Sep 16, 1998

FINANCE: INSOLVENCIES, DOMESTIC CREDITORS AND THE GATS

Geneva, 14 Sep (Chakravarthi Raghavan) -- A report by the Group of 30 setting out the areas of international consensus and areas where consensus is lacking on measures and procedures to deal with cross-border insolvencies in the financial sector, coming in the wake of the Asian financial crisis, has highlighted the problems developing countries will face as they weigh the ratification of the Financial Services accord under the WTO's General Agreement on Trade in Services. 

The Group of 30 is a prestigious group of establishment figures in the world of money and finance. It is headed by Lord Richardson, former Governor of the Bank of England and includes Paul Volcker, Andrew Crockett (BIS), Gerald Corrigan, Paul Krugman, Jacques de Larosiere (former IMF head and of the EBRD), Jean-Claude Trichet (Governor of the French Central bank), and a number of Wall Street bankers.

The WTO financial services accord, concluded in Dec 1997, has a January 1999 deadline for acceptance or ratification by the 80 odd signatories to that protocol. If this is not met, these requirements, signatories who ratify are to meet and decide on what should be done. So far 12 countries have accepted the protocol, with two (Brazil and Uruguay) subject to ratification by their Parliaments. Others who have signed/accepted are Bahrain, Chile, Colombia, the Czech Republic, Hong Kong, Singapore, Israel, Peru and the Netherlands (within the EC).  

The problems developing countries will face under the GATS/Financial Services accord, relate to the policy responses of governments to deal with financial crisis, involving external payments balances and their banking systems, of the kind that has swept Asia, and is spreading to other emerging markets, and the measures governments could take to safeguard their domestic financial institutions, without falling foul of the GATS, and the financial services accord.

Even before the negotiations were concluded in December 1997, participating developing countries received expert technical advice on problems they may face, in terms of challenges to their measures to safeguard domestic institutions in conditions of a balance-of-payments crisis or a generalised banking crisis, where they may provide liquidity as 'lender of last resort' on grounds of "discrimination", and more favourable treatment to domestic creditors when banking and financial institutions become insolvent. 

The solution to these problems, they were advised, may need changes to the financial services annex of GATS, and/or their writing some limitations (including specific prudential regulations they already may have in their laws) in these matters into their schedules as limitations to national treatment.  

When filing their GATS schedules on financial services, some developing countries wrote in some of their regulations favouring domestic enterprises, as limitations to 'national treatment', while many others appeared to have taken the view, on other advice given to them, that there was no need to write into their schedules the prudential regulations they have in place.  

But the report of the Group of 30 on international insolvency questions brings out the lack of any international consensus in another key, but related area: the treatment under national insolvency laws of different creditors. An issue here is the ocalled "ring-fencing" -- under which domestic creditors get preferential treatment over foreign creditors when financial institutions become insolvent and go into liquidation.  

The origins of the G-30 report go back to 1995, when, in the wake of the collapse of the Barings, the Group of 30, in cooperation with the International Insolvency Practitioners Association (INSOL International) convened an expert group which examined the issues surrounding the insolvency of a global financial institutions. 

Though triggered by the Barings collapse, the just published report and recommendations has come amidst widespread insolvencies in the emerging markets of Asia, involving both financial institutions and large industrial conglomerates, but (so far) has not triggered failure of any globally active financial institution, the report notes in its introduction. 

The afflicted Asian countries, under the IMF conditionality packages and arrangements, have been forced to close down and/or declare insolvent their domestic financial enterprises, and these are in the process of being grabbed by foreign firms at "fire-sale" prices.  

While these have become wider questions of politics and political economy, the Group of 30 report draws attention to both the lack of an international framework to deal with insolvency of financial institutions with cross-border effects, and the need for cooperation among various regulatory authorities and liquidators. The draft out of a panel meeting went out to bank supervisors and monetary authorities of Australia, Brazil, Canada, the Czech Republic, the EU, France, Germany, Hong Kong, Indonesia, Italy, Japan, Luxembourg, Mexico, the Netherlands, the Netherlands Antilles, Singapore, Switzerland and the United Arab Emirates, and discussed at a London conference in May 1997.

One of the recommendations for cooperation (in the report) calls for insolvency practitioners and governments ensuring that measures taken to improve cooperation, recognition and access will also provide for speed and certainty in international financial insolvencies.  

A specific recommendation in this area relates to what is called "Ring-Fencing" -- rules and regulations to protect local creditors and give them preferences in bank liquidation proceedings. Australia, Hong Kong and Indonesia are among the countries that have such provisions.  

The report shows that on this question there is no international consensus - with Australia, Hong Kong and Indonesia strongly supporting this in the discussions of the expert group, Germany not favouring 'ring-fencing' but supporting use of local insolvency procedures, and other experts opposed.  

In a presentation earlier this year to an expert meeting of the Group of 24 at Algiers, Andrew Cornford, Economic Adviser in the UNCTAD's Division on Globalization and Development Strategies, and who specializes in banking and financial markets and services regulatory matters, referred to the Asian crises as illustrating the processes characterising crises involving both a country's external payments and banking systems and the policy choices confronting governments. 

In the Financial sector, he noted, the distinctions often made between efficiency and competitiveness on the one hand, and macroeconomic conditions and policies on the other, become blurred. The competitive weakness of a country's banks and other financial firms may become more fully exposed by the strains caused by some features of an external payments crisis like the depreciation of the currency, rise in interest rates and consequent collapse in value of financial and real assets, like property. 

In such cases, in terms of government policy responses, the rules of the GATS may constrain policy, he noted.

GATS allows for several types of policy actions a country might take in various circumstances -- to deal with a BOP crises, to take prudential measures and other actions to preserve the integrity and stability of its financial system (under the Annex on financial services) and to protect its financial sector from excessive competition on the part of foreign firms, by putting limitations on market access and national treatment in the country schedules.  

In a BOP-cum-banking crises, governmental response could be as lender-of-last resort operations, as well as provision of other types of financing to firms affected such as finance and mortgage firms and securities firms as well as commercial banks. 

Under the Financial Services annex governments retain considerable discretion on these, but it is not at all certain as to the allowable discrimination between domestic and foreign firms, according to Cornford.  

While the provision in the annex that countries "shall not be prevented from taking measures for prudential reasons - or to ensure the integrity and stability of the financial system" appear to permit a broad range of policy responses (which generally include measures to restructure the financial sector and enhance its competitiveness), an issue to be faced is the differential treatment of foreign and domestic firms. For, the same annex also provides that measures not conforming with the GATS, "shall not be used as a means of avoiding a country's commitments or obligations", and these provisions may be invoked by the parent countries of foreign firms against actions perceived as involving such treatment. 

For e.g. in crises such as in Asia, the government may choose to include among policy responses infusions of equity capital provided by foreign banks as an integral part of restructuring of the financial sector. But the objectives of the government even in such cases may be difficult to attain without measures contradicting the GATS commitments.

Also, Cornford points out, in the aftermath of an external payments cum banking crises, decisions may be necessary on how the costs are distributed among affected parties when financial firms with cross-border connections become insolvent. 

Cornford notes in this connection that international consensus is still lacking in this area on, for example, the extent to which non-discrimination between residents and non-residents should be applicable to the order in which a failed bank's creditors are paid off. 

In the absence of GATS law, he notes, it is unclear how far insolvency procedures of countries are covered by the protection for governments' discretion regarding prudential measures. If they are not so covered, Cornford points out, then the discriminatory features of insolvency procedures of some countries may be in conflict with the principle of 'national treatment'. 

In this view, Cornford advocates inclusion by countries of the relevant features of their insolvency laws as limitations on national treatment in their schedules. Otherwise, he adds, the wording of the GATS annex on financial services may need changes. 

Since the conclusion of the financial services accord, and the Algiers meeting of the G-24 experts, the Asian financial crises and its insolvency effects on domestic institutions has become very visible. 

Few of the countries actually wrote their insolvency provisions into their national schedules as exceptions.  

And as in many other cases, many developing countries are still to develop adequate prudential regulations.  

But with ratification and entry into force of the GATS financial services accord due by January 1999, some of these issues have become urgent in the wake of the Asian crises.  

And experts say that, given the penchant of the IMF and the international system -- favouring foreign creditors, and forcing the adjustment costs on domestic borrowers and countries -- and pressures sought to be exerted on crisis-ridden countries to force them to "schedule" as commitments under WTO, their conditionality reform measures, developing countries may find it useful to withhold ratifications until the financial services annex is clarified or changed in these areas. 

Otherwise, finance ministers of developing countries may find themselves and their macro-economic policy measures having been mortgaged to the rules of the WTO by their trade officials, and being held to ransom by challenges at the WTO, and the uncertain outcomes of the WTO dispute settlement panels, guided by the advice given to them by the WTO secretariat, and expert panels they may consult.