of domestic responses. Finally, as a bridge from my remarks to the rest of the panel, I will speak briefly about some of the initial responses by policymakers, particularly with respect to bailouts in the banking sector, and address some important implications for trade law.


The 2008 global financial crisis occurred in large part due to exceptionally high amounts of leverage among institutional investors and the public at large. Excessive consumer leverage was fueled by low interest rates and unregulated (and at times fraudulent) mortgage products offering artificially low interest rates, which stoked asset bubbles, particularly in the housing market. Run-ups in housing prices in turn fueled speculative activity in the housing market predicated not so much on supply and demand dynamics, but on the ultimately unfounded belief that housing prices would not fall.

The low interest rates that at least indirectly fueled increased leverage by consumers directly drove greater leverage among financial institutions (i.e., greater debt-to-equity and debt-to-earnings ratios in financings). Additionally, an unregulated shadow banking system emerged, typified by the credit default swap market, which allowed institutions to avoid regulation, yet act as sources of both insurance and speculative credit---often without capital cushions or even having a direct economic interest in particular financial transactions beyond bets as to the likelihood of repayment.

Greater leverage by financial institutions was also caused by increasing complexity in the financial products offered by institutions. Securitization, for example, not only created incentives for banks to make loans because they did not have to hold the products on their books, but it also fueled opacity, insofar as no one knew precisely what was in any particular financial product. Added to this was the fact that credit ratings agencies, which were being paid by the very financial institutions whose products they were rating, often misunderstood the "assets" held by banks and were intellectually outmatched by the originators of such products.

Finally, although perhaps not causing the financial crisis, accounting and investment scandals also played a role in the 2008 global financial crisis by undermining investor faith in the integrity of the global financial system. Both the Bernie Madoff and Robert Allen Stanford investment frauds, for example, demonstrated the global reach of conmen as nearly half of all losses were borne not by U.S. persons, but by foreigners. (2) Further, the implications of Greece's "off-balance sheet" accounting regulations for the purposes of meeting EU fiscal regulations now threaten to imperil not just the economy of Europe, but that of the world.

Enhanced International Coordination Arising, from the Crisis

The responses to the crisis have been not only national, but also international in character. For that reason, it is useful to at least understand the basic contours of the international financial system. Perhaps surprisingly to most, the global financial architecture is not led by Bretton Woods-type institutions like the IMF or World Bank. Rather, financial regulations have generally been coordinated or developed through soft-law bodies composed of national regulators and experts. These groups include organizations such as the Basel Committee, which has worked to develop new capital adequacy standards for banks; the International Organization of Securities Commissions (IOSCO), which is actively examining the practices of securities firms and credit rating agencies; and the International Association of Insurance Supervisors, which is examining the role and exposure of cross-border insurance and reinsurance companies. The International Accounting Standards Board has also played a key role recently with regards to how, among other things, to account for illiquid and derivative instruments on bank balance sheets.

Another important coordinating body is the Financial Stability Board (originally named the Financial Stability Forum). Like the G-20, the Financial Stability Board was founded in 1999 (following the 1997 Asian financial crisis) to promote international financial stability.

Its membership, however, originally included not only the G-7 and each member's finance ministry, central bank, and supervisory agency, but also the major international standardsetters, such as IOSCO and the Basel Committee. As a result, securities regulators have been able to participate in an independent capacity as part of their country's delegation as well as through IOSCO, although, admittedly, banking authorities have tended to dominate the Financial Stability Board.

In its incarnation as the Financial Stability Forum, the group exercised no regulatory authority and had no mandate to generate standards, even on a voluntary basis, as IOSCO has done. However, the 2008 financial crisis has dramatically changed the organization's activism and international engagement. As the only "network of networks" where standardsetters, financial ministries, and central banks all interacted, it became an essential platform for addressing the interdisciplinary nature of the global financial crisis. It was renamed the Financial Stability Board and given a mandate to monitor global financial stability and promote medium-term reform. The G-20 also expanded the membership of the Financial Stability Board to include representatives from all the G-20 nations--in effect turning the board into the nearest thing the world has to an overarching global financial regulatory group--although it still is far from a fully fledged international organization like the WTO.

Since the crisis, the Financial Stability Board has issued a series of recommendations and principles to strengthen the global financial system. These include the Report on Enhancing Market and Institutional Resilience, which called for limits on bank leverage, higher margin requirements for derivatives trades, and a reassessment of value-at-risk models and fair value accounting. In its Principles for Sound Compensation Practices, the Financial Stability Board set out principles for executive compensation and for compensation to be adjusted for all types of risk, to be symmetrical with risk outcomes, and to be sensitive to the time horizon of risks. Finally, in its Recommendations for Addressing Procyclicality in the Financial System, the Financial Stability Board laid out a mix of quantitative, rules-based, discretionary measures. These recommendations sought to mitigate mechanisms that amplify procyclicality in both good and bad times, and are to be implemented over time when financial markets have stabilized.

Far from comprising "a think tank with no place to go," as one critic has described the Financial Stability Forum, (3) the organization has pushed these recommendations in front of the G-20 and is credited with providing a basis for the G-20's political communiques. Likewise, it has helped set the basis for deeper coordination in the future between supervisory agencies, central banks, finance ministries, and political elites.

National Responses to the Financial Crisis and Their Lawfulness Under WTO Rules

Beyond enhanced international coordination, the 2008 financial crisis has produced unilateral action by many counties. Two general types of responses have been observed:

* National regulatory efforts, many of which are still in flux, as we see here with our financial reform initiatives; many are based on international principles.

* Fiscal stimulus, which is where we see greater implications for existing trade and bilateral investment regimes. Policymakers have, in short, sought to provide lifelines to politically and economically important constituencies. The two that have been of especially high profile have been auto bailouts and bailouts of obviously the "too-big to fail" banks.

Many WTO member countries in Europe and Asia spent billions of dollars in 2008 and 2009 bailing out firms in their financial services industries. In Europe, bank bailouts totaled $4 trillion. Japan, China, and South Korea each also undertook measures to recapitalize their troubled financial institutions. Although these bailouts were presented as being aimed at preserving stability in these countries' financial systems, some have suggested that, because they were aimed at domestic institutions and excluded foreign institutions, they might have caused protectionist effects and thus violated WTO rules and agreements.

The primary objection to the bailouts has been that they constitute subsidies whereby governments have made payments that unfairly favor domestic financial services firms over their international competitors. (4) However, the General Agreement on Trade in Services (GATS) has no rules on subsidies although Article XV of GATS authorizes WTO members to enter multilateral negotiations to develop rules for limiting the trade-distortive effects of subsidies within service-sector industries, such rules have not yet been adopted. This makes the argument for...

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