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Columbia FDI Perspectives

Perspectives on topical foreign direct investment issues by

the Vale Columbia Center on Sustainable International Investment

No. 78   September 10, 2012

Editor-in-Chief: Karl P. Sauvant ([log in to unmask])

Managing Editor: Jennifer Reimer ([log in to unmask])

 
Reconciling IMF rules and international investment agreements:
An innovative derogation for capital controls

by

Elizabeth L. Broomfield*

 

There is currently no universal framework governing capital controls. As a result, a conflict has arisen due to the different approaches taken by various international organizations and many international investment agreements (IIAs). In particular, the International Monetary Fund (IMF) -- established to manage the international financial system -- preserves national autonomy over capital controls when such measures are deemed necessary; in contrast, IIAs, and especially bilateral investment treaties (BITs) -- crafted primarily to protect investors -- typically do not allow for the imposition of restrictions on capital outflows associated with foreign investments for balance-of-payments reasons.

 

More specifically, countries that significantly limit the policy space for capital controls in their IIAs (that is, do not allow for a balance-of-payments derogation) can potentially come in direct conflict with the IMF. For instance, a senior IMF lawyer, expressing concern that this approach might be contrary to a request by the Fund that a government adopt capital controls, observed that there is a risk that, “in complying with its obligations [under Free Trade Agreements] … a member could be rendered ineligible to use the Fund’s resources under the Fund’s articles.”[1] Recent volatile capital flows to developing countries, as well as the greater acceptance of capital controls today, make it likely that this issue will stay on the international agenda. This dilemma has been recognized in the international community, as demonstrated by several attempted solutions.[2]

 

In response to this issue, IIAs should incorporate derogations for countries when treaty obligations conflict with IMF recommendations. More specifically, if and when the IMF suggests that a government employ capital controls for a limited time to respond to severe economic hardship, the employing country would have a complete defense against investor lawsuits under IIAs incorporating such derogations.

 

This recommendation may be more politically palatable than other proposed derogations that might afford greater discretion to treaty parties in the implementation of capital controls and therefore should be the most politically feasible. Moreover, the IMF has the preeminent role in international economic rule-making on this issue; the General Agreement on Trade in Services defers to IMF authority on the question of transfer restrictions and some countries have already demonstrated a willingness to rely on IMF judgment on this subject: the North American Free Trade Agreement’s balance-of-payments derogation relies upon IMF statistical information and recommendations. US Treasury Secretary Timothy Geithner has even advocated a greater role for the IMF in policing international capital flows.[3]

 

This proposal could be especially useful for US IIAs and the US Model BIT; the US has been particularly reluctant to incorporate any derogation for capital controls into its IIAs. This plan offers several advantages over the potential balance-of-payments derogation currently debated by the US State Department. First, an IMF exemption could allow controls to prevent a crisis from escalating, rather than addressing problems purely retrospectively; this problem has already occurred regarding the NAFTA balance-of-payments exception. Though permission to use capital controls in this manner would likely be extremely rare, the possibility may prevent a costly and potentially unnecessary buildup of reserves, as occurred in Mexico.[4] The requirement of an IMF recommendation to use controls would also limit abuse of the flexibility by host countries. It is also more objective and therefore promotes legal predictability, as the existence of a balance-of-payments crisis can be subjective. A country may be threatened with lawsuits even if it believes capital controls are needed to respond to a clear balance-of-payments dilemma; IMF permission to impose capital controls would remove this uncertainty. If the IMF states that capital controls are needed to address a financial difficulty, a country may proceed without fear of lawsuits.

 

Most importantly, this proposed derogation would directly address the IMF’s concern that its authority to recommend capital controls could be undermined by IIAs. While rules of international institutions are carefully designed to ensure that they do not create conflicting obligations, this is not the case for most treaties crafted in the investment area. Currently, it is possible that a country in crisis will have to face two potentially conflicting international obligations: an IMF recommendation to employ capital controls, and IIAs that allow investors to sue if controls are imposed. A simple derogation in IIAs would remove this risk and enhance the compatibility of such agreements with international rule-making.

 

The material in this Perspective may be reprinted if accompanied by the following acknowledgment: “Elizabeth L. Broomfield, ‘Reconciling IMF rules and international investment agreements: An innovative derogation for capital controls,’ Columbia FDI Perspectives, No. 78, September 10, 2012. Reprinted with permission from the Vale Columbia Center on Sustainable International Investment (www.vcc.columbia.edu).” A copy should kindly be sent to the Vale Columbia Center at [log in to unmask]

 


* Elizabeth L. Broomfield ([log in to unmask]) is an associate at Cleary Gottlieb Steen & Hamilton. The author would like to thank Sergey Ripinsky, Diana Rosert, Manfred Schekulin and two anonymous reviewers for their helpful peer reviews. The views expressed by the author of this Perspective do not necessarily reflect the opinions of Columbia University or its partners and supporters. Columbia FDI Perspectives (ISSN 2158-3579) is a peer-reviewed series.

[1] Deborah E. Siegel, “Using free trade agreements to control capital account restrictions: Summary of remarks on the relationship to the mandate of the IMF,” International Law Student Association Journal of International and Comparative Law, vol. 10 (2004), p. 301.

[2] E.g., some IIAs state that in exceptional cases restrictions to the transfer of funds provisions are allowed when they conform with relevant WTO agreements and IMF regulations. Furthermore, more recent IIAs increasingly incorporate balance of payments exceptions. However, in contrast, the new 2012 US Model BIT does not allow for capital controls.

[3] Statement by the United States Secretary of the Treasury Timothy Geithner in the twenty-third meeting of the International Monetary and Financial Committee, April 16, 2011, available at: http://www.imf.org/external/spring/2011/imfc/statement/eng/usa.pdf.

[4] Manuel Perez-Rocha, “Mexico's hot money challenge,” The Epoch Times, March 6, 2011, available at: http://www.theepochtimes.com/n2/opinion/mexicos-hot-money-challenge-52467.html.


For further information, including information regarding submitting to the Perspectives, please contact: Vale Columbia Center on Sustainable International Investment, Jennifer Reimer, [log in to unmask] or [log in to unmask].

 

The Vale Columbia Center on Sustainable International Investment (VCC – www.vcc.columbia.edu), led by Lisa Sachs, is a joint center of Columbia Law School and The Earth Institute at Columbia University. It seeks to be a leader on issues related to foreign direct investment (FDI) in the global economy. VCC focuses on the analysis and teaching of the implications of FDI for public policy and international investment law.

 

 

Most recent Columbia FDI Perspectives

 

·       No. 77, Sandy Walker, “A new economic nationalism? Lessons from the PotashCorp decision in Canada,” Columbia FDI Perspectives, August 27, 2012.

·       No. 76, Perrine Toledano and Julien Topay, “A good business reason to support mandatory transparency in extractive industries,” Columbia FDI Perspectives, August 13, 2012.

·       No. 75, Alex Berger et al., “Attracting FDI through BITs and RTAs: Does treaty content matter?,” Columbia FDI Perspectives, July 30, 2012.

·       No. 74, M Sornarajah, “Starting anew in international investment law,” July 16, 2012.

·       No. 73, Lorenzo Cotula, “Law at two speeds: Legal frameworks regulating foreign investment in the global South,” June 29, 2012.

·       No. 72, Torfinn Harding and Beata Javorcik, “Roll out the red carpet and they will come: Investment promotion and FDI inflows,” June 18, 2012.

·       No. 71, Thomas Jost, “Much ado about nothing? State-controlled entities and the change in German investment law,” June 4, 2012.

·       No. 70, Terutomo Ozawa, “FDI, catch-up growth stages and stage-focused strategies,” May 28, 2012.

·       No. 69, Karl P. Sauvant, “The times they are a-changin’ -- again -- in the relationships between governments and multinational enterprises: From control, to liberalization to rebalancing,” May 21, 2012.

·       No. 68, Sophie Meunier et al., “Economic patriotism: Dealing with Chinese direct investment in the United States,” May 14, 2012.

 

All previous FDI Perspectives are available at http://www.vcc.columbia.edu/content/fdi-perspectives.



Karl P. Sauvant, Ph.D.
Senior Fellow
Vale Columbia Center on Sustainable International Investment
Columbia Law School - Earth Institute
Columbia University
435 West 116th Street, Rm. JGH 638
New York, NY 10027
Ph: (212) 854-0689
Fax: (212) 854-7946

Please visit our website - http://www.vcc.columbia.edu

The Yearbook on International Investment Law and Policy 2010-2011 was released by Oxford University Press in December 2011. For details please see www.vcc.columbia.edu.
The following ebooks are available free of charge from the same website: FDI Perspectives: Issues in International Investment; Inward and Outward FDI Country Profiles; MNEs from Emerging Markets: New Players in the World FDI Market.
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