Legitimacy and Effectiveness in Global Economic Governance [1 ed.] 9781443863391, 9781443853019

Citation preview

Legitimacy and Effectiveness in Global Economic Governance

Legitimacy and Effectiveness in Global Economic Governance

Edited by

Biagio Bossone, Maria Chiara Malaguti, Susanna Cafaro and Saverio Di Benedetto

Legitimacy and Effectiveness in Global Economic Governance, Edited by Biagio Bossone, Maria Chiara Malaguti, Susanna Cafaro and Saverio Di Benedetto This book first published 2013 Cambridge Scholars Publishing 12 Back Chapman Street, Newcastle upon Tyne, NE6 2XX, UK British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Copyright © 2013 by Biagio Bossone, Maria Chiara Malaguti, Susanna Cafaro, Saverio Di Benedetto and contributors All rights for this book reserved. No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the copyright owner. ISBN (10): 1-4438-5301-1, ISBN (13): 978-1-4438-5301-9

TABLE OF CONTENTS

Introduction ................................................................................................. 1 Legitimacy and Effectiveness of Global Economic Governance: Rethinking Traditional Premises against the Complexity of the Present Section I - Understanding a Multifaceted Dimension Chapter One ................................................................................................. 8 The Impact of Financial Crises on the Transformation of Global Economic Governance Luca Einaudi Chapter Two .............................................................................................. 30 Rethinking Global Financial Governance: Some Preliminary Thoughts Daniel Bradlow Chapter Three ............................................................................................ 44 Information Asymmetry vs. Communication Isonomy: Some Notes on Transparency Regulation of Financial Markets Roberta Marra Chapter Four .............................................................................................. 66 (Un)Fair Resource Sharing: A Networking Perspective Angelo Coluccia Section II - Multilateral Institutions at a Cross-road Chapter Five .............................................................................................. 80 The G-20 at the UN ECOSOC: A Complementary Perspective Claudia Cinelli Chapter Six .............................................................................................. 107 Towards a New Bretton Woods? The Financial Crisis, the Doha Round and the Future of the WTO Roberto Soprano

vi

Table of Contents

Chapter Seven.......................................................................................... 130 Forward-looking Estimation of States’ Default Probability in Time of Debt Turmoil: Which Perspectives for Credit Rating Agencies' Multilateral Regulation and Control? Liboria Maggio Chapter Eight ........................................................................................... 166 A New Governance for European Monetary Union and its Economic Policy Framework Daniele Schilirò Section III - Governments and Economic Governance Chapter Nine............................................................................................ 186 Cross-border Bank Insolvency Regimes and Financial Supervision: Domestic, Regional and Supranational Levels of Regulation Silvia Solidoro Chapter Ten ............................................................................................. 210 Recognizing a “Government Case” for Corporate Social Responsibility: Impact on Legitimacy and Efficiency on Global Governance through Institutionalization of CSR and Business Access to Rule-making at Intergovernmental Level Karin Buhmann Chapter Eleven ........................................................................................ 238 The Intervention of the State in the Economy through the Lens of the Chinese Anti-Monopoly Law Laura Sempi Chapter Twelve ....................................................................................... 264 A History of Failure: Rediscovering the Role of Punishment in Economic Governance and Corporate Insolvency Keith Crawford Section IV - Global Development Policies Chapter Thirteen ...................................................................................... 298 International Regulation of Export Taxes: Development Tools or Inefficient Trade Instruments? Francesca Martines

Legitimacy and Effectiveness in Global Economic Governance

vii

Chapter Fourteen ..................................................................................... 326 The Role of Government in Building the Smart Economy Natalia Dmitrievskaia and Valentina Maksimova Chapter Fifteen ........................................................................................ 343 Sustainable Development or Strong Growth? Perspectives in G8 and G20 Declarations on Global Economic Governance in Times of Crisis Saverio Di Benedetto Chapter Sixteen ....................................................................................... 369 The Principle of Solidarity in the Global Economic Law Priscilla Baglioni, Marta Bordignon, Giada Lepore, Antonella Sarro and Evelina Strippoli Chapter Seventeen ................................................................................... 406 Economic Development and Marine Living Resources, between Unilateral Actions and Institutionalized Multilateral Cooperation Irini Papanicolopulu

INTRODUCTION LEGITIMACY AND EFFECTIVENESS OF GLOBAL ECONOMIC GOVERNANCE: RETHINKING TRADITIONAL PREMISES AGAINST THE COMPLEXITY OF THE PRESENT

Coping with the challenges of global economic governance is a topical issue of the current international agenda and the object of a vivid debate among scholars. The on-going international financial and economic crisis reveals the fallibility of the neoliberal paradigm that has dominated the world economic landscape over the last quarter of a century: regulatory and supervisory institutions have disclosed their weaknesses, and markets have shown their limits to the rational allocation of risks and resilience to shocks. This book intends to offer a comprehensive view of this subject matter, taking on the dialectic and very fluid relations between State sovereignty, supranational rules and the role of markets, looking with the authors’ eyes at finance, trade, economic development, social values and the rule of law in the many aspects relevant to governance. The opportunity to deal with economic and regulatory challenges through the lens of legitimacy and effectiveness is the fil rouge of the coauthors’ original contributions and the inner sense of the book. The global economy today needs a system of governance that is both effective and legitimate. Only bodies and institutions that are perceived to be legitimate can ultimately make choices that are accepted and effective. Legitimacy requires (direct or indirect) participation in decision-making, and participation in decision-making provides the only way to make choices that draw on the views and interests of all the parties involved, which are affected by those choices. Only those who see their rights recognised to participate in decision-making are then motivated to “own” the decisions taken and to respect them. Effectiveness in governance requires a capacity to respond adequately and rapidly to emerging challenges, to prepare for foreseeable future

2

Introduction

developments, to strive for the best possible action results, and to act in ways that are appropriate to the given contexts. This is only possible if an adequate allocation of power is established, so that the best placed entities can take the most suitable measures for the circumstances. In a complex and articulated reality, both legitimacy and effectiveness are essential for sound governance. Indeed, legitimacy and effectiveness may trade off each other in the short term: broad participation would secure legitimacy but might hinder rapid decision-making. A monocracy, instead, can lead to very rapid decisions but might totally lack legitimacy. Effectiveness and legitimacy, in fact, are mutually complementary in the long haul. In communities with multiplicities of growing voices and interests, effectiveness would be at risk if decisions were taken in contexts that were not recognised as legitimate by the members of the communities; that is, if decisions were taken outside of institutional frameworks that granted proper recognition to those multiplicities of voices and interests. Perception of illegitimacy would sooner or later raise forms of resistance or opposition to the governance system, eventually compromising the effectiveness of its action. Moreover, ignoring voices and interests would cause the decisionmaking process to lack relevant information, thereby putting effectiveness at risk. It would also weaken the incentives for the community members to co-operate for the success of the action taken. Effective governance requires efficient decision-making; yet efficiency may not be pursued at the expense of legitimate representation, and decisions must be the expression of a shared understanding of common objectives among community members. On the other hand, decisions that persistently produced ineffective action would induce community members to challenge the legitimacy of the governance system in place. They would push for revising and reforming the institutional set-up underpinning the governance system and the mechanisms presiding over its decision-making processes. Legitimacy and effectiveness are dynamically and mutually linked: they constrain and condition each other and require achieving a balance between the demand for legitimate representation and the quest for effective results. But they also support one another, and no governance system would survive without one of them. To place these considerations in a concrete perspective, it is necessary to reconsider a number of premises and to re-appraise the multifaceted dimension of the governance system of the current global economy. Indeed, both legitimacy and effectiveness have to come to terms with the multi-layered structure of the existing governance system, its highly

Legitimacy and Effectiveness of Global Economic Governance

3

articulated allocation of powers, and its inherent combination of old and new paradigms and actors. It is in this light that the co-authors of this book have approached different relevant topics in the context of global economic governance, highlighting inner tensions, and proposing new interpretations. Section One draws on the theoretical key-concepts of the investigated subject, with a view to re-thinking critically the assumed premises underlying the functioning of global financial and economic markets. This exercise serves as a conceptual introduction to the following sections, by discussing the very essence of the neo-liberal paradigm and its shortcomings to understand the most recent events and to offer satisfactory solutions. Solutions that have been proposed at the highest levels to overcome the financial and economic crises of these years are criticised for attacking only the surface of the problems, while leaving the rules of the game substantially unchanged. In Section Two, this critical approach results in investigating gaps and ambiguities of the institutional framework of the major international economic organisations (G20, WTO, IMF, EMU), by pointing out the unavoidable trade-offs between the claim for legitimacy and the need for effective decision-making. The crisis of the Bretton Woods institutions has been the main topic in the agenda of political leaders since 2008 but the solutions found have been largely insufficient and clearly oriented not to reinforce multilateralism, but rather to re-allocate powers upon limited groups of nation states, thus raising the question as to whether multilateralism is still a shared value across today’s international community. It is then recognised that multilateralism today has to be reconsidered in the light of regionalism. The still on-going crisis within the European Union, which is commonly understood as being a crisis of governance in the first place, has re-opened the same kind of issues that occupied the debate at the global level, showing that common patterns can be detected within the trade-off between legitimacy and effectiveness. It has also shown that regional crises are strictly linked to global crises, and cannot be treated exclusively as local events that are only relevant to the parties directly involved. “Systemic” has become the new catchword for reading the present, since in a global world we are all connected and interdependent. Section Three proposes a re-discussion of the regulatory role of the State to cope with the challenges of the global economy, by focusing on new legal paradigms for corporate activities, referred to as concrete experiences, such as regimes of insolvency, competition, and corporate social responsibility. The issue of the role of sovereign states in global

4

Introduction

economic governance is of course not new, and overlaps with the general discussion over the role of the State in economic matters, vis-à-vis that of the Market. In fact, the whole mainstream approach to international law and global governance in the past was based on the role of sovereign states, and has slowly evolved towards the acknowledgment of its gradual erosion. Many words have been spent regarding the new limits to state sovereignty, up to the prophecy of the death of the State. Yet, it is clear that nation states still play a relevant role in global economic governance, and that what has changed are in fact their tools or the forms of cooperation among nation states. Regulatory competition and regulatory harmonization, often by means of soft law, produce challenging trade-offs, which need to be considered within the general appraisal of global economic governance, and form part of the overall picture of the multifaceted dimension of governance today. Finally, Section Four provides a test-bed to evaluate the possible contradictory interactions between financial paradigms and sustainability with regards to economic development policies. Indeed, too many efforts have been devoted to the analysis of financial crises, putting aside the inherent linkages between finance, trade and development. By focusing exclusively on financial markets, the analysis has suffered from too narrow a perspective and has shown an inherent inability to address issues from the roots. The authors in this section try, by the opposite, to combine finance, trade and economic development within the same conceptual frame, with a view to defining new paradigms that can better help address the real challenges of the present and the future. In discussing global governance, we realise that the world evolves quickly. The debate on the global financial crisis of 2007-09 has left it to the sovereign debt crisis within the European Union, and its possible worldwide repercussions. The crisis of legitimacy of the institutions acting in support of the crisis countries - the IMF and the European Union in the first place – has become more and more evident: their decisions replace those of governments legitimised by the popular vote. The demand for effectiveness, too, has grown stronger in light of the role played by the time factor. It is impossible for the growing number of unemployed people to wait for solutions yet to be invented. Some partial solutions have been explored at the global and European level, starting with the strengthening of surveillance. The dialectics between the supporters of fiscal discipline and the defenders of the welfare state, and the trade offs between rigor and growth, have put the spotlight on the failure of the capitalistic model itself – at least as we know it – to

Legitimacy and Effectiveness of Global Economic Governance

5

resolve those dialectics and trade offs, but there still aren’t new paradigms in sight that could replace that model. In short, while this volume is now completed, topics and ideas emerge for the next one. The Group of Lecce (GoL) 1 keeps organizing new meetings of scholars and experts, to continue a conversation that inevitably will never end. The scope of the contributions to this book is not exhaustive, and the objective of the editors was not to strive for achieving an unrealistic completeness of the topics. The purpose was rather to tackle the issues of legitimacy and effectiveness of global governance from a variety of prospective angles, which, taken together, show the complexity of the 1

Established in early 2009 at the Scuola Superiore ISUFI (Euro-Mediterranean Law and Politics Section), under the auspices of the University of Salento, Lecce (Italy), and now become an autonomous think tank which collaborates with many domestic and international institutions, The Group of Lecce (GoL) consists of experts in law, finance and economics who share an interest in the development of democratic and effective institutions of global governance. In the course of its activities, GoL has elaborated a number of proposals to reform the governance system of the world economy, to be submitted to world leaders. Initially, the group has limited its contribution to proposals to strengthen economic and financial multilateralism with a view to reviving the original international co-operative spirit of Bretton Woods within the new global economic, political and social context of our times. This then led to considering the reform of the governance of the IMF and the World Bank as the first step of a broader analysis that the group has carried out. In light of this more ambitious plan, the group has then monitored and keeps monitoring policy developments following the G20 summit deliberations and other fora, and has contributed ideas and further proposals on specific aspects of global economic and financial governance (including at European Union level), with the purpose of soliciting governments’ policy actions supportive of democratic and effective international institutions of global economic governance. GoL intends to expand its composition to include foreign scholars. It establishes international contacts to promote new ideas, and is open to participation of experts who share its basic principles – as enshrined in its proposals – and who wish to support its mission. All the activities and documents of GoL are available at www.the groupoflecce.org. Within this context, GoL also organises events to discuss specific topics with scholars, civil society and members of think tanks and institutions, to open a wider debate on the future of global governance. In particular, an international workshop was held in Lecce in Spring 2011, where a large number of scholars from around the world joined together for an open discussion. This book comes from the results of that occasion for discussion and confrontation, and we are proud and would like to thank Cambridge Scholars Publishing for having offered us the chance, by publishing this book, to progress on our way towards an open dialogue on what we believe lies at the heart of our future.

6

Introduction

matter and the inadequacy of the solutions that are only meant to dust the surface of existing paradigms. This purpose is in line with the objectives of the GoL – of which the editors are all members – as well as with the GoLs efforts to facilitate an open debate among scholars and practitioners from many different places and backgrounds. It is the GoL’s firm belief that the crisis the world is currently experiencing cannot find unilateral solutions. A genuine multilateral approach to governance is needed for the world, not only to recover from the current crisis but, even more importantly, to mitigate the risks of instability inherent in global capitalism and to build institutions to achieve sustainable growth. A creative effort is needed in the spirit of multiculturalism and inclusiveness. Biagio Bossone, Maria Chiara Malaguti, Susanna Cafaro & Saverio Di Benedetto, Editors and among the founding members of the GoL The editors thank Liboria Maggio for her precious help in the last revision of this volume.

SECTION I – UNDERSTANDING A MULTIFACETED DIMENSION

CHAPTER ONE THE IMPACT OF FINANCIAL CRISIS ON THE TRANSFORMATION OF GLOBAL ECONOMIC GOVERNANCE LUCA EINAUDI

Abstract Since the first signs of a long economic and financial crisis of the West appeared in 2007, important changes have taken place in global economic governance, but within an incomplete and unstable new framework. The newly created G20 leaders’ process has largely superseded the G8 in its first year of life, achieving a successful start beyond expectations. In September/October 2008, the G8 followed the events, and only later managed to co-ordinate with difficulty and delays, the reaction of Europe and the US to the fallout of the Lehman Brothers collapse. Shortly after, in November 2008, the G20 leaders’ process was created and took over for the following year the leading role in co-ordinating, in a much more substantial manner, a response at the global level to the threat of a depression, involving for the first time emerging countries on a truly equal footing. Against the expectations of many, the G8 has survived the emergence of the G20 and the growth of Chinese, Indian, Brazilian and Russian influences (the so-called BRIC countries). The G20’s effectiveness stalled in 2010-2012, when the common interests of G20 members weakened with the end of the perception of a symmetric global threat to economic growth. Since 2010, global economic problems have focused on European debt and European institutions have been called to

Luca Einaudi is an economic historian. He is a research associate at the Joint Centre for History and Economics, Cambridge and an Italian civil servant involved in the G8 and G20 summit process in 2008-9. The views expressed in this article are those of the author and do not involve the responsibility of any institution. Updating: January 2013.

The Impact of Financial Crisis

9

engineer solutions to a new set of problems. The EU’s difficult governance has become the focus of attention among additional signs of an accelerated relative decline of old industrialized countries and threats to the single European currency. The largest international shift of economic and political influence since the WWII is taking place at an accelerated pace and contributes to maintaining an open-ended process of global governance reform. Historical precedents offer some insights about how unstable the evolution of international economic governance can be, especially when new potential leaders are not ready or willing to assume their new role.

1. Massive crises accelerate shifts of relative economic weight and political influence, the birth of new institutions and episodes of co-operation The transformation of global governance has always followed in a nonlinear manner and, with a certain delay, the transformation of relative economic weight of countries. Since 2000, a great convergence has accelerated between a rising China (and to a lesser extent India), returning to a more reasonable weight in the world economy, and a stagnant EU and USA (in relative terms). This is a return towards a pre-industrial relative importance of Europe and Asia, but today’s grandiose convergence is happening much faster than the divergence of the previous 150 years. According to Angus Maddison’s figures, in 1820 China represented approximately a third of the world GDP, India more than 15% and Europe 27%. In the following century and a half, industrialization, colonialism, opium and then Communism in Asia produced a concentration of production and wealth in Europe and the US that had reduced the two Asian giants combined to a mere 4.7% of the world GDP in Purchasing Power Parity by 1980, despite representing around 40% of the world population. By 2000, reforms, trade liberalization and globalization had increased Chindia’s share of the world GDP to 10.8%, and by 2011 to 20.1%, through a virtuous cycle of growth (see graph 1). So far, the lack of adequate real exchange rate readjustment of the Chinese currency has reduced the impact on the world GDP at market prices of China’s economic importance (14.4% at PPP and 10% at market price in 2011), but a re-evaluation of the Renminbi, called for by the USA and Europe, would suddenly reveal its real extent. The readjustment of global economic and political Governance to the rapid rise of Asia (and on a much smaller scale of Latin America and Africa) had been very limited. It accelerated only as a consequence of the

10

Chapter One

shock of the 2008-2009 crises. During the past decade, European countries have tried to slow down as much as they could the growth of emerging countries’ role in international institutions, from the G8 to the International Monetary Fund (IMF) or the World bank (WB), accepting only a limited redistribution of influence and voting powers. In 2008 reinforced international co-operation meant an acceleration of change and the birth of new institutions. The economic emergence of China, facilitated by its accession to the World Trade Organisation (WTO) in 2001, received real political recognition in terms of influence throughout the crisis and thereafter. In the past century every major economic or financial crisis has led to the creation of new institutions (see table 1). The Federal Reserve System was created as the US response to the panic of 1907, solved by the private banker J.P. Morgan, because of the lack of a lender of last resort and adequate public institutions. Out of the Great Depression and WWII came the Bank of International Settlements (BIS) and the Bretton Woods Institutions (IMF and WB) to manage, in a co-operative manner, exchange rates, and financial imbalances, to manage current account disequilibria, facilitate adjustments, prevent crises and foster joint development. The crises of the 1970’s produced the G’s summitry, starting in 1974 with US, Germany, France, UK and Japan (G5), and then adding Italy and Canada in 1975-76 to form the G7. The addition of Russia in 1997 into the G8 did not include the involvement of the latter country in the financial operations of the G7, except for occasional invitations. The main economic success of the G5-G7 was a concerted effort to contain excessive fluctuations of the dollar exchange rate in the 1980’s. In response to the Asian crisis in 199798 the Financial Stability Forum (FSF) was formed, as well as the G20 Finance Ministers’ process. Given that it appeared only after the end of that crisis, the G20 became, in its early years, mainly a forum for discussions, without many practical effects. Only the 2008-9 crisis produced the G20 leaders’ process and caused the transformation of the FSF into the Financial Stability Board (FSB) with a larger membership and wider mandate, followed by a cascade of new EU and national financial institutions, from the European Banking Authority to those created by the Dodd-Frank Act in the USA in 2010. The creation of institutions after crises, however, does not guarantee that attempted co-ordination at the transnational level actually works. The initial success of the G20 in 2008-2009 in averting a global depression is even more notable for that. Most economic, financial and military crises in the last 150 years have led to episodes of attempted international cooperation, but the majority failed, either straight away or at the

The Impact of Financial Crisis

11

implementation stage of decisions initially agreed upon. Successful cooperation is not the norm but rather the exception, as a rapid review of cooperative attempts in table 3 shows. Four major inter-governmental conferences between 1867 and 1892 attempted to regulate the international monetary system during the first globalization, when the emerging gold standard worked much less smoothly than is remembered today. After initial agreement on the gold standard and on the demise of silver as a monetary instrument, all attempts failed to achieve a more expansive monetary policy during repeated cyclical downturns through the partial remonetisation of silver, despite the efforts of several countries. After WWI monetary reconstruction worked up to a point and the financial system emerging out of it collapsed between 1929 and 1933. The 1933 London World Economic Conference call to agree a common response against the Great Depression in terms of exchange rates, foreign debts and reparations was an utter failure. Only Bretton Woods in 1944 was a significant success, rebuilding a monetary system based on a dollar standard with fixed but re-adjustable exchange rates, new International Financial Institutions (IFI), assistance for countries in need of readjustment and a process to re-start international trade and capital movements. As Harold James put it “only at the end of a war that had required an all-out mobilization of resources, and only in the context of a fundamental consensus about overall economic objectives, could such an international project of supranational co-operation be accomplished”1. As already mentioned, Bretton Woods was the outcome of three years of negotiations, with a limited number of participants, all belonging to the same Anglo-American wartime alliance and under a strong US hegemony. The Bretton Woods arrangement collapsed in 1971 and none of the following attempts of international co-operation managed to bridge the diverging interests and reconstruct a full system regulating exchange rates, readjustment mechanisms, and cross-border financial regulation.

2. The G8 and the G20 during the post Lehman crisis In 2008, some European leaders initially thought they had a “good” crisis in terms of influence on the transformation of global governance, because they sensed an opportunity to show their financial expertise in hard times (Brown), or their skills in crisis management (Sarkozy), or the 1

Harold James, International Monetary Co-operation Since Bretton Woods, Washington, IMF, 1996, p. 57.

12

Chapter One

limits of the US deregulated model of financial capitalism (the German social-democratic leadership). By the beginning of 2009 it emerged that Europe was actually hit by the economic crisis far worse than any other area of the world, including the US. Furthermore, global governance reform, called to make room in favour of emerging powers, took a turn which weakened primarily large European countries and Japan, while the US still kept its leadership and suffered smaller losses of GDP, despite the fact that the crisis had originated there.

3. The ballet of the G’s: G8, G13, G14, G16 or G20? The need for co-ordination at the international level against a spreading crisis forced, in October 2008, the discussion on which new format would best address the situation. It was necessary to find an optimal equilibrium between a larger representation of emerging and developing countries and the highest level of effectiveness in decision-making. The G8 was widely considered to be insufficiently representative because emerging and developing countries were excluded. The G8 itself was aware of this and in 2007 the German Chancellor Angela Merkel initiated a process of involvement in part of the activities of the G8 of the five main emerging economies (China, Brazil, Mexico, India and South Africa) through the Heiligendamm Dialogue. Most G8 countries, however did not want a full enlargement of the G8, particularly continental Europe, Canada and Japan. In the key weeks leading to the definition of a new format for world governance the Japanese G8 presidency was paralysed by a domestic governmental crisis and its slow reaction left the way open for all sorts of proposals by G8 members (G8, G10, G13, G14, G18, G20, etc…). Candidates wishing to join an enlarged G8 multiplied, including Spain, the Netherlands, Switzerland and the African Union on behalf of the clearly under-represented Africa continent. French President Sarkozy invited the US to call for a G8+ summit with restricted additional participation. Ultimately Bush announced a leaders’ summit in November, under the G20 format chosen by the host for several reasons. Formally the G20 had existed since 1999 as a meeting of finance ministers and central bankers, therefore it had the diplomatic advantage that there was no need to choose who was in it and who wasn’t, avoiding more discontent. The UK was already scheduled to hold the chair in 2009 and Brown was recognised as competent and reliable. Furthermore, China had repeatedly proved reluctant to join an enlarged G8 as a guest and not on a truly equal footing. The US policy community had a long-standing preference for the G20 (which represented two thirds of the world

The Impact of Financial Crisis

13

population and four fifths of the world GDP) over the G8, where Europeans were considered to be over-represented and quarrelsome. The G20 was particularly well equipped to represent Asia, with China, Japan, Korea, Indonesia and India being part of it. Some European states which were not members managed to “gate-crash” the G20, with the support of Sarkozy. He had several hats available: as rotating president of the European Council as well as French President, and used them to “smuggle” Spain and the Netherlands inside. When international arrangements evolve, countries and institutions excluded by any new format tend to fight to get into the club. Those, which are already in it, resist being excluded from it, even if they are not full members. Therefore formats keep expanding, with more and more people in the room: for the G7 in 1976 there were 14 leaders and Sherpas in the meeting room; in the 1999 G20 of Finance Ministers and central bankers such numbers had grown to 88 and in the leaders’ G20 in 2011 it reached a record 116, representing governments and international organisations. The consequence of this process of bureaucratization is a tendency to decline in effectiveness, an evolution which damaged the G20 as well as its predecessors (see graph 2). The expansive tendencies of such bodies reduces confidentiality, informality and openness, in favour of more rigid and official exchanges based on written speeches, with less speaking time available for each participant and less capacity to reach decisions rapidly. The tendency to over-expand the agenda is also detrimental. Big states are therefore tempted to move real decision making elsewhere, towards smaller caucuses, even if less democratically accountable. In 2008-2009 the weakest members of the G8 and G20 feared smaller directorates, such as a US-Chinese G2 or a slightly larger group. The apparent US-Chinese harmony of 2009 somehow deteriorated afterwards, allaying such fears. In reaction to the proliferation of meetings and excessively large formats, Obama simplified and focused the 2012 G8 summit at Camp David to the core members, without inviting any other country. The Russian President Putin was invited but did not attend for the first time, showing how his priorities were shifting. The G20 leaders also reduced their meetings from two to one per year from 2011. In this context, the concerns of the non profit sector for democratic legitimacy are often difficult to insert in official policy, also because the political representatives of large parts of the world excluded from the table are themselves often far from being democratically presentable: for example in 2009 Col. Gaddafi was the rotating head of the African Union.

14

Chapter One

Overall in 2010-13, the G20 has normalised its effectiveness; in other words it was reduced to the limited progress that is normally achieved on an ordinary basis in most international organisations or fora. In the first year of the G20’s life, the fear of a major crisis facilitated co-operation and increased short-term effectiveness. There were clearly perceived symmetrical advantages for all participants in stopping the financial crash, stimulating the economy, preventing a return to protectionism, re-assuring financial markets and public opinion. The images of the disaster in the 1930s was very present in the minds of participants, together with the lessons commonly drawn from it in terms of Keynesian deficit spending, the importance of free trade and of effective co-operation. Even the Republican President Bush said to his aides in late September 2008: “If we are really looking at a Great Depression, you can be damn sure I’m going to be Roosevelt, not Hoover.”2 Upon entering the White House, his successor Obama had research done on the consequences of the failure of international co-operation in 19333. His chair of the Council of Economic Advisers, Christina Romer and the President of the FED, Ben Bernanke, both were scholars of the Great Depression and placed what they had learned from it at the centre of their policy making. Ultimately the recession brutally hit the G8, but most emerging countries did not enter into a recession, despite a strong decline in the rate of growth. After the G20 summit in London on 1st April 2009, confidence improved and the recovery started. Monetary policy played an important role in addressing the crisis, through massive co-ordinated reductions of interest rates and an abundant supply of liquidity to the private financial and non-financial sector by central banks. That type of action, however, had been displayed already from mid-2007 after the Bear Stearns crisis in the US. It was clearly insufficient to address financial contagion and a massive recession in the West, spreading to the whole world through the collapse of world exports. The latter was more intense at the beginning of 2009 than during the early phases of the Great Depression and a cause of great concern for policy makers, also because of the fear of a protectionist backlash as in the 30s4. 2

George W. Bush, Decision points, Crown Publishers, New York, 2010. Author’s conversation with White House Staff. 4 Barry Eichengreen and Kevin H. O’Rourke, ‘A tale of two depressions: what do the data tell us? February 2010 update,’ Voxeu.org. http://www.voxeu.org/index.php?q=node/3421. The column was originally published on 6th April 2009 and then periodically updated. It showed that in the first months of 2009 industrial production, world trade and equity markets were declining faster than in the early phase of the Great Depression. 3

The Impact of Financial Crisis

15

The G20 managed to change the perception of the relative impotence of international economic co-operation through its first three summits by addressing macroeconomic stimulus, stopping the risk of a protectionist reaction, refinancing international financial institutions to address local crises, beginning re-regulation and starting a new process of institutional reform. The key period in designing the responses to the crisis was between September 2008 and September 2009 (see table 3). The first G20 leaders’ summit (Washington, 15th November 2008) launched the new process, endorsing measures to stabilise financial markets and agreeing to reject protectionist measures and conclude positively the Doha round of trade liberalisation managed by the WTO. The Keynesian principle of a co-ordinated international macroeconomic stimulus was adopted by governments even though most were politically on the centre right. Such a cumulated stimulus was later estimated at five trillion dollars, the first operation of that kind agreed on such a global scale. The summit also decided to support developing countries and established principles for the reform of global financial regulations drawing on the work of the FSF and promised a larger role to emerging countries. While the second G20 summit was being prepared, the concrete fear of a major economic calamity focused the energies of all governments5, leading to forms of compromise usually absent. The US for example, promoted an increase in IMF lending resources by 500 billion dollars and the issue of Special Drawing Rights (SDR) for 250 billion dollars as a form of additional liquidity for member states, exactly the type of action that the US Congress had opposed for more than a decade. A new informal institutional architecture developed temporarily in early 2009. The G20 Sherpas (personal representatives of heads of state and governments delegated to negotiate) and finance deputies (representatives of finance ministers) of member countries co-ordinated the work and interacted with all the relevant international economic institutions as well as being tasked with producing reports and proposals, from the IFI’s to the WTO, the UN system, the OECD, the FSB and regulators and standard setting bodies, represented in graph 3. At the time a visible process of “Gtwentification” of institutions was taking place, with changes in governance, voting rights or membership in IMF, WB, OECD and FSF to adapt each institution to the G20’s characteristics. The intensity of all that 5

Group of Twenty, Meeting of the Ministers and Central Bank Governors, March 13–14th, 2009, London, U.K., Global Economic Policies and Prospects, Note by the Staff of the International Monetary Fund.

16

Chapter One

work was extreme and worked during the crisis, but of course it could not be sustained in the long term and through ordinary times. The G20 summit of London (1st April 2009) was focused on providing more than a trillion dollars of resources to International Financial Institutions in order to provide the necessary firepower to support any country in difficulty. It was also necessary to provide credit to re-start international commerce which had collapsed under the joint pressure of the credit crunch and a freeze of private consumption produced by fear. The leaders agreed to the principle of redistribution of influence in favour of emerging countries in the IMF, World Bank and FSB, and defined principles for financial re-regulation, deciding also on an increase in capital requirements in the banking system, while keeping the pressure and monitoring against protectionist moves. Actions against fiscal paradises was also decided, putting pressure on them by publishing black and grey lists, associated to possible future sanctions against persistent refusal to co-operate on international tax evasion. The sceptics viewed the London G20 summit as a simple photo opportunity, devoid of substance and unable to stop the recession from becoming a depression. This view proved to be wrong. The London Summit was a successful effort and did rebuild confidence, defeating the ghost of the failure of the 1933 London summit. World leaders patched up some high profile public differences about stimulus (Germany resisted it), regulation (France wanted more, the US and UK were less enthusiastic) and moves against non-cooperative jurisdiction on international tax evasion (France promoted it while China was concerned about its dependencies of Honk Kong and Macao). Although not perfect and despite some visible disagreements, the G20 worked in a cohesive way and made all the necessary compromises under the threat of disaster and the fear of financial collapse and economic depression. The huge amount of work done at the technical level and not visible to the outside world also meant that the process had more depth than most had realised. To deliver more than expected by observers was part of the strategy. To protect part of the negotiations from outside view was necessary to help governments compromise and achieve a deal, preventing the excessive rigidity typical of positions adopted publicly. The Europeans, however, realised in 2009 that they were losing influence, between the persistent US resilience to the crisis and the emerging powers. Obama seemed less interested in the G8 and in Europe than in the G20, the Middle East or emerging Asia. The third G20 summit took place in Pittsburgh in September 2009, when the first signs of economic improvement were clearly there and the

The Impact of Financial Crisis

17

collapse of the GDP had already stopped in most countries. The G20 focused on finding a new path for growth, more stable and without the imbalances which had shattered the previous cycle of globalization. It produced the “Pittsburgh framework for strong, sustainable and balanced growth”. It was the attempted response to the build-up of global imbalances from 2000 to 2007 (China, Germany, Japan and oil exporters had large current account surpluses, while USA, Spain, UK and Italy had large deficits). Obama declared immediately after being elected that the USA could no longer be the “consumer of last resort” to support world growth. The Pittsburgh agreement provided a framework to reduce global imbalances in consumption, trade balance and public finances. The IMF was asked to monitor and assist in a mutual assessment process, subordinated to national governments. It was not intended to be an IMF-led peer review, refused by emerging countries which still resented heavyhanded IMF austerity packages of the past. In fact the effects of the Pittsburgh framework have been quite limited, because in 2010 economic growth re-started spectacularly and regardless of the framework (5% as a worldwide average, with Europe trailing behind), fears of disaster receded and co-operation declined rapidly. While reports and recommendations for growth were produced at the international level, Europe focused too much on fiscal austerity in response to the Greek debt crisis, transformed in the spring of 2010 into a European debt crisis, hitting Ireland, Portugal and later on the whole of southern Europe. Spreading synchronized austerity policies have reduced growth prospects in Europe and worldwide. A certain degree of austerity was necessary and unavoidable in some countries affected by very high debt or deficit, but it has to be at least partially compensated by an expansion of demand in surplus countries with sound public finances. Such policies of localised stimulus are necessary to reduce their imbalances; otherwise the principles of Pittsburgh are ignored. Too much attention was focused on exchange rates (the hoped for re-evaluation of the renmimbi, fears of “currency wars”, private expectations of a Euro break-up). Despite the efforts for co-operation the world is back to the concerns raised by Keynes during the preparatory work for Bretton Woods: the burden of adjustment of current account imbalances cannot be left exclusively to deficit countries but must be shared by surplus countries as well, to prevent a fall in aggregate demand and a vicious cycle leading to recession. Under pressure from the US, the UK and emerging countries, the G20 proclaimed itself at Pittsburgh the “premier forum for international economic co-operation”. The question of a future G8 survival was left

18

Chapter One

open, but at the time the US appeared to prefer its abolition, or at least a drastic reduction in its scope. The IMF benefited from a new life through the G20, becoming its main instrument of action and reversing its worst decline in relevance since it was founded. In 2007, its outstanding loans had reached a minimum since the 1970’s (graph no.4) and it was trying to reinvent its role and mission, amid an internal funding crisis. Globalization and booming financial markets were providing governments with alternative sources of private funding, more attractive because of being devoid of traditional IMF conditionality. The IMF returned to the centre of the scene with the crisis in 2008-09, reducing conditionality in its programmes, redefining its policies, becoming one of the main advisers of the G20 and promising a larger role to emerging economies. It also received many more financial resources in 2009, so that it could help stabilise several countries in Eastern Europe, Latin America and Africa. That rebirth had limits nevertheless, because when called to negotiate a programme of readjustment with a government in need, the IMF still requires austerity (although often milder than what is demanded by the EU under German leadership). It is therefore still unpopular when it intervenes, the Strauss Kahn resignation has weakened it and the institution, like the FSB, still depends on the full co-operation of member states to be really effective.

4. G20 and G8 at the periphery of the European crisis in 2010-2012 In 2010-2012 the crisis morphed into a European debt crisis. The action moved from the G20 and G8 to the European council, Eurozone meetings and bilateral European meetings, with occasional warnings and interventions by the US. In facing the European crisis the G20 has proved unable to provide meaningful help, apart from some pressure on Italy during the Cannes summit in November 2011. An attempt failed to obtain financial support from the USA, the UK and emerging countries to reinforce the European Financial Stability Facility (EFSF), providing it with capital needed to be able to tackle the possible extension of support to larger Eurozone countries such as Spain or Italy. BRICs appeared to offer some support against contagion in the European debt crisis but then stepped back. They argued that they would channel their intervention only through the IMF, in exchange for a larger voice and representation in its decisions. China was asked bilaterally to buy bonds issued by the EFSF but declined. In the end, the June 2012 G20 summit committed to reinforce further IMF resources for possible support to Eurozone countries, with

The Impact of Financial Crisis

19

commitments of contributions for 456 billion dollars. However, none of the funds were coming from the US or Canada and only 75 billion came from BRICs, while it was Europeans themselves who put most of the financing on the table (259 billion dollars). The great ambition of the French G20 presidency in 2011 to achieve a new international monetary agreement failed, as did most previous attempts on this matter. Sarkozy discovered in 2011 what Gordon Brown had realised in 2009: a highly visible and successful chairmanship of the G20 does not help win a re-election in the domestic arena.

5. The future role of the G8 and the G20 After 2009 the G20 expanded its agenda from economic and financial issues to development, energy and other fields, while the G8 concentrated on political issues, security, development aid, energy and climate change. But, given that leaders cannot be prevented from addressing any issue when they decide to meet, in fact the G8 has kept some space for energy and monitoring of economic policies, especially after the enthusiasm for the G20 has started to decline. On a more political level it was not the G20 that seized the initiative during the Arab revolutions of 2011 but rather some G8 countries, especially in Libya, together with other European and Arab allies. Obama decided to hold back-to-back G8 and NATO summits in 2012, indicating that the two are coming closer together. On the other hand the financial arm of the G8, the G7 Finance Ministers’ process, which does not include Russia, managed to mount a successful coordinated operation to support the yen after the earthquake and tsunami which hit Japan in 2011, showing that it was still relevant and capable of action. The G8 discussed widely the European crisis in 2012, placing again economic issues at the centre of its agenda, despite G20’s claim of pre-eminence on the subject.

6. What’s left of the efforts of 2008-2009 and the reform process? It is always easy to watch from the outside the complex and confidential work and negotiations of international institutions such as the G8 and G20, and judge it in a negative manner on the basis of scarce information. In fact the very nature of its complex operations, divided into a very large stream of activities, which are very difficult to monitor from the outside, can lend itself to hyper-simplified assessments by external observers, missing some real progress.

20

Chapter One

A lot of work has been done indeed, but many of its results are disappointing (see graph 5). The Doha round of international trade liberalization has stalled and made no progress since the G20 took up the issue. The 2010 reform of voting rights at the IMF will produce a shift of 6% of quota shares in favour of the dynamic emerging markets and developing countries (Brazil, China, India, and Russia will move up among the top 10 shareholders of the IMF). It has not yet, however, been ratified by a sufficient number of member states to take effect, like the previous agreement of 2008. Financial regulation reform is proceeding, mainly through the FSB, but so far with limited and sometimes controversial effects on the financial system. Private financial firms lobby against more severe rules, as always after any new attempt to regulate, interlinking their claims with repeated acute phases of tension in European markets. As a consequence, policymakers hesitate and repeatedly reverse course of action. For example, capital requirements for the banking system were supposed to be raised rapidly to give banks the stability needed to prevent excessive risk taking and future bailouts at the expense of taxpayers. Then in 2010 the Basel Committee on Banking Regulation decided to implement the new rules only very progressively, until 2018, so as not to force banks to raise capital during periods of financial tensions and to prevent them from shrinking their loan portfolios to meet the new requirements. Instead at the end of 2011, the European Banking Authority (EBA) responded to the fears of a new debt fuelled financial crisis in Europe by anticipating higher capital requirements in 2012, contributing to further tensions on the banking system and prompting a new round of calls to slow down the process, leading in early 2013 to new decisions of the Basel Committee to ease and slow the process. Rating agencies, despite endless discussions on how to reduce conflicts of interest and de-stabilising decisions, still work as pro-cyclical amplifiers of instability through continuous downgrading of sovereign debt. The regulation of Over the Counter Derivatives is taking different directions in different countries. Compensation and bonus schemes in the financial sector still defy principles of prudence, reason and the need to reinforce capitalization through more retained profits6.

6

Eric Helleiner, “Unfinished Business: Priorities for the International Financial Regulatory Agenda,” 27 September 2011, CIGIOnline. http://www.cigionline.org/publications/2011/9/unfinished-business-prioritiesinternational-financial-regulatory-agenda.

The Impact of Financial Crisis

21

7. Conclusions A real and enduring change has taken place in global governance, but its effect has been weakened by a combination of inertia and political and financial counter-reactions. In 2009 the G20 succeeded on a number of points beyond what many acknowledged, thanks to the sense of absolute and symmetrical emergency. The G20 has not been fully successful on long-term structural changes and the hardest topics to solve are left on the agenda, undermined by a declining willingness to compromise (global imbalances, exchange rates, re-regulation). The G20 will remain, less effective, but still useful in a more “normal” way. In light of historical precedents it is not reasonable to expect transformational decisions to take place on a routine basis. The G8 has been weakened in a permanent manner, but will not disappear and is showing signs of persistent relevance as a caucus of more homogeneous, likeminded countries, while the BRICS do not yet show much strength and coherence as an alternative forum for decisions. After the “great moderation” of the early 2000’s, we are now in an “age of turbulence” characterized by a relative western decline, but so far without an alternative centre of power for international economic and financial co-operation.

Chapter One

22

Graph 1 Evolution of the share of World GDP (in %, PPP, 1820-2017) 35

EUROPEAN UNION

WESTERN EUROPE

30 25

CHINA

20 15

USA

USA

INDIA JAPAN

10

CHINA

5 0 1820

INDIA 1840

1860

1880

1900

1920

1940

1960

1980

2000

2020

Source: until 1973 data is from Angus Maddison, The World Economy, vol. 1: A Millennial Perspective, Vol. 2: Historical Statistics, Development Centre Studies, OECD, Paris, 2006, p.641. For data and forecasts from 1980 to 2016, see IMF, World Economic Outlook, October 2012. IMF data on the European Union includes all 27 current members for the whole period, even before their actual membership of the Union.

The Impact of Financial Crisis

23

Graph 2 Expanding G's: growing number of participants to summits reduces speaking time and effectiveness, fostering smaller informal groups 140 120

94

100

103

108

114

116 108

88

80 60 40 20

6

12

14 7

20 20 10

27

30

32

35

33

38

0 G6 (1975) G7 (1976) G8 (1997)

G20 G20 G20 G20 G20 G20 G20 (Ministerial, (Leaders, (Leaders, (Leaders, (Leaders, (Leaders, (Leaders 1999) Nov 2008) Apr 2009) Sept 2009) June 2010) Nov 2010) Nov 2011)

Governments and international organisations participating

People sitting in the summit meeting room

Source: authors’ estimates based on official G8 and G20 documentation.

Chapter One

24

Graph 3 The institutional process of global economic and financial governance reform in 2009 National governments Heads of State and Gvmts and Fin Min

Sherpas and Finance deputies WTO

G20 commissions

Advance Doha and monitor protectionism

IMF New funds, analysis, support framework for growth

G20

Implementation of decisions

National Governments and Eu

National Parliaments and Eu Parliament

Source: Author’s view

Other Int. Istit., UN, WB, OECD, ILO,

19 (+2) countries + EU + Int. Instit.

National regulators and Eu regulators

expert advice

Financial Stability Board Fin Min, Central Banks, Regulators, standard setting bodies

BCBS Basel Committee Banking regulation

IOSCO Securities Commissio ns

IASB

BIS

Accounti ng Standards

and other bodies

The Impact of Financial Crisis

25

Graph 4: The return of the IMF IMF lending 1974-2012, in Billion SDRs (credit outstanding) Argentinian, Turkish and Brazilian crises

100 Latin American debt crisis

80 60 40

Global crisis

Russian crisis Asian crisis Mexican crisis

Oil crisis

20 0 1974

1978 1982 1986

1990 1994 1998

Source: calculations on IMF official data at current prices.

Graph 5.

2002 2006 2010

26

Chapter One

Table 1: Crises with financial repercussions as incubators of new institutions US financial panic International 1929 financial crisis Great Depression 1930's and WWII 1974 Oil crisis 1997- Asian financial 98 crisis 1907

Global financial 2008crisis and Great 09 Recession 2010- European debt 12 crisis

Federal Reserve System (1913) Bank of International Settlements (1931) Bretton Woods Institutions (IMF and WB) 1944 G5 (1974), G6 (1975), G7 (1976) G20 ministerial process, Financial Stability Forum (FSF) G20 leaders process, Financial Stability Board (FSB). In the EU: European Banking Authority (EBA), European Systemic Risk Board (ESRB), etc. In the US “Financial Stability Oversight Council” and “Bureau of Consumer Financial Protection” European Financial Stability Facility (EFSF), European Stability Fund (ESF)

Sources: Luca Einaudi, Money and Politics, European Monetary Unification and the Gold Standard, 1856-73, Oxford, Oxford University Press, 2001, Harold James, International Monetary Co-operation Since Bretton Woods, Washington, IMF, 1996, John Williamson, The failure of world monetary reform, 1971-74, New York, New York University Press, 1977, Charles Kindleberger, A Financial History of Western Europe, Second edition, 1993, Oxford University Press.

The Impact of Financial Crisis

27

Table 2: Successes and failures in international monetary and financial co-operation since the gold standard

1867 1878 1881 1892 1922 1933

Attempted international cooperation International Monetary Conference of Paris to establish a global gold standard and international monetary unification International monetary conferences in Paris and Brussels to expand the monetary base, giving back a larger monetary role to silver (bimetallism) Genoa Conference to reconstruct monetary and trade relations after the war London World Economic Conference to stop the Great Depression

1944

Bretton Woods to reconstruct a cooperative economic system

1971

Smithsonian agreement to save a collapsing Bretton Woods

1972-74

Committee of the 20 at the IMF after Bretton Woods system collapsed

G5 (enlarged to G6 in 1975, to G7 in 1974-76 1976 and to G8 in 1997) leaders' summit process G5 Plaza agreement to drive down the 1985-87 dollar and G7 Louvre Agreement to stabilize it two years later “Committee to Save the World”, initially C22 and then C33, ultimately 1997-99 G20 financial ministers’ meetings (1999) 2008-9

G20 leaders summits

EU decision making process to 2010-12 manage the European debt crisis

Sources: see sources for table 1.

Outcome Succeeded in launching the gold standard but failed on monetary unification despite some initial success Failed to reach an agreement Partial agreement, without the USA, but not implemented Failed to reach an agreement Succeeded in agreeing a dollar standard and an international monetary system with new institutions Failed to re-evaluate currencies different from the dollar and to save fixed exchange rates Failed to create a new system of managed exchange rates Failed to address economic crisis Succeeded in driving down the dollar and stabilised it for some time Controversial results on the evolution of the Asian crisis, failed on regulation Succeeded in stopping the global crisis then re-regulation faltered Provided financial resources to peripheral countries in exchange for austerity and institutional reform – on-going.

Chapter One

28

Table 3: Key phases of co-operation in the G8 and G20 against the 2008-2009 crisis Date

Measures decided Level

Amounts Cause mobilized Co-ordinated Eu-G8 More than 1.6 Global October guarantees and trillion $ of debt financial panic 2008 beginning of rescue guarantee. 1,134 of the banking and trillion $ financial sector. committed on recapitalization Co-ordinated G20 5 trillion dollars Intensifying November macroeconomic of stimulus global 2008, recession Washington stimulus. Beginning of financial reregulation. Co-ordinated G20 1.1 trillion dollars Fear of April 2009, to IFI’s, trade depression London increase of financial resources for IMF, loans etc… after collapse MDB’s and for of Trade Finance international trade and output None Attempt to reSeptember G20 transformed G20 into the premier start global 2009, growth on a Pittsburgh forum for economic co-operation, sustainable framework for path growth, more reregulation Source: official communiqués of the G20, G8 and EU.

The Impact of Financial Crisis

29

Bibliography Brown, Gordon, Beyond the Crash, overcoming the first crisis of globalization, Simon & Schuster, Chatham, 2010. Bush, George W. Decision points, Crown Publishers, New York, 2010 Centre for International Governance Innovation, The G20 agenda: a process, analysis and insight by CIGI experts, Brem M., ed.), Waterloo, Ontario, March 2011 Eichengreen Barry and H. O’Rourke, Kevin ‘A tale of two depressions: what does the data tell us?,” February 2010 update,’ Voxeu.org. Einaudi, Luca, Money and Politics, European Monetary Unification and the Gold Standard, 1856-73, Oxford, Oxford University Press, 2001, Group of Twenty, Meeting of the Ministers and Central Bank Governors, March 13–14th 2009, London, U.K., Global Economic Policies and Prospects, Note by the Staff of the International Monetary Fund Guerrieri Paolo and Lombardi Domenico (eds), L’Architettura del mondo nuovo, Governance economica e sistema multipolare, Il Mulino-Arel, Bologna 2010. Helleiner, Eric, “Unfinished Business: Priorities for the International Financial Regulatory Agenda,” 27 September 2011, CIGIOnline. Helleiner Eric, Pagliari Stefano, Zimmermann H, (eds.), Global finance in crisis, the politics of global regulatory change, Routledge, London, 2010. James, Harold International Monetary Co-operation Since Bretton Woods, Washington, IMF, 1996 Kindleberger, Charles, A Financial History of Western Europe, second edition, 1993, Oxford University Press. Maddison, Angus, The World Economy, vol. 1: A Millennial Perspective, Vol. 2: Historical Statistics, Development Centre Studies, OECD, Paris, 2006 Official communiqués, declarations and official documents of the G20 and G8, both at the leaders and ministerial level, are available on the website of the University of Toronto- Munk School of Global Affairs G8 and G20 Information Centre. Williamson, John, The failure of world monetary reform, 1971-74, New York, New York University Press, 1977.

CHAPTER TWO RETHINKING GLOBAL FINANCIAL GOVERNANCE: SOME PRELIMINARY THOUGHTS DANIEL BRADLOW

Abstract This paper, which was prepared for the conference on “Legitimacy and Efficiency in Global Economic Governance” held in Lecce at the University of Salento on 6-7th May 2011, was a first attempt to develop a new approach to analysing global financial governance. Its starting point is that a new approach is needed because the current approach is being undermined by the shifting balance in geo-political power and the emphasis that the rising powers place on the principle of sovereignty. The paper proposes a set of five principles that can both guide the design of a long term vision of the arrangements for international economic governance and can assist in assessing any proposals for the reform of the current arrangements. The five principles are: a holistic vision of development, comprehensive coverage, respect for applicable international legal principles, co-ordinated specialization, and good administrative practices.

At the time of writing this paper, the author was SARCHI Professor of International Development Law and African Economic Relations at the University of Pretoria and Professor of Law at the American University Washington College of Law. His email is: [email protected]. This paper was prepared for the conference on “Legitimacy and Efficiency in Global Economic Governance” held in Lecce at the University of Salento on 6-7th May 2011and the author is very grateful for the useful comments he received on the paper from the other speakers and the participants in the conference.

Rethinking Global Financial Governance: Some Preliminary Thoughts

31

1. Introduction It has been clear for a long time that the current institutional arrangements for global economic governance are flawed. They suffer from a range of problems relating to their existing decision making structures, the scope of their mandates, and the performance of their responsibilities. For example, many states are concerned that they cannot directly participate in such key global economic decision making bodies as the G20, or the Financial Stability Board (FSB) and are inadequately represented in the deliberations of global institutions such as the International Monetary Fund (IMF) and the World Bank. Furthermore, many state and non-state stakeholders in the global economic system contend that the mandates of these key international financial bodies are overly broad and that they often stray into the areas of responsibility of other international organisations, such as the other specialized agencies of the United Nations. This undermines the efficacy of these latter institutions and distorts the functioning of the overall global governance system. In addition, there is concern that the most prominent international financial governance entities—the G20, the IMF, the FSB, the international standard setting bodies such as the Basel Committee of Banking Supervisors (BCBS), the International Organisations of Securities Commissions (IOSCO), and the International Association of Insurance Supervisors (IAIS) – make decisions that have profound impacts on people’s lives without adequate transparency or accountability to or participation by affected parties. The experience of the last few years, by demonstrating the limited capacity for global policy co-ordination and co-operation, has highlighted the gravity of this problem. The global community was able to jointly manage the most acute phase of the financial crisis in 2007-09 - at least to the extent of avoiding it becoming another great depression. However, it has been unable to either agree on how to redesign the global financial system so that it responsibly and sustainably serves the interests of its various stakeholders or to effectively address the many other problems besetting the global economic system. As a result, the global economy continues to suffer the consequences of its flawed global financial governance arrangements. These include the continuing fallout from the 2007-09 financial crises and the fragile state of the global financial system; the failure to bring closure to the Doha Round of trade negotiations; the failure to reach a coherent and sustainable international agreement on climate change; and the failure to effectively address the challenge of growing inequality both within and between countries.

32

Chapter Two

Another manifestation of the malfunctioning arrangements for global financial governance is that the entities involved in international financial regulation tend to pay more attention to the issues that are of direct interest and relevance to the richest countries, such as regulation of compensation for banking executives and new capital adequacy rules, than to the challenges of developing countries, such as financial inclusion, and the financing of small and medium sized enterprises. The most powerful states in the international financial system, essentially the G7, have acknowledged that there are serious problems in the arrangements for global financial governance and have, albeit inadequately, attempted to address them. They invited the rising emerging markets to participate in global financial governance by creating the G20 and later by raising its status to a ‘summit’ of heads of government and of state, and expanding membership in the FSB. They have also agreed, although not yet fully implemented, changes in the governance and voting arrangements of the IMF and the World Bank. In addition, they have agreed to some operational changes in the IMF to enhance its ability to oversee the global monetary and financial system. For example, the IMF has been authorized to increase its utilization of precautionary financing mechanisms and to incorporate the external implications of the macroeconomic policies of its key member states into its surveillance operations so that it can respond more effectively to the challenges that the global community is facing. However, the sincerity of the G7’s willingness to reform the governance arrangements of the international financial system is open to question. Despite their earlier claims to the contrary, they continue to insist that the Managing Director of the IMF should be a European. When both the Europeans and the Japanese realised that they needed support from the international community to deal with their current monetary and financial situations, they turned to the G7 and not the G20. Unfortunately, the G7 has proven unable to help the Europeans resolve their problems and they may still have to call on the assistance of their new G20 partners. Unfortunately, the reformist shortcomings of the G7 have been matched by the emerging G20 powers. There is little evidence of the emerging G20 states effectively co-ordinating negotiating positions or their priorities for G20 meetings. As a result, they have failed either to assume a leadership role in the G20 or to ensure that the G7 abide by their earlier commitments to reform. This year (2011) the emerging powers were unable even to agree on a candidate for the post of Managing Director for the IMF, thereby facilitating the Europeans assertion of their privilege of having the Managing Director be a European. They have also

Rethinking Global Financial Governance: Some Preliminary Thoughts

33

not succeeded in getting the G20 to agree to significant reform of existing international monetary arrangements or even to substantial reforms in the World Bank and the IMF. The above indicates that the balance of power in the global economy is shifting but that it has not yet resulted in a substantial transfer of effective decision-making power from the G7 to a broader group of states. This suggests that an effective and sustainable global governance regime is unlikely to emerge before the current process of redistributing global power has been completed. This inter-regnum is an opportune time to begin thinking about the principles that should undergird any future global economic governance regime and that will enable us to identify ways to effectively exploit whatever opportunities to improve global economic governance should arise during this redistributive process. This article is a preliminary effort to address these issues. It consists of three parts. The first part explains in more detail the problems in global economic governance. The second section spells out a set of principles that can be used to evaluate both the establishment of new arrangements for global economic governance and evaluate the response to any opportunity to reform the existing arrangements. The third section describes some short-term opportunities that exist for improving international financial governance and that can help move the international community towards a more sustainable and effective global governance regime. It focuses specifically on how these tactical considerations apply to a middle income power like South Africa.

2. Reasons for the Problems and Why they cannot be Solved There are at least two sets of reasons underlying the failure to sustainably resolve the current challenges in global financial governance. These are the current shifting balance of geo-political forces and the increased significance of sovereignty as a factor in international financial governance. Each of these is discussed in more detail below.

Shifting Balance in Geo-Political Power The recent financial crisis demonstrated that the G7 countries are no longer able to function as the pre-eminent forum for global economic governance. They have been forced to recognise that they need to cooperate with countries that are viewed as the emerging economic powers to effectively manage the global economic and financial system. In order

34

Chapter Two

to meet this demand they elevated the G20, which had previously been only a gathering of finance ministers and central bankers, to the level of a meeting of heads of state and government. The creation of the G20 summit process has resulted in pressure to expand the agenda of the G20 beyond its prior relatively narrow focus on financial and monetary affairs. Thus, since the first G20 summit in Washington in 2008, the agenda of the G20 has broadened to include a development agenda, food security, and climate financing. It has initiated a parallel process of meetings of business leaders from the G20 countries and, in time, may also include a parallel civil society process. This expansion in its range of interests and activities, particularly given that the G20 has no mandate to act on behalf of the international community and is a self-appointed body, raises concerns about both its legitimacy and its efficacy. This is a particularly relevant concern, given that the G20 lacks stable membership, a permanent secretariat and a formal legal existence. The relatively fluid and informal nature of the G20 is a reflection of the fact that the current shifts in global geo-political power away from the G7 towards a broader group of countries is not yet complete. In fact, as indicated above, the shift in power away from the G7 countries should not be over-stated. While these countries have accepted that they cannot manage the global financial and economic system on their own and have agreed to the G20’s pre-eminence in economic matters, they have not surrendered their control over the global economic agenda. This continues to be dominated by the regulatory and governance issues of most interest to them. The shifting balance of power merely means that the rising powers in the G20 can participate in the discussions on these agenda items and can influence their prioritization. They do not appear able, however, to persuade the G20 to take decisions that the G7 oppose. Thus, this shift in the balance of relative power has only advanced far enough to deprive the G7 of their previous dominance. The rising powers however have not yet gained sufficient power to have the ability to take over leadership of the governance arrangements for the global economic system. The result is an unstable situation in which the institutional arrangements for global governance are likely to remain provisional until the process of rebalancing global power has played itself out and the relative positions of the new and old powers are clarified. Until this point is reached, it is important to recognise that the outcome of this process is uncertain and could result in a range of possibilities, ranging from a reassertion of power by the old powers, the G7, to an assumption of leadership by one or more of the group of new powers.

Rethinking Global Financial Governance: Some Preliminary Thoughts

35

There are two important consequences that seem to flow from the current unstable global governance situation. First, we can only be confident that the G20, as currently constituted, will remain the primary manager of global economic governance in the short-to-medium term. It is already possible to see pressure to change its composition, as evidenced by the facts that additional invitees, such as Spain, Singapore (as the representative of the 3G group of countries), Malawi and now Equatorial Guinea (as the chair of the African Union), Ethiopia (as the head of NEPAD); and Vietnam (when it chaired ASEAN) have been included on an ad hoc basis in the G20 summits, together with the heads of key international organisations. Second, the institutional relationships between the G20 and global institutions like the International Monetary Fund and the World Bank Group, and the role that sub-global groupings of states, whether based on regional or other criteria, should play in global governance cannot be effectively resolved until the over-arching global power relations are clarified. This means that any efforts to produce sustainable institutional arrangements for global economic governance are unlikely to succeed. At best, they will result in arrangements that are capable of reaching only partial solutions to global financial governance challenges. Nevertheless this unstable environment will also create opportunities for reforming the current order and helping to shape a future global order into one that is more open to effective participation by all stakeholders.

Sovereignty There is a growing emphasis on sovereignty in international affairs. For many years the trend in international affairs was to de-emphasize sovereignty and to focus on the growing importance of international organisations and international mechanisms for dealing with international and domestic affairs. This can be seen in such developments over the past few decades as the assertive role that the IMF and the World Bank played in the affairs of its member countries, and in the growing attention paid at the international level to the internal human rights situation in many countries around the world. This trend is now being reversed and the pendulum is swinging back in the direction of re-emphasizing the importance of sovereignty. This change is being driven primarily by the rising countries, such as China, India and Brazil but it is also being supported, at least in some contexts, by other states as well. The elevation of the G20 to the summit level can be seen as one indication of this phenomenon. For example, it has resulted in

36

Chapter Two

these 20 sovereigns reasserting their control, through the FSB, over such trans-governmental networks as the BCBS, IOSCO and the IAIS. Another manifestation of this trend is that the role and authority of international organisations, like the IMF and World Bank, in regard to their member states, is being reconsidered. For at least the past 30 years, the trend has been towards increased power of international financial institutions over their member states, or at least those ones that utilize their services. It is clear that there is a backlash developing amongst these states and they are demanding that organisations like the IMF and the World Bank show more respect for their sovereignty. This can be seen in the IMF’s efforts to streamline and narrow the focus of its conditionality policies and in the World Bank’s strategy of de-emphasizing its own safeguard policies in favour of ‘country systems’. The ultimate result of this current process of power rebalancing is that the range of issues on which meaningful and sustainable governance reforms can be agreed and implemented is likely to be narrow and limited to tinkering with the existing arrangements. This can be seen, for example, in the limited agreements reached on reforming the governance of the IMF and the World Bank, despite the general agreement on the need for changes in their decision making procedures and their mandates. The changes that have been agreed and, in some cases actually implemented, have not substantially altered the real power arrangements in these institutions. For example, the recently announced change in World Bank voting, once implemented, will merely increase the vote for developing and transitional countries from about 44% of the total vote to 47% of the total and it will not affect either the US veto or the ability of the EU member states to block decisions that they strongly oppose. Similarly, the promised change in the procedures for selecting the leader of the World Bank and the IMF is unlikely to significantly change the functioning of these organisations. As the example of the United Nations shows, those states with vetoes are able to dominate an institution even if its head is not one of their nationals. The current international efforts to reform global financial regulation are similarly constrained. The items at the top of the global regulatory reform agenda-capital adequacy, liquidity, hedge funds, derivatives, executive bonuses, bank taxes to recoup the costs of earlier bank bailouts—are all items of most interest to G7 countries. There appears to be limited space on the international agenda for such issues as financial inclusion that is expanding access to the financial system, an important issue for African countries and others in the developing world, encouraging reinvestment of capital flight back into the developing

Rethinking Global Financial Governance: Some Preliminary Thoughts

37

countries, or using regulatory incentives to encourage greater attention to development issues. The fact that currently there are limited opportunities for substantially reforming global financial governance, suggests that this might be a useful time to begin rethinking the arrangements for global financial governance. Such an exercise should entail formulating a set of principles that can guide the design of an ‘ideal’ set of arrangements for global financial governance. These principles can also help in the assessment of how to most effectively exploit any good opportunity for promoting governance reform that might arise in the future. The content of these principles is the topic of the next section.

3. A Set of Guiding Principles for Global Financial Governance The purpose of this section is to set out the principles that will need to underpin any sustainable and effective arrangement for global financial governance. The following five principles are not intended to define a future set of global governance arrangements; instead, their purpose is to provide a framework to guide the development and operation of such arrangements. The five principles are: 1) A Holistic Vision of Development: All states are developing states in the sense that they are striving to create better lives for their citizens. While states may differ in defining their responsibilities in this regard and on which aspects of the development process they wish to prioritize, they all agree that the well-being of both individuals and societies can be positively or negatively affected by a range of economic and non-economic factors. Thus, they all see development as a comprehensive and holistic process in which the economic aspects cannot be separated from the social, political, environmental, and cultural aspects, all of which are integrated into one dynamically integrated process. The extent to which the global governance arrangements incorporate this holistic vision of development will influence how effectively they help all states achieve their developmental objectives. 2) Comprehensive coverage means that the mechanisms and institutions of international economic governance should be applicable to all stakeholders in the international economy and to all aspects of the issues that affect the global financial system.

38

Chapter Two

For example, the mechanisms of international financial governance must incorporate the activities and operations of financial intermediaries that engage in sophisticated national and cross-border financial transactions and their clients, savers and investors, who wish to base their financial transactions on religious principles, as well as small financial institutions that operate only in local markets, and micro-financial institutions. There are three important corollaries that follow from the principle of comprehensive coverage: ƒ First, the mechanisms of international economic governance must be sufficiently flexible and dynamic that they can adapt to the changing needs and activities of their diverse stakeholders and to the key aspects of each substantive issue that they must address. ƒ Second, the totality of international economic governance arrangements must ensure that the international community receives all the services it requires from a well-functioning global economic system. ƒ The third corollary, which is intended to ensure that the governance arrangements are flexible, efficient and not unduly centralized, is the principle of subsidiarity1. This principle holds that all decisions should be taken at the lowest level in the system compatible with effective decision making. It is a complicated principle to implement because it must apply both in standard operating conditions and in crisis situations, which may require that decisions are made at a different level than is the case during standard conditions. In addition, it needs to be linked to a conflict resolution mechanism that is capable of resolving disputes between regulators at different levels as to which level is the most appropriate for resolving a particular issue.

1

Specifically, it is the principle whereby the Union does not take action (except in the areas which fall within its exclusive competence) unless it is more effective than action taken at a national, regional or local level. It is closely bound up with the principles of proportionality and necessity, which require that any action by the Union should not go beyond what is necessary to achieve the objectives of the Treaty.” Subsidiarity, http://europa.eu/scadplus/glossary/subsidiarity_en.htm (Retrieved on July 7, 2009).

Rethinking Global Financial Governance: Some Preliminary Thoughts

39

3) Respect for applicable international law: The institution arrangements for international economic governance, either because they are formal international organisations created by treaty or involve decision making by sovereign states, should comply with applicable international legal principles. In particular, this means that the decision-making bodies and institutions engaged in international economic governance should conform to universally applicable customary and treaty based international legal principles. There are four sets of principles that are applicable in this regard: ƒ The first is the principle of respect for national sovereignty. It is clear that by participating in a global governance arrangement, states are agreeing to forego some level of sovereignty in order to reap the benefits of a well-functioning international system. Given the different power and wealth characteristics of the participating states, it follows that, de facto, the amount of independence they give up will be positively related to their power and wealth. However, the principle of national sovereignty should still provide them with the means for preserving as much independence and policy space as is practicable and consistent with the demands of effective global financial governance. ƒ The second is the general principle of non- discrimination. This means that the institutions of international economic governance should treat all similarly situated states and individuals in the same way. This inevitably means that there will be disparate treatment for differently situated states and individuals. The key question thus becomes what standards can be used to ensure that all stakeholders receive treatment that is fair and reasonable. In the case of sovereign states, this means that, while the institutions of global governance should base their treatment of all states on the same principles, they should apply these principles in a way that is responsive to the different situations of each member state. One way of implementing this approach could be to apply the general principle of special and differential treatment that is applicable in a number of international legal contexts-for example international environmental and international trade law-- to international financial

40

Chapter Two

governance. This could result in special consideration being given to weak and poor states so that they are able to enjoy a meaningful level of participation in international financial decision making structures, even when they are based on principles like weighted voting. A consequence to this may be that the organisation offers some mechanism of accountability to these states and their citizens to compensate for any participation deficit. In the case of non-state stakeholders in global economic governance, the relevant principles should be derived from documents like the Universal Declaration of Human Rights, which many now consider to be part of customary international law. Thus, one indicator of good economic governance could be the level of respect that the institutions of international financial governance show for human rights in their member countries. ƒ The third set of international legal principles applicable to international economic governance deals with the responsibility of states for the functioning of the global economic system. Based on general principles of state responsibility, they have an obligation to provide foreign legal persons, which are present in the state, either through an investment or an individual transaction, with fair and non-discriminatory treatment. This means that these foreign entities should receive comparable treatment to similarly situated domestic institutions. ƒ A fourth set of applicable international legal principles are derived from international environmental law. At a minimum these principles would impose on regulators an obligation to insist that all financial institutions and other economic actors fully understand the environmental and social impacts of their practices and of individual transactions. 4) Co-ordinated specialization: The principle of co-ordinated specialization acknowledges that, even though development is holistic and all aspects of international governance are interconnected, international economic governance cannot function efficiently without a limited and specialized mandate. Thus, the principle of co-ordinated specialization has two requirements.

Rethinking Global Financial Governance: Some Preliminary Thoughts

41

ƒ

First, the mandate of the mechanisms and institutions of international economic governance must be clearly defined and limited to international economic affairs. ƒ Second, these institutions cannot ignore the other important aspects of the development process. Consequently, there is a need to ensure some form of coordination between the institutions and mechanisms of international economic governance and other organisations and arrangements for global governance. The co-ordinating mechanism, if it is to effectively resolve tensions between the different aspects of international governance, needs to be transparent and predictable. It may also need some dispute settlement mechanism. 5) Good Administrative Practice: The basic principles of good administrative practice in global governance are the same as those applicable to any public institution. These principles are transparency, predictability, participation, reasoned decisionmaking, and accountability. This means that all the institutions involved in international economic governance must conduct their operations in a manner that is sufficiently open that their procedures, decisions, and actions are predictable and understandable to all stakeholders. They must also offer these stakeholders some meaningful way of raising their concerns and having them addressed by the institutions. The institutions should also be required to explain their decisions and operations to all interested stakeholders. Finally, the stakeholders should be able to hold the institutions accountable for their decisions and actions.

4. Short-Term Tactical Issues It is clear that there is neither general consensus on how to design or construct global governance arrangements based on these principles. This lack of agreement is not a serious problem because, in the current phase of the transitions in global power, it is not possible to construct such governance arrangements. This suggests the most effective short-term approach to global financial governance reform is a pragmatic and opportunistic one. This requires concentrating on developing short-term tactics that both result in real current benefits for states and their citizens

42

Chapter Two

and that open up further opportunities for achieving global financial governance reforms that are consistent with these principles. This short-term tactical approach is best understood in the context of the situation of a particular actor in the global financial system, such as South Africa. Implementing this strategy, for a middle sized country like South Africa, requires both setting priorities for the short term and developing a plan of action for achieving these objectives. For example, given that South Africa’s and Africa’s concerns in the global financial arena are focused on questions of poverty and inequality, the sorts of issues that South Africa should prioritize in the G20 are those that can enhance the ability of Africa to address these issues. Given this general orientation, there are two issues in the financial area that offer suitable short-term objectives. The first relates to financial regulation. South Africa can call for broadening the scope of the banking regulatory reform agenda. In particular, she can point out that for many African countries a key issue is the fact that many of their citizens and small companies do not have effective access to financial services. They can add that regulation can help address this issue by encouraging banks to develop new products that are specifically targeted at this problem. In this regard, it can also remind the rich countries of Paul Volcker’s contention that the most important financial innovation of recent years is the ATM because of its impact on enhancing convenience and access to financial services. South Africa could also remind the world that the next innovation of this sort might be cell phone banking, in which Africa is a leader. Another regulatory issue that should be addressed is the problem of how to get international banks to recycle at least a small proportion of the capital flight that they attract from African and other developing countries back into these countries. A third regulatory issue is incentivizing the banks to extend some of their more impressive social responsibility initiatives to other aspects of their business. A good example of such an initiative is the Equator Principles, which deal with the management of the social and environmental risks in large project financings. The second issue that South Africa and other middle powers can prioritize is reform of the governance arrangements of the IMF. It is becoming increasingly clear that, regardless of the rhetoric about the need for substantial reform of the IMF’s governance, substantial reform is unlikely to take place in the short term. Consequently, the most realistic reforms are those that are possible within the existing legal framework. One reform that can easily be achieved within this constraint is increasing the IMF’s public accountability. Unlike the World Bank and all the other multilateral development banks, it does not have an independent

Rethinking Global Financial Governance: Some Preliminary Thoughts

43

accountability mechanism. These mechanisms allow non-state actors, who claim that they have been harmed by the failure of these organisations to comply with their own policies and procedures, to have their claims investigated and reported to the Boards of these organisations. Their benefit to the organisation is that they increase the efficacy of the operations of these entities by both enhancing compliance with their policies and procedures and by enabling the institution to gain more detailed empirical knowledge about the actual impact of their operations. This improves their ability to learn from their operations and to improve them. Another action that would improve global financial governance and is relatively easy to implement is increased effective participation by developing countries in the FSB and in the appropriate decision making bodies of the international standard setting authorities like the BCBS, IOSCO and the IAIS. This increased participation should result in these bodies developing principles and policies that are more sensitive to the needs of these countries and to impact of financial regulation on poverty and inequality. Finally, South Africa should combine this short term substantive vision with a plan of action that seeks allies from both other middle powers, like Australia, Brazil, Indonesia and Korea, as well as other G20 members including, if appropriate, the G7 countries.

5. Conclusion In this paper, I have argued that, given the existing configuration of geo-political forces and the process of change they are undergoing, there are currently only limited opportunities to influence the institutional arrangements for global economic governance. However, in order to identify these opportunities and the best ways to exploit them, it is necessary to have a set of principles that can both guide the design of a long term vision of the arrangements for international economic governance and can assist in assessing any proposals for the reform of the current arrangements. This paper proposes a set of such principles.

CHAPTER THREE INFORMATION ASYMMETRY VS. COMMUNICATION ISONOMY: SOME NOTES ON THE TRANSPARENCY REGULATION OF FINANCIAL MARKETS ROBERTA MARRA

Abstract Transparency is a, if not, the keyword in the context of financial market regulation. On its basis, international, EU and national legislators have built the assumption that investors need to be protected and that investment firms have the duty to inform investors, in order to bridge the information asymmetry existing between these two parties. In this paper, I suggest that legislators regulating transparency make use of metaphors, since normative language is, more generally, metaphoric. In other terms, the words they choose are never accidental or neutral, but significant signs, recalling evocative images. Even information asymmetry, the very premise of transparency regulation, is a metaphor in and of itself: the term asymmetry evokes the image of two points – the parties - which are not equidistant from a given centre, but one in front of the other, or one opposite the other from a geometrical perspective. Their position, or rectius, the distance between each of them and this ‘centre’ can, according to this premise, be measured and, by measuring such a distance, it is possible to state whether a party is weak or strong. Their ‘distance’ is measured through the parameter of information; the more a party is informed, the closer it is to the centre. Moreover, information is

PhD student in Law and Economics at the Scuola Superiore ISUFI – University of Salento and Lecturer in Public Law at the Faculty of Law - University of Salento (Lecce, Italy).

Information Asymmetry vs. Communication Isonomy

45

neither accessible, nor free of charge: getting close to the centre is not ‘naturally’ possible. A recovery of symmetry can only happen through the influence of exogenous factors. Revealing the metaphorical value of words may be a favourable path to relativize the tacit assumptions on which positive rules laid down by legislature are grounded. By trying to challenge such assumptions in the context of financial transactions, it would be possible to connect questions of fairness to those regarding communication, rather than information, and this would suppose that the balance towards which the contractual relationship strives is not a symmetrical order, but rather an isonomic one. In this sense, the issue of transparency in financial markets could, therefore, be summarized according to the geometrical parameters of a straight line joining two points to a centre at equal or unequal distances. Instead, as I would suggest, transparency could rely on the complexity of fractals: it is neither reducible to the regularity of one-dimensional forms, nor can it be ascribed to the simplicity of linear geometry. In this perspective, the metaphor of communication reveals the unpredictability of physiological and irregular fractals: the data stream provided does not exhaust the issue of communication, nor warrant the accuracy or certainty of results. Meanwhile, an isonomic, rather than a symmetric order, at which communication –as opposed to information - would aim, may result from the spontaneous convergence of the investor’s need to know and the issuer’s fairness, in terms of compatibility rather than correctness.

1. Information, asymmetry and the omnipotence of legislators With reference to ‘mandatory disclosure’, legal data offer various chances to investigate the impact of the notion of ‘transparency’; I could say that legislators justify the need for transparency through the idea that the investor must be paternalistically protected, on the basis of the assumption that his information deficit is a negative externality in his rational pursuit of wealth maximization goals. In legislative terms, transparency has a clear meaning: in the case of an asymmetrical relationship, the rule of law justifies the prescription of detailed rules of conduct in order to fill the gap and assure an ‘equality of arms’ between the parties involved. A full description of the recesses of internal and international regulations on transparency is beyond the scope of this paper and the few remarks I propose here in this regard take the legislative framework used for granted; I merely highlight some key-words or recurring trends, in

46

Chapter Three

order to suggest a relativizing perspective for this survey. The European legislative framework of security regulations has been mainly influenced by the EU Markets in Financial Instruments Directive (Mifid), n. 2004/39, as subsequently amended by the directive n. 2008/10, both of which were further transposed and implemented into national legal regulations and are today the subject of a reform proposal1. Specific rules of conduct applied to investment firms operating in market contexts in order to ensure transparent transactions have a double aim: on one side, legislators call for the protection of investors; on the other, the efficiency of markets is wilfully promoted2. It is likely that by emphasizing the liberal idea that, on certain conditions, individual and collective interests coincide, legislators assume that the investor’s confidence is directly proportional to the degree of information available to him or her and that such a transparent regime promotes individual interests; at the same time, the pursuit of individual interests coincides with the “general” interest, or Pareto efficiency, of the market3. 1

Recently, the European Commission published its proposal for a Directive of the European Parliament and of the Council on markets in financial instruments repealing Directive 2004/39/EC (Brussels, October 20th2011): see http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=CONSLEG:2004L0039:20070921: EN:PDF 2 See the preamble (§ 44) of the Mifid Directive, which states: «(…) These rules are needed to ensure the effective integration of Member State equity markets, to promote the efficiency of the overall price formation process for equity instruments, and to assist the effective operation of ‘best execution’ obligations». 3 The preamble of the EC Directive 2004/109 on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market opens by stating: «The disclosure of accurate, comprehensive and timely information about security issuers builds sustained investor confidence and allows an informed assessment of their business performance and assets. This enhances both investor protection and market efficiency». The national rules of implementation also follow such a premise: see, e.g., the Italian Decreto Legislativo n.58/1998, as amended after the achievement of the communitarian directives, which states that «Consob shall exercise the powers provided … having regard to the protection of investors as well as to the efficiency and transparency of markets for corporate control and capital markets» (author’s translation). The myth of transparency is far from limited to the European legal framework; Islamic financial regulations recall some categories which could seem similar, even if the relation between investor protection and market efficiency seems to be less clear; according to the «Disclosures to promote transparency and market discipline for institutions offering Islamic financial services» provided by the IFSB (Islamic Financial Services Board), transparency is the core principle of the discipline. Nevertheless, efficiency is not a priority:

Information Asymmetry vs. Communication Isonomy

47

In this sense, Article 19 of the Mifid Directive is crucial: it states that member States shall require that, when providing investment services and/or, where appropriate, ancillary services to clients, an investment firm act honestly, fairly and professionally in accordance with the best interests of its clients;

all information must be fair, clear and not misleading

Marketing strategies shall be ‘unequivocal’ and ‘appropriate’ information shall be provided in a ‘comprehensible’ form to clients or potential clients, so that they are reasonably able to understand the risks of

disclosure is a virtue per se as it is compatible with the Shari`ah: “Any form of concealment, fraud or attempt at misrepresentation violates the principles of justice and fairness in Shari`ah as mentioned in the Qur’an in, among others, Surah An- Nisa’ verse 135 and Surah Al-Mutaffifin verses 1 to 3”. Transparency regulations are justified on the basis of the alterum non ledere principle and this is also the underlying reason for its compatibility with Islamic Law. Similarly, the declared aim of US regulations, whose milestone is the Securities Exchange Act, is unspecified “public interest” or “the protection of investors” (cf. SEC. 3 (11, 12A, (vii), 27, 35, 42(B), 51(C), SEC. 5, SEC. 6, 5); in section 6, in particular, US legislation states that: «The rules of the exchange are designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest». With particular regard to English regulations, it is significant that the Financial Services and Markets Act 2000, which created the Financial Services Authority as a regulator for insurance, investment business and banking, specifies its regulatory objectives as follows: « (a) market confidence; (b) public awareness; (c) the protection of consumers; and (d) the reduction of financial crime». It may not be dicey to point out the order in which the legislature has listed the objectives of financial market regulation: at the top there are “confidence” and “awareness”, whose association with “market” and “public” does not allow us to immediately perceive their connection with individual or collective interests. I would venture to find here some traces of the cultural – rather than legal – roots of a common law system: these may suggest the value of looking at positive law through the lens of the liberal ideals - in the classical rather than modern sense - of confidence and awareness, as involuntary and intrinsic links connecting self interest with public interest.

48

Chapter Three

the financial instruments on offer and to take investment decisions on an informed basis4. In its latest reform proposal, the European Commission focused on a significant restyling of the Mifid, in order to increase and reinforce market transparency and the power of regulators in key areas, to raise investor protection and improve coordination at the European level. The proposal was probably influenced by the trend to getting back to regulation, as a consequence, somehow, of the current financial crisis: the reform confirms the ratio of the Mifid directive and even exasperates warnings of transparency aimed at enhancing investor protection, as a condition for ensuring a level playing field between market participants5.

In both old and new legal texts, the lexical choices of legislators with respect to mandatory disclosure reveal the usual insufficiency of words and how hazardous it is to reduce the ‘confidence’ and ‘awareness’ of investors simply to the compliance of investment firms with some positive 4

Similarly, and for further examples, see Art. 21 of the Italian Testo Unico della Finanza, d. lgs.58/1998; Section 5, (Articles L. 533-11, 12, 13) of the French Ordonnance n. 2007-544; Art.32bis of the Spanish Ley del Mercado de Valores n.24/1988, as amended by the Ley n. 2007/47. 5 As we can read in the Proposal for a Directive of the European Parliament and of the Council on markets in financial instruments repealing Directive 2004/39/EC of the European Parliament and of the Council (Brussels, 20.10.2011), «(…) A Regulation sets out requirements in relation to the disclosure of trade transparency data to the public and transaction data to competent authorities, removing barriers to non-discriminatory access to clearing facilities, the mandatory trading of derivatives on organised venues, specific supervisory actions regarding financial instruments and positions in derivatives and the provision of services by third-country firms without a branch». The central aim of the proposal seems to be the need for regulation. The EC clarifies that the purpose of the expected reform is «(…) To ensure that all organised trading is conducted on regulated trading venues: regulated markets, multilateral trading facilities (MTFs) and organised trading facilities (OTFs). Identical pre and post trade transparency requirements will apply to all of these venues. Likewise, the requirements in terms of organisational aspects and market surveillance applicable to all three venues are nearly identical. This will ensure a level playing field where there are functionally similar activities bringing together third-party trading interests». As amended according to this proposal, investor protection is strengthened and more expressly stated: the framework it introduces is meant to ensure that investors are properly ‘informed’ and that some practices are not detrimental for them, in relation to the services provided and to the execution of their orders.

Information Asymmetry vs. Communication Isonomy

49

rules of conduct. In some way, this irreducibility may explain the need for the use of such terms as ‘fair’, ‘honest’ and ‘appropriate’; from a qualitative perspective their meaning, however, seems to be far from clear. The entire framework of regulations holds on the basis of faith in legislature and, more precisely, on the basis of faith in the normative use of language6; that is, the idea that legislators can actually calculate the proportionality of the means needed to achieve certain ends, without any qualitative consideration of those ends; in other terms, the internal logical coherence of this legal order stands on the uncritically taken on idea that, when legislators require information to be clear, or an issuer’s conduct to be fair, such a prescription is sufficient, and it is, moreover, unambiguously accepted that these words correspond to something that can be precisely identified7. We may object that the drafting technique on financial market regulation has become increasingly detailed and that legislative prescriptions are neither vague nor general. In this case, I am referring to the legislative process distinguishing8 different categories of investors 6

Among others, A. Giuliani, La «nuova retorica» e la logica del linguaggio normativo, in Rivista Internazionale di Filosofia del diritto, XLVII, IV, 3-4, 1970, pp. 374-390. 7 R. Barthes, Il brusio della lingua. Saggi critici IV, (It.transl.), Torino, 1988 (1984). With regards to the emotional and physiologically metaphoric origin of language, J.J Rousseau, Essai sur l’origine des langues, published posthumously by Du Peyrou in Oeuvres posthumes de J. J. Rousseau, tome III, pp. 211-327, Geneva, 1781. 8 See § 19 of the preamble of the Mifid Directive, which states that «One of the objectives of this Directive is to protect investors. Measures to protect investors should be adapted to the particularities of each category of investors (retail, professional and counterparties)». The proposal for the Mifid reform confirms and deepens such a classificatory trend, by strengthening it, wherever possible. The transparency requirements are calibrated for different types of instruments (notably equity, bonds, and derivatives, and for different types of trading, notably order books and quote driven systems); however, the EC underlined how extensive examples concerning transactions in complex instruments by local authorities and municipalities have demonstrated that their classification is inadequately reflected in the legislative framework and how «(…) The overarching high level principle to act honestly, fairly and professionally and the obligation to be fair, clear and not misleading should apply irrespective of client categorization». As regards Italian legislation, for instance, before the Mifid directive, the duty to disclose information was established by a general and flexible rule, imposing an unspecified duty on investment firms «to acquire necessary information, and to act so that they are always adequately informed» (author’s translation). Such a general regulation, confirmed by the Consob rules, at the cost of less certainty and predictability of

50

Chapter Three

retail, professional and qualified clients - and to the choice of calibrating the degree of mandatory disclosure on the basis of the presumed experience and familiarity of investors with such financial instruments, in order to measure their understanding of the risks involved. I am also referring to the joint efforts of clients to gain information: as such, the information flow between parties could not be seen as one-way, since those receiving information would be involved in the process of ascertaining what is true in the transaction, en route towards transparency9.The level of investor protection –to object further - has been customized depending on the services on offer. In most cases, in fact, the investment firm is asked to verify the appropriateness of the information to be given, exclusively on the basis of the data that the customer has provided about his experience and knowledge of the relevant investment sector. If the issuer has offered investment advice and portfolio management, however, the need for client protection is assumed to be stronger: the issuer shall make an assessment of adequacy aimed at ascertaining the will and consequently the interest of the counterparty in order to translate these into concrete and specific investment choices10. Such a trend towards less standardized mandatory disclosure does not weigh on these remarks. The increasingly more detailed legislative provisions, their distinctions according to the ‘qualifications’ of investors, or with regards to the financial services to be offered, may be considered, (if ever) as a confirmation of the legislative faith in its own capacity of providing for all possibilities, by relying on the idea that the existing legal order may not have any shortfalls; in this sense, the question of whether sophisticated regulations, such as this one, assure effective awareness of the risks involved and whether these regulations are reasonable, presents a false problem: it is of no importance whether the multiplication of information reduces and confuses - rather than increases - the clients’

law, entrusts judges with the task of specifying the object on whom the duty to disclose mandatory information is imposed, by way of a case-by-case definition of what information needs to be disclosed and how this may be adequately provided. 9 In order to allow issuers to calibrate information to be addressed, investors shall provide all data about their previous experience and could even request, where appropriate, to be treated as retail investors, though being a professional counterparty, and vice-versa. 10 See the Mifid Directive (cf. Art. 19, par. 4-5); the distinction between appropriateness and adequacy was then transposed into national law: as an example, see all Section II «Adeguatezza, appropriatezza e mera esecuzione o ricezione di ordini» of the Consob rule n. 16190/2007.

Information Asymmetry vs. Communication Isonomy

51

knowledge, independently of whether the moral hazard involved is no longer an exception, but rather the general rule. I would venture to say that the formal involvement of the information receiver, or the very meticulous legislative provisions used to distinguish, detail, separate and personalize the rules may be just an illusory solution to the root problem between form and substance: that is, the dilemma between will and truth. According to the positive rules, the principle of veracity is not a value per se: if anything, it is functional to the legally binding nature of such transactions. Without the legal certainty of information, the intentions of parties will not meet and financial contracts cannot be signed. Here fairness lies outside truth, since it is reduced to compliance with formal rules, on the basis of the assumed correspondence of ‘words’ and ‘things’.11 Such a legal framework stressing the virtue of transparency and making it a legal requirement through the formulation of the mandatory disclosure rule, somehow echoes the paradigm of rationality existing since Descartes’ time, in its calculative nature, its indifference to the objectives at hand and immunity to any consideration of values. An identification between ‘truth’ and the ‘obligation of truth’ follows the first Cartesian precept to admit only what is ‘clear’ and ‘distinct’ as an object of knowledge, in order to exclude all doubt, error or possible uncertainty. In this sense, values are banned, as the subject of knowledge fails if affected by any form of prejudice or pre-understanding12.In this perspective, certainty or uncertainty are thus assumed to be attributes relating to an object to be known: they are not seen to be the partial and always questionable result of a process of knowledge acquisition, nor are they somehow linked to a subject’s attitude towards knowledge and doubt, or even error. Hence, certainty or uncertainty do not refer to a physiological step in the process of acquiring knowledge, but rather to a form of pathology, to a deviation from the only perceived correct outcome; and, in this sense, all possible values and conventions affecting individual or collective experiences disappear, as if they inevitably degrade scientific truth13. 11

A. Giuliani, Informazione e verità nello Stato contemporaneo, in Il diritto come ordinamento: informazione e verità nello Stato contemporaneo: atti del 10° Congresso nazionale, Bari, 3-5 ottobre 1974, Società Italiana di filosofia giuridica e politica, Milano, 1976, p.174. 12 R. Descartes, Discorso sul metodo (It. transl), Milano, 1993 (1637), p. 21. 13 It may be worthwhile to look at certainty from a different point of view: «That a fact is or is not practically certain is an opinion, not a fact; that I judge it practically certain is a fact, not an opinion», in E. de Finetti, Probabilismo. Saggio critico

52

Chapter Three

Thus, where the Mifid Directive states that marketing strategies shall be unequivocal and appropriate information shall be provided in a comprehensible form, it rids itself of the problem of certainty, by absorbing this notion into the larger issue of respecting the requirements of mandatory disclosure. It is of no matter if the investor really understands, or really knows, or rather still, fully trusts: the issue concerning the transparency of contractual relationships is broken up into smaller parts, crushed into a procedimentalized sequence of negotiations, and thereby simplified in order to formally comply with all legal rules regulating a financial transaction14.

The relationship between two individuals, in short, seems to faithfully reproduce the voluntary paradigm which is proper of modern legal order: with a certain dose of approximation, regulation reveals the undisputed primacy of legislative will, central to modern civil law systems. This could be seen, perhaps, as a recurrence of the Enlightenment tendency to reduce ius - related to fas15- to positive law,16 and to identify it as the epiphenomenon of will (‘free’, ‘plural’, ‘democratic’, ‘sovereign’)17. Even sulla teoria della probabilità e il valore della scienza, 1931, in La Logica dell’incerto, Milano, 1989, p. 39. 14 It seems to me that it is possible to find here an echo of Descartes’ second rule: “The second, to divide each of the difficulties under examination into as many parts as possible, and as might be necessary for its adequate solution”, in his Discorso…, cit. p. 21. 15 R. Orestano, Dal ius al fas. Rapporto fra diritto divino e umano in Roma dall’età primitiva all’età classica, in BIDR, 46, 1939, pp. 194 ss. 16 ‘Law’ is neither ‘diritto’, nor ‘derecho’, nor ‘droit’, nor ‘recht’, but there is no scope here for a discussion on the insurmountable limits and potential insufficiencies of any translation, which could concern the signs relating to words, whose corresponding cultural aspects may be untranslatable. Suffice it here to cite a passage from G. Steiner, After Babel. Aspects of language and translation, Oxford, 1975, p. 12): «Translation is formally and pragmatically implicit in every act of communication…To understand is to decipher. To hear significance is to translate. Thus the essential structure and executive means and problems of the act of translation are fully present in acts of speech, of writing, of pictorial encoding in any given language». F. De Franchis, Law Dictionary, Milano, 1984 provided me with some interesting cues on this matter. 17 F. Cammeo, Le manifestazioni di volontà dello Stato, in Trattato Orlando, III, Milano, 1901. With regards to the modern primacy of the “legislative will as the only rule of recognition” (author’s translation), A. Giuliani, Le Preleggi. Gli articoli 1.15 del Codice Civile, Torino, 2003; Il modello di legislatore nel diritto naturale moderno, in Raccolta di scritti in memoria di Angelo Lener, Napoli, 1989, 549-567; Il modello di legislatore ragionevole (Riflessioni sulla filosofia italiana

Information Asymmetry vs. Communication Isonomy

53

in private relationships, which may ‘naturally’ seem far from any paradigm of authority and subjection, the voluntary model, intrinsically authoritarian, dominant and even violent, prevails at least on two levels: first, because a legislative prescription defines which possible ‘content’ and ‘shape’ this will must have; and, moreover, since the ‘free’ will of either party, consecrated in a written and signed text, is law between them18. Such faith in the legislator’s ability to foresee human behaviour and, as a consequence, its regulation, reveals the supreme value of legal certainty taken as a guarantee of equality although being formal-, of the predictability of the consequences of actions and, therefore, of the reliance of contractors: legal certainty19 is the justification behind a written rule and the main objection against anti-Positivist arguments. By way of an obvious logical leap, according to legislative rationality, what is at the most certainty of formal legal data, is transformed into certainty of

della legislazione), in M. Basciu, Legislazione. Profili giuridici e politici (Atti del XVII Congresso Nazionale della Società Italiana di filosofia giuridica a politica), Napoli, 29-31 maggio 1989, Milano, 1992, pp. 13-56; A. de Nitto, In tema di norme di riconoscimento, in Diritto romano attuale, 2003, pp. 161-176; A proposito di “diritto positivo” e “diritto legale”, in Ritorno al diritto, 07/2005, pp. 204 and foll. 18 Regarding the “dogma of consent”, see G. Gorla Il dogma del «consenso» o «accordo» e la formazione del contratto di mandato gratuito nel Diritto continentale, in Rivista di Diritto civile, 1956, p. 923; in Studi in onore di Filippo Vassalli, Torino, 1960, II, p. 921; and in Diritto Comparato e Diritto commune europeo, Milano, 1981, p. 211. .It is worth remembering S. Romano’s intuitive idea of ius involontarium in Frammenti di un dizionario giuridico, Milano, 1953, pp. 64-70: although only referring to so called “objective law”, the author notes how “The legal system, in fact, if considered in the variety of its aspects and, therefore, in its complex unity, is not always and exclusively a statement or expression of will”; some, not exhaustive, examples are “general principles”, which “are neither formally declared by the written law or implicit in it, but which are deduced from the essential structure of the institutions in which they come true”, or customs which emerge “spontaneously, without a particular will being directed to this extent, so that … (their) making may be even unconscious or almost unconscious” (author’s translation). More generally and apart from these examples, which could seem recessive in the context of modern civil law systems, the focus is on rules as “hypothetical judgments” or “evaluation criteria”, rather than as orders: as «auspices», according to A. de Nitto, Diritto dei giudici e diritto dei legislatori, Lecce, 2002, p. 143. 19 F. Lopez de Oñate, La certezza del diritto, Milano, 1968 (1939).

54

Chapter Three

juridical phenomena on the whole, i.e. the certainty of ‘facts’ and the ‘exact’ meaning of the rules which regulate them20.

2. The burden of metaphors At the risk of being too brief, I believe that a reminder of the etymological roots of words used by legislators could be useful at this point, in order to appreciate their historical authenticity and relative impacts. A survey on ‘the words of law’ may reveal how unaffected these actually are by the presumed rigor and uniqueness of language in the ‘exact’ sciences, as assumed by the Cartesian rationalist paradigm. In fact, juridical language draws from everyday language use, which is inevitably defective and incomplete in itself: but it is precisely in order to fill these unavoidable gaps, that a jurist cannot but make use of metaphors21. Even in the setting of financial market regulation, and in defiance of its ‘intrinsic’ technicality, the choice of words employed by legislators is anything but neutral or, in other words, aseptic: ‘symmetry’, ‘transparency’ and ‘information’ (to merely cite a few typical examples) are, in fact, deposits of rationality, as well as sedimentations of values and their corresponding cultures. According to its Greek etymology (from ıȪȞ and ȝȑIJȡȠȞ, that is ‘the same measure’), the word ‘symmetry’ evokes the image of two points which are equidistant from a centre on the assumption that the nature and 20

With regards to this issue, B. Leoni’s Freedom and Law, 1991 (1961) remains unequalled: “The certainty of the law, in the sense of a written formula, refers to a state of affairs inevitably conditioned by the possibility that the present law may be replaced at any moment by a subsequent law. The more intense and accelerated is the process of lawmaking, the more uncertain will it be that present legislation will last for any length of time. Moreover, there is nothing to prevent a law, certain in the above-mentioned sense, from being unpredictably changed by another law no less “certain” than the previous one” (p. 79). 21 See S. Romano, Frammenti…, cit., p. 67: “When we speak about orders, or imperatives, or legislative will, it is improper and the reason for many and serious misunderstandings to give a literal meaning to these words, while they are nothing but imaginative expressions to be meant only in a metaphorical or figurative sense” (author’s translation).With regards to the logical value of metaphors in juridical language and to the affinity of law with myth, see A. Giuliani, Contributi ad una nuova teoria pura del diritto, Milano, 1954; La «nuova retorica»…, cit.; Droit, mouvement et reminiscence, in Archives de philosophie du droit, 29, 1984, p. 101-116. See, therefore, J. L. Austin, How to do things with words, Harvard University Press, 1962 (It. transl.: Come fare cose con le parole, Genova, 1987), regarding the performative function of language.

Information Asymmetry vs. Communication Isonomy

55

quality of that centre is obvious and that its distance from the two extremes can be measured. The position of both parties in a financial transaction is, therefore, subject to being measured: one can calculate the distance from the centre, i.e. from the Pareto optimal point where all parties have the perfect amount of information, and one can measure the degree of disclosure which is necessary to achieve it. In this instance, ‘distance’ is measured through the parameter of information; the more a party is informed, the closer it is to the given centre. Moreover, information is neither accessible, nor free of charge: getting close to the centre is not ‘naturally’ possible. A recovery of symmetry can only happen through the influence of exogenous factors. Information itself is a metaphor: to inform, a compound and derivative of the Latin ‘forma’, recalls the idea of giving shape to something shapeless, of attributing boundaries, not only by enclosing a content - that is the knowledge and awareness of investors - within certain perimeters, but also by defining the same content, as that enclosure is constitutive of the enclosed object: and the information that flows through the mandatory statement from the financial intermediary to the investor is just a piece of data, which was given a shape (detailed, generic, customized, technical - it does not matter), and which is considered as sufficient, within its boundaries, to contain all that ‘you need to know’, that is everything you need so that a certain truth of the transaction is reached. And the ‘knowledge’ - if we attribute a more substantial meaning to this term - that the addressee should reach tends to coincide with this already shaped data. In the same way, the word transparency is a metaphor: it identifies disclosure statements as plastic images of something which is fully clear, unequivocal and unambiguous: investors are thereby reassured about the extent of their awareness of the financial transactions to be undertaken, as the form of the information received is seen to be a guarantee of the effective balance that can be recovered with their counter-party. In this sense, the notion of justice that underlies this perspective refers to the distributive idea of justice, the ideal of ‘giving to each his own’; to this extent, equality implies a geometrical proportion or, in other words, the equivalence of two fractions. The process of adjusting any imbalance between parties cannot be but objective and quantitative, if not physical: any redistribution which does not take such calculations into account is inevitably unjust. In the transparency regulation of financial markets, the restoration of justice is not devolved to the parties which reduce imbalances, but pre-determined by the positive rules which have been dictated by the legislator: law not only states the rule of conduct that the

56

Chapter Three

parties must observe, but, because of the parties’ inequality of arms, it also incorporates in itself the automatic resolution of any imbalances.

3. Public and private sides of transparency In supranational22 and in national regulations, the codified virtuous effects of transparency on the rational allocation of market resources would manifest both in ‘private’ and ‘public’ domains: but the traditional private/public law distinction is confirmed, once more. Legislative provisions regulating the investor/intermediary relationship are kept separate from the rules governing the intermediaries’ obligations towards the supervisory authorities. The former would pertain to a private affair par excellence, involving a single transaction between two private parties, and, more generally, bringing into question the right to be informed, that is a very ‘personal’ (in this sense ‘private’)issue. Only those rules obliging the issuer to periodically report to the authorities at the most would pertain to the ‘public’ domain, in the sense of ‘relating to the State’. In other terms, the positive rules stating the issuer’s obligation to provide periodic reports to the supervisory authority seem to have nothing to do with his duty to disclose information to the investors about the financial service on offer; such an option probably echoes the mainstream idea of a clear-cut distinction between ‘public’ and ‘private’. This dichotomy is likely to be based on the idea that the former pertains to the ‘traditional’ subjugation of the individual by the State, while the latter concerns his or her relationship with other private ‘subjects of law’23and, in particular, the meeting of free wills: the ‘source’ and nature of legislative rules binding negotiations between individuals thus disappear as legal obligations are neutralized, naturalized and made aseptic by means of the judicial techniques employed, in order to reduce these obligations to the epiphenomenon of mythical contractual freedom and self-regulation of individuals, far from the paradigm of authority and beyond any interference from the ‘State’ (i.e of the ‘public’)24. 22

See, for instance, the Basel III Accords, http://www.bis.org/publ/bcbs189.pdf; or the IOSCO Principles for Periodic Disclosure by Listed Entities, published in February 2010 (http://www.iosco.org/library/pubdocs/pdf/IOSCOPD317.pdf); 23 With regards to the subjectivist perspective of positive law, see R. Orestano, Il problema delle persone giuridiche in diritto romano, Torino, 1968, pp. 74-78. 24 It is worth remembering the heated debate that has emerged in the context of Italian doctrine and jurisprudence about the effects of breaching the disclosure requirements of a financial contract: according to at a first glance, such a contract would be void, because of the violation of mandatory rules under Article 1418 of

Information Asymmetry vs. Communication Isonomy

57

It would be interesting to consider if an intermediary’s obligations towards authorities, on the one side, and towards clients, on the other, rather represent two sides of the same coin: that is to assess whether both cases deal with positive legal rules fixed by legislators, thereby inexorably involving the authority of the State. It is probably fictitious to assume that parties self-determine their contractual equilibrium, as even in ‘private’ relationships mediation by the State is inevitable. Negotiations between two parties can only be seen to be notionally independent, as they are indeed strictly governed by legislative restrictions, ‘clearly’ prescribing to parties ‘what they have to want’ and ‘how they have to want this’25. If this were not so, the corresponding idea of ‘public’ would be completely overthrown and re-discussed, especially in relation to what is considered to be ‘private’.

4. About the fractal nature of communication: Isonomy and trust In order to sketch out a tentative, alternative conceptual framework for ‘transparency’ in financial markets regulation, I would suggest moving beyond the usual market/State dichotomy. It may seem impossible to the Italian Civil Code, (see, i.c., Trib. of Ravenna, October 12th 2009, in Nuova giu. civ., I, 456; Trib. of Parma, January 1st 2006, in Nuovo dir., 2006, 823; Trib. of Pesaro, June 27th 2005, in Corti marchigiane, 2006, 163); on the contrary, the latest case law on this matter excludes the sanction of nullity, since, unless otherwise required by law, only the violation of mandatory provisions concerning the validity of a given contract is likely to lead to such a sanction. Meanwhile, the violation of rules regarding the behaviour of contractors, can only be assessed according to the terms of contractual accountability. See, among others, Court of Cassation, December 19th 2007, nn. 26724 – 26725, (in Contratti, 2008, 221, Giur. it., 2008, 347, Dir. fallim., 2008, II, 1, Giur. comm., 2008, II, 344, Resp. civ., 2008, 547, Corti salernitane, 2007, 840, Riv. dir. comm., 2008, II, 17, Dir. e giur., 2008, 407, Banca, borsa ecc., 2009, II, 133, Strumentario avvocati, 2008, fasc. 3, 24), Trib. of Torino, sec. I, December 3rd 2010, (in Giuffrè Database). It is interesting to see how, depending on the answer given, judges and scholars have recognized or denied that the national regulation implementing the MiFID directive (i.e. the Testo Unico della Finanza) with regard to mandatory disclosure would express a “public” interest. It would be useful to enquire here, what is meant by the idea of “public”. 25 See, A. V. Dicey, Introduzione allo studio del diritto costituzionale (It. trans.), Bologna, 2003 (1885); M. d’Alberti, G. Arena, G. Di Gaspare, L. dello Russo, La partizione pubblico privato: esiste ancora?, in (by F. Spantigati), Sulle trasformazioni dei concetti giuridici per effetto del pluralismo, Napoli, 1998, p. 25.

58

Chapter Three

disregard this dichotomy, perhaps also due to a radical misunderstanding of the two extremes inherent in such a polarization26. On the other hand, a reappraisal of the notion of market may come from that largely recessive doctrinal trend which tends to re-examine the idea of self-interest from the ground up, by challenging it, as it has been consolidated according to liberal economic theories: such a reappraisal highlights the work of Adam Smith as a philosopher of law27, rather than as the father of economic liberalism; it emphasizes the logical priority of the Theory of Moral Sentiments and Lectures on Jurisprudence over the Wealth of Nations. His theory of sympathy28, so close to the classical idea of ijȚȜȓĮ29, steeped in anti-voluntarism, in prudence30, in the virtues of practical intellect, could enlighten the notion of market, through the idea of the natural individual inclination to persuade and to be persuaded31. In this perspective, which

26

The contribution of behavioural economics on this matter cannot be ignored. At a first glance, legislative actions implemented as corrective measures to market failures may be considered to be exogenous, while in fact they are endogenous to the system, of which they represent a part, and a highly relevant one as such, and consequently they are subject to the same fallible tendencies and limited rationality as any other actor at hand. It seems to me that, according to this theory, the dominant paradigm is not actually questioned: the undisputedly taken on idea of "market" is that of a place where human wills rationally pursue their self-interest; only if and when markets fail, that is only in a hopeless case, does the hypothesis of un-rational behaviour really surface. Likewise, the idea of "law" seems to be related to a legal-rational paradigm, to the extent that one of the “biases” listed by the theorists of behavioural economics includes “social” rules, that is rules which are designated to be besides, beyond and outside law. 27 A. Giuliani, Adamo Smith filosofo del diritto, in Rivista Internazionale di filosofia del diritto, XXXI, 4, 1954, pp. 505-538; Le Lectures on Rhetoric and Belles Lettres” di Adamo Smith, in Rivista critica di storia della filosofia, XVII, 3, 1962, pp. 328-336. 28 A. Smith, The Theory of Moral Sentiments, London, 1790, Sixth edition, I, 1.1, pp. 1-2: «Of this kind is pity or compassion, the emotion which we feel for the misery of others, when we either see it, or are made to conceive it in a very lively manner (…) As we have no immediate experience of what other men feel, we can form no idea of the manner in which they are affected, but by conceiving what we ourselves should feel in the like situation»; A. Giuliani, Simpatia in Enciclopedia Filosofica, Varese, 1957; L. Bagolini, La simpatia nella morale e nel diritto, Bologna, 1952 and Giustizia distributiva e simpatia, Milano, 1954. 29 A. Genovesi, Lezioni di commercio o sia di economia civile, Napoli, 1765. 30 ibidem, VI.1.8, p. 425 31 A. Smith, Lectures on Jurisprudence, Oxford, 1978 (1723), p. 352 (lecture of Wednesday, March 30, 1763): the author states that “natural inclination every one

Information Asymmetry vs. Communication Isonomy

59

owes much to the New Rhetoric Movement32, if general moral rules are formed out of our judgments of the particular experiences that we observe in conjunction with the judgments of others and if they are universally acknowledged and established by the concurring sentiments of mankind33,

the virtues of markets emerge as the result of an involuntary cooperation of market actors. Along these lines, the terms ‘market’ and ‘law’ may reveal how ‘persuasion’ - which is strictly connected with ‘trust’34 as its etymological origin shows - is the basis of an order where the search for compatible forms of balance is based on collective and cooperative actions taking place in a dialectical process through exchanges based on the assumption of the authority given to prudent behaviour35. With regards to the notion of ‘state’, the modern premises of its identification as the only law ‘producer’ have already been touched on. Any attempt to relativize these premises, would imply that the related notion of ‘public’ departs from ‘what is inherent to the State’ and, accordingly, would need to be radically rethought: this would suggest that ‘public’ and ‘private’ might not indicate two different ‘objects’, more or less identified with the subjects of study in a graduate programme, but rather two perspectives from which the phenomenon of ‘law’ can be observed: in this sense, by emphasizing the subjectiveness of the perspective taken, the object of observation may be considered as a whole of which the terms ‘public’ and ‘private’ may describe two different aspects, two ‘positions’ that may be assumed while looking at the selfsame object. ‘Public’, in this sense, would not be the opposite of ‘private’, but rather another term for ‘common’: to this extent, the ‘transparency issue’ may involve the investor or the issuer by expressing their ‘public’ or has to persuade” is “the principle in the human mind on which this disposition of trucking is founded”; ibidem, pp. 493-494. See also his TMS, cit., VII.iv.25. 32 C. Perelman, L. Olbrechts-Tyteca, Traité de l'argumentation: La nouvelle rhétorique, Paris, 1958. 33 A. Smith, TMS, III, 4.11, p. 333 34 E. Benveniste, Il vocabolario delle istituzioni indoeuropee, I, It. transl., Torino, 2001, p. 85. Trust would be derived from the Old Norse traust (“confidence, help, protection”) from Proto-Germanic *traust- from Proto-Indo-European *drouzdofrom Proto-Indo-European *deru- (“be firm, hard, solid”); the West Indo-European translation of trust would be the Latin fides, corresponding to the Greek ʌİȓșȦ, “I persuade”. 35 P. Aubenque, La Prudence chez Aristote, Paris, 1963; see M. C. Malaguti, Crisi dei mercati finanziari e diritto internazionale, Milano, 2003, pp. 269-279.

60

Chapter Three

‘private’ attitudes, their interest in the transaction being a ‘personal’, ‘individual’ concern, but also a ‘collective’ and ‘shared’ one at the same time. ‘Common’ may allude to those interests, evaluation criteria or contexts involving any individual who is a member of a group as well as this group at the same time36: a common place where the individual does not disappear in the whole and which is not exhausted by the sum of many individuals involuntarily ‘put’ together. Some of the doctrine of commons37 has the merit of courageously exploring a third way, beyond the power of the individuals’ will and beyond the sovereignty of the will of the State, the two being allied and all-encompassing according to the legal and economic model that would characterize modernity. I would lean towards a recovery of the sense of ‘common’ in the understanding of the term ‘public’: in this sense, the event of the modern State would be considered as a historical episode, which can be dated and spatially circumscribed, taking part in a wider and much more complex and multifaceted ‘space’ (and ‘space’ here would allude to the geographical place in which ‘infra’ and ‘supra’ - State powers would be exercised, as well as to the ‘time’ before and after the moment in which that event is placed; I venture to suggest that it would bring up the problem of the memory of those individuals who have occupied this ‘place’ and the future interests of those who will). By trying to challenge the logical and methodological premises of transparency regulation, as already hinted at earlier, I would connect fairness in a financial transaction to communication, rather than to information, and I would suppose that the balance to which the contractual relationship strives is not of a symmetrical order, but rather an isonomic one. More radically speaking, it would be possible to suggest that the concept of fairness in financial transactions may be qualitatively far from the semantic field of the notions of information and asymmetry. Of course ‘communication’ and ‘isonomy’ are metaphors, too: they both evoke the possibility that knowledge in a transaction is strictly connected with 36

J. Dewey, The Public and its Problems, New York, (1927), It. Transl., Firenze, 1971, pp. 8 and foll.; F: Tönnies, Community and Society, The Michigan State University Press, 1957 (1887) 37 After G. Harding and his Tragedy of Commons, in Science, 1968, the main references are to P. Grossi, Un altro modo di possedere. L’emersione di forme alternative di proprietà alla coscienza giuridica post-unitaria, Milano 1977; E. Ostrom, Governing the Commons. The Evolution of Institutions for Collective Action, Cambridge, 1990; A. Negri, M. Hardt, Comune. Oltre il pubblico e il privato, Milano, 2010 (2009), It. transl.

Information Asymmetry vs. Communication Isonomy

61

exchange. This proposition is inspired by the minority doctrine of legal scholars who have outlined an understanding of ‘law’ outside of a legalistic and formal model, which is, however, intrinsically connected to the idea of exchange and reciprocity. If legal phenomena - unless limited to positive normative data - are inevitably linked to a dialectical and controversial field, exchange appears to be the key38. Markets, in the context of which law unfolds physiologically, are inexorably dialogical fields of exchange, not simply of goods and money, but also of ‘what is true’ and ‘what is right’. According to this perspective, outlined very briefly and in general terms here, the issue concerning the knowledge that parties have at their disposal could never be reduced to the flow of data which passes, even bilaterally, from one party to another, nor can it be governed by the rules of conduct laid down to protect the supposedly weaker party. In this sense, the ‘truth’ that presides over the fairness of a contractual relationship cannot be reduced to the ‘obligation of truth’: the will of a legislator, who puts down a rule of conduct, or the will of an issuer who, in compliance with that rule, provides a coherent statement and submits it to the other party, has nothing to do with the ‘truth’ of that transaction, since, to rephrase what has just been said, compliance with positive laws does not in itself guarantee that the result pursued is attained. In terms of communication - and this word too is anything but neutral, as it entails connections with the notion of ‘community’ and, in a wider sense, with the notion of ‘public’ as ‘common’39, as suggested above - the duty to speak the truth is justified only in a situation of reciprocity and equality: the exception being the domain of fraud and violence, exemplified by any kind of market abuse. Insider trading may not simply be the consequence of a violation of mandatory disclosure; from the perspective suggested here, it may also be the result of a lack of reciprocity, or rectius, that is, an abuse of fairness40. As such, the issue of 38

A. Giuliani, Giustizia e ordine economico, Milano, 1997. A. Giuliani, Il problema della comunità nella filosofia del diritto, in La comunità tra cultura e scienza, I: il concetto di comunità nelle scienze umane, ed. by G. Delle Fratte, Roma, 1993, pp. 83-97. 40 A. Giuliani, N. Picardi, La «restaurazione» del fallimento nella crisi delle economie pianificate (Riflessioni sul diritto dell’economia), in Giurisprudenza commerciale, 1993, I, p. 416-429; A. Giuliani, Giustizia…, cit., pp. 137 – 149: with respect to legal experience commonly known as ius commune, any kind of market abuse can be explained as a breach of the ethical code on which the perpetuation of the medieval system of merchant corporations is based. In A. Smith’s Lectures, cit., p. 538, we read that “whenever commerce is introduced into 39

62

Chapter Three

communication is a public question, not because it is left to the regulatory powers of legislative procedures, but because it relates to something which is ‘common’, and hence deeply ‘shared’. In this sense, the issue of transparency in financial markets could not therefore be summarized according to the geometrical parameters of a straight line joining two points to a centre at equal or unequal distances. It could rely, instead, on the complexity of fractals. Although the association proposed here may seem ventured, I would nevertheless suggest using fractals as reference images, following research outcomes from Mandelbrot onwards41. I refer to that ‘rough and fragmented shape’ which is taken from nature and which is neither reducible to the regularity of onedimensional forms, nor can it be ascribed to the simplicity of linear geometry. In finance, as in nature, if we assume that the objects of study of the social sciences are not ‘outside of nature’, but that, as with the natural sciences, they also deal with men and ‘human affairs’, no objects exist in integer dimensions and the simplified shapes that men have outlined are the result of reductions and simplifications applied on the basis of the classificatory needs with which they were born. Any fractal can be broken down into smaller parts, each of which replicates the complexity scale, as its performance is unpredictable and a deviation from any regularity of shapes, i.e. the proportionality and symmetry of its parts is neither an accident nor an imperfection: instead, irregularity itself sets the rule. In this perspective, the metaphor of communication draws on the unpredictability of the physiologically irregular fractal: communication proceeds by trial and error, and it cannot be reduced to a mere data stream. It is of course not certain that, given specific data, the investor will be ‘informed’: the flow of information might not be enough or, indeed, could not serve. According to this perspective of complexity, any investor is no closer to the centre than any intermediary: we may consider, in fact, that the respective positions define themselves in relation to each other, rather than with respect to a given centre; that the two parties exchange their places from time to time, and that the progress of their mutual positions reflects any country, probity and punctuality always accompany it”: the merchants’ sense of belonging to their corporation is probably justified on the basis of their practice of equity and prudence, since their expertise deals with practical reason; in this sense corporations play a public role, as members are pushed away from the group, in cases in which the Aristotelian ideal of virtue is deceived and betrayed. 41 B. R. Mandelbrot, The fractal geometry of nature, New York, 1982; B. R. Mandelbrot – R. L. Hudson, The (Mis)Behaviour of Markets: A Fractal View of Risk, Ruin and Reward, Berkshire, 2005.

Information Asymmetry vs. Communication Isonomy

63

the precarious and partial balance which describes each micro-portion of their mutual and continually evolving relationship. With respect to communication and exchange, the notion of order seen not simply in the sense of legal order - does not coincide with the orderly unfolding of will which positively prescribes and disposes; order would be the outcome of an equilibrium resulting from an exchange, according to an idea of justice as ‘reciprocity’42. The word ‘isonomy’43 embodies this meaning, with reference to its affinity to the cosmic order, not set in stone, but spontaneously emerging and, at the most, troubled by possible external interferences. The assumption is that actions are not governed by calculative and quantifying reasoning, but by dialectical reasoning, which assesses what is considered to be right and is oriented on the basis of commonly accepted values. This may easily lead to deductions that the only alternative to a deterministic idea of information and transparency in financial markets would be chaos; in this sense, the relation between the parties of a transaction would be dominated by anarchy and disorder. The unpredictability of the issue of communication, which follows from the idea that the positive regulation of fairness is an inevitable failure, does not correspond to its unknowability and inaccessibility44; such a nihilistic result would also undermine every form of trust in the market. Even fractal theory itself has basically identified a degree of regularity in the wider spectrum of irregularity: it is not about to negate any kind of order, but rather to outline the historicity - and, the partiality - of the set order, by emphasizing the inevitable distance between the dogmatic structure on which the legal system - which would put in order - is founded and ‘factual reality’45, which would be put in order46.

42 A. Giuliani, La giustizia come reciprocità (a proposito della controversia aristotelico-pitagorica), in Rivista Trimestrale di diritto e procedura civile, XXIV, 3, 1970, pp. 722-756; La definizione aristotelica della giustizia. Metodo dialettico e analisi del linguaggio normativo, Perugia, C. L. B. E. U., 1971, p. 111; G. Del Vecchio, La giustizia: saggio di filosofia del diritto, Roma, 1961, , pp. 94-100; J. Rawls, A Theory of Justice, Cambridge, Mass., 1971, pp.10-15. 43 I owe these remarks about the significant distinction between asymmetric and isonomic order to the entire corpus of work by A. Giuliani and, in particular, to his Giustizia…, cit., p. 231 – 240, Ordine isonomico ed ordine asimmetrico: “nuova retorica” e teoria del processo, in Sociologia del diritto, XIII, 2-3, 1986, pp. 8190. 44 With regards to certainty and doubt in science, mutatis mutandis, see E. de Finetti, Probabilismo…, cit., p. 4 45 Ibidem, pp. 10-11.

64

Chapter Three

Instead, the alternative might be a re-evaluation of the notion of probability: on the one hand, this could hold more heuristic possibilities than ‘certainty’ to which positive rules would tend; on the other hand, ‘probability’ could be an appropriate instrument for governing chaos and disorder. This very much applies to fractal geometry, studies of which aim at finding forms of regularity in the context of perceived irregularity, not in terms of certainty but in terms of probability, not in terms of correctness, but in terms of compatibility, in order to penetrate the perfect randomness of the structure of a snowflake or the rough profile of a mountain. In this context, chaos is not tout court the opposite of certainty and symmetry, and also the fractal dimension of communication, tends towards a kind of order, which is not symmetric but isonomic: the result of the spontaneous convergence of the investor’s need to know and the issuer’s degree of fairness, in terms of compatibility rather than correctness. The disclosure statement that intermediaries must provide to retail investors could be nothing but a security blanket, even if a very detailed and sophisticated one; the increasing number of data to be included in the required prospectus does not guarantee, but if ever could undermine, the knowledge and awareness of investors; any attempt not to generalize the duty to inform, by adjusting it to the requirements of the addressee, more or less in need of protection, or to the type of financial service offered is a mere substitute, which only gives the illusion of effectively bridging the gap between the parties involved, while actually perpetuating a formalistic model; the adequacy and appropriateness of information to be provided, and to be reviewed by the issuer are a means to formalize (and neutralize) the evaluation of fairness which characterizes all the steps in any communication process, in which the protagonists are naturally inclined to weigh their words before using them, to estimate the plausibility of the information received, to evaluate the credibility of the interlocutor, to retract, to insist or to lease, according to a flow which is not fully predictable even by those directly involved and which therefore eludes any formalization. Even assuming the virtuous effects that transparency might have on financial markets, it may be relevant to consider the hypothesis that it may represent only a compromise, given the cultural means available. 46

Regarding the connections between and departures from what has been “foreseen” and what has “happened” (author’s translation), see A. de Nitto, Diritto dei giudici…, cit., pp. 101-103 and p. 131.

Information Asymmetry vs. Communication Isonomy

65

The penalty of such a possibility cannot be ignored: it challenges the question of legitimacy, the bugbear of legitimacy and the matter of time. This could provide a possible key to understanding the development of crises such as the one we are currently experiencing and may suggest that such turmoil, given its devastating impact on the sophisticated legal tools at our disposal, epitomizes modern failures in the management of complexity.

CHAPTER FOUR (UN)FAIR RESOURCE SHARING: A NETWORKING PERSPECTIVE ANGELO COLUCCIA

Abstract Resource sharing is an important point of connection between economics and engineering, with Pareto optimality and fairness as prominent common factors. In this work, after highlighting the role of uneven (“heavy-tailed”) distributions, we spotlight the analogy between the problem of the distribution of wealth and the framework of network resource allocation for analysing the relationships between the concepts of efficiency (utility maximization), inequality reduction and fairness. The goal is not to make bold claims about the “golden rules” of welfare, nor to provide models for data analysis and forecasting, but rather to contribute to the debate on such an important and extensive topic from a different perspective.

Introduction Economics is recognized as one of the most interdisciplinary research fields, attracting efforts from disciplines as diverse as sociology, law, politics, philosophy and others. Motivated by the need of quantifying economic variables and phenomena, formal sciences have tried to cover economic issues by analogy with mathematical or physical problems. This has led to hybrid disciplines like e.g. econometrics and ‘econophysics’, with useful contributions to economic studies, especially in terms of

Post-Doc Researcher and Lecturer in Signal Processing, Networks and Systems at the Faculty of Information Engineering - University of Salento (Lecce, Italy). Email: [email protected]

(Un)Fair Resource Sharing: A Networking Perspective

67

statistical tools. Indeed, models and techniques for data analysis or forecasting are valuable complements to economic studies, and can serve for evaluating the effects of governance policies. They ultimately provide quantitative arguments on the table of economists, policymakers and analysts to support claims and decisions. Usually, scientific research in economic subjects is focused on socioeconomic systems “as they are” found in reality. While this is undoubtedly necessary and useful in practice, nonetheless we believe it is also worth thinking about the founding principles of socioeconomic systems “as they should be”. This is a speculative matter traditionally covered by non-quantitative sciences, but it can benefit somewhat from formal sciences too. A prominent example is the work of Vilfredo Pareto, which by studying theoretical systems ended up with very important and ubiquitously applicable concepts such as the Pareto principle (popularized as “80-20 rule”) and the Pareto optimality (or efficiency). Nowadays, newer disciplines in the ICT show potential intersections with economics. Among those, the broad field of networking studies the interconnections between different kinds of entities, hence lends itself well to the modelling of phenomena that take place in complex interconnected systems ʊ economies being no exception. A significant point of contact is the ubiquitous presence of very uneven (so-called “heavy-tailed”) statistics in the distribution of several variables, a fact tied up with Pareto's findings mentioned above. Along this line, in the following we spotlight the analogy between the problem of the distribution of wealth and the framework of network resource allocation. We formalize the essential elements of the problem, without adhering to any particular doctrine, and discuss how in a really equitable world it could be effectively possible to reduce wealth concentration in a fair way without sacrificing the maximization of utility. The goal of our contribution is not to make bold claims about the “golden rules” of welfare and global fair governance, nor to provide models for data analysis or forecasting, but to feed the discussion with a different “food for thought”.

1. Resources, wealth, inequality: a matter of fairness Since mankind begun to live in communities, sharing common resources and distributing them in the right way has been the cause of conflicts. Nowadays, the problem of a fair distribution of wealth extends on a worldwide scale, since countries are factually members of a unique socioeconomic system after the onset of the globalization era ʊ therefore, they should care about ethical issues on a likewise global scale. This can

Chapter Four

68

be summed up in the quote “any parent with two or more children needs no formal analysis to be persuaded of the importance of distributive justice” (Amiel & Cowell, 1999). Actually, the matter is controversial ʊ even to define “wealth” and “fair”. Wealth has a broader meaning than income, and its distribution is much more unequal than that of income: for example, an individual with a large income but also with large medical expenses experiences low wealth (but this is not the only case). Nonetheless, income is much easier to measure than wealth. On the other hand, there is no consensus about how to ethically judge inequality. In fact, inequality is usually regarded as an evil thing, but a “flat” society can be deemed equally bad for several reasons. A brief digression about some of the arguments that fuel the debate follows. Strong inequality is usually deemed as ethically unacceptable, from both a philosophical and a practical point of view. Negative social phenomena such as worsening health conditions, crime and emotional depression seem to correlate with higher socioeconomic inequality (Wilkinson & Pickett, 2009). Inequality pushes for competition and consumerism rather than sharing, which in turn makes it harder to implement certain policies, e.g. to reduce global warming1. Rather than stimulating innovation and progress, great inequality would waste the talents of a large proportion of the population. Also, some analysts claim that the rich getting richer makes the poor/middle class worse off, because the latter become discouraged and give up (Porter, 2011). Indeed, markets are often “winner-take-all” places, where the first-moving will gain far more than the other competitors who arrived just a bit later. This large earning gap will persist, since the early winners have captured and locked in most of the available gains (Cowen). On the other hand, a righteous and even positive role of a certain level of inequality is sometimes recognized. Different types of inequality may have different or even opposite effects on growth: inequality that rewards effort is likely to be pro-growth, while wealth accruing because of inheritance, monopoly or lobbying is likely to be anti-growth. Hence, it has been argued that for policy makers it is more important and beneficial to avoid the extremes and target the lowest level of inequality in an “efficient inequality range” (Cornia & Court, 2001). Actually, growth-centric arguments would require a more thorough justification: according for instance to the advocates of steady-state economy or to Latouche's theory of de-growth, countries with positive growth indicators (e.g. the GDP) do not always experience a better quality of life. In fact, growth indicators like the GDP do not consider externalities, side-effects and many other (especially negative) aspects of growth. 1

http://www.equalitytrust.org.uk

(Un)Fair Resource Sharing: A Networking Perspective

69

Many pro-equality and anti-equality arguments could be mentioned, but a treatise on the topic is certainly out of our scope. We just want to stress that, evidently, the debate is still to be settled and a univocal conception of inequality is missing. To solve the impasse, we advocate shifting the focus from inequality per se to the “degree” of such an inequality. As we will discuss in detail later, it is exactly the extreme unevenness actually present in real economies that objectively calls for some inequality reduction. Indeed, despite the controversy about the role of inequality, there is consensus on the fact that the extremes ʊ very unequal but also extremely egalitarian societies ʊ are bad, hence resources would need to be reallocated to some extent in a fairer (more equitable) way. Since the beginning of the 20th century mathematical methods have been applied with some success to model wealth-related aspects, and an entire branch of economics often called “optimal tax theory” (see e.g. (Tuomala, 1990)) is devoted to these studies. But here our aim is different: we will not try to derive mathematical tools for optimal resource/wealth redistribution, nor to accurately model the dynamics of a real economy. Our objective is to highlight the importance of two key elements in the debate on economic governance: the factual unevenness in the distribution of wealth and the implications of the concept of equity. We do not rely on assumptions that reflect particular doctrines or economic theories: our effort is exactly to focus on basic but general aspects. To this aim, we will adopt a nomenclature that avoids specific terms, so that results can apply to any context where resources need to be shared in a fair way. Beforehand, in the next section we explain in more depth and detail the reasons why, despite the controversy about its role, inequality should be nevertheless reduced at least to some extent.

2. A tail that rules the world

Fig. 1 Examples of heavy-tailed (left) and Gaussian (right) distributions.

70

Chapter Four

Our discussion begins from the following fact: as in the famous Paracelsus quote “the dose makes the poison”, the problem is not inequality per se but its extent. In other words, if the role of inequality can be still deemed controversial (ref. previous section), the degree of inequality actually present in real societies cannot be disregarded for sure. As a matter of fact, the statistical distributions of income/wealth at national or supranational level, and worldwide, are characterized by a typical heavy-tailed shape similar to the one depicted in Fig. 1: for instance, the horizontal axis may be the wealth amount, and the vertical axis the corresponding number of people owning that specific amount. In practice, the heavy-tailed shape means that most people have a very limited amount of wealth, while a few people are thousands/ millions/billions times better off. Such a particularly strong unevenness occur in a variety of different real contexts, from social and physical phenomena to natural disasters, to computer and network science ʊ in the latter case, it is the typical shape of e.g. web links, file sizes and traffic distributions. In general, it appears in systems compound of complex interacting units: in this sense, heavy-tailed distributions (also called scale distributions) are more “normal” than the Normal distribution (Willinger, Alderson, Doyle, & Lun, 2004) ʊ i.e., the Gaussian shape depicted in Fig. 1 ʊ so popular in models, also in economics and finance (Mandelbrot & Hudson, 2004) (Mandelbrot, 1997)

Fig. 2 Heavy-tailed distribution of the world income depicted as a champagne glass. Each horizontal line represents 20% of the population.

The reasons for this ubiquitous presence and the generative mechanisms that can lead to heavy-tails cannot be discussed here. The point to be taken is that not only wealth is distributed unevenly, but the degree of such an inequality is extreme. A popular way to visualize this

(Un)Fair Resource Sharing: A Networking Perspective

71

disproportionate resource partition is the classical “champagne-glass” picture reported in Fig. 2, where the top 20% of the world population own the vast majority (say 80%) of the whole wealth. It is worth remarking that this issue is dramatically evident in the current global crisis, dominated by financial speculations. From the discussion above, it should be clear that inequality per se would not be so dramatic if its impact were more evenly distributed, with still different wealth levels among people/countries but in a milder way2. An interesting analogy arises therefore with the problem of resource allocation in networking, which has basically the same root cause. In networked systems users access various resources but many of these are limited, hence must be shared among users. The problem is complicated further by the fact that, as in (financial) economies, a few entities can cannibalize most of the resources ʊ i.e., heavy-tails are common. This requires implementing policies for regulating the number of connections, bandwidth allocation and so on ʊ in a word, to guarantee fairness, with the ultimate goal of satisfying all users as much as possible. Several network fairness criteria can be considered depending on the particular assignment goal (Le Baudec, 2007): one of the most important and commonly-used is maximizing the satisfaction of users with minimum demands, which otherwise would be starved by users with high demands ʊ this is called max-min fairness, and will play a role later in our discussion. In some cases a fairness index is used to measure the degree of inequality in a given allocation, a prominent example being the Gini coefficient3. Not surprisingly, such an index is widely adopted also to measure inequality in the distribution of wealth4. Ironically, at the present time more attention seems to be paid to effectively implement fairness in the cyber-world than in the human-populated one. We believe that 2

Recalling the previously reported quote, Paracelsus would say that everything is unhealthy in excessive dose ʊ but other big names would agree, from Aristotle to Horace (“est modus in rebus”). 3 The Gini coefficient is a popular index for measuring inequality: a value of 0 expresses total equality, while a value of 1 (or 100%) maximal inequality. It is based on the Lorenz curve, a graphical representation which shows the cumulative share of a given resource assumed by a certain cumulative share of the population in abscissa. The Gini coefficient G is then defined as the ratio G = A/(A+B), where A is the area between the line of perfect equality and the Lorenz curve and B is the area under the Lorenz curve. There exist different ways for computing G, which are more or less convenient depending on the application. 4 For example, it is used to monitor the inequality levels of countries in the world, see e.g. the UN Development Programme (http://hdr.undp.org/en/statistics/).

Chapter Four

72

focusing on the basic principles of resource sharing is a good “food for thought” that can help for analysing critically real present-time policies.

3. Formalizing basic concepts in the distribution of wealth In the following section we discuss the problem of the distribution of wealth at an abstract level, using a networking-based approach. We consider a socioeconomic system that includes a certain number of members: according to the considered scale, the system is made of individuals (within a country) or countries (at worldwide level). At a given time, a generic member i owns a certain amount wi of resources generically labelled wealth. Imagine there is the common will to build a better world. As a simple and effective step towards this aim, it would be an idea to reduce inequality by making the distribution of wealth less uneven (ref. previous section). Analogously to the concept of “excess burden” used in optimal tax theory to refer to the disincentive to produce more if taxation on high incomes is too heavy ʊ an effect that a policymaker wants to minimize ʊ we coin the (slightly provocative) term “excess wealth” to refer to the amount that people in good circumstances could generously give up for solidarity. These resources could be used for instance to implement opportune welfare policies, to improve public functions, etc.; in any case, unlocking them from better off members would ultimately reduce inequality. Denoting by X the target budget, let us suppose the common will is to quantify the individual excess wealth not on a political or doctrinal bases but rather according to an objective criterion fair and agreeable to all members. One may argue that a good criterion is to draw more from better off members than from worse off ones, i.e. a more than proportional rule: this is what happens in real economies when taxing incomes, since progressive taxation is usually recognized by modern democracies as a righteous principle. However, in our hypothetical world, decisions are not taken a priori because nobody wants to impose any doctrine on the others: aiming at implementing a fair policy, members decide to resort to mathematical optimization which will tell them objectively what is the “right” share xi of each member out of the overall ʊ according to some notion of optimality5. Of course, each member can 5

Obviously, it is of interest only the case in which X is much smaller than the

overall wealth

.

(Un)Fair Resource Sharing: A Networking Perspective

73

never provide more than his individual wealth wi. Moreover, the shares xi's are expected to be significantly smaller than wi ʊ reasonably, nobody is interested in implementing deprivation. Given the constraints above, the problem can be written as follows: maximize f(x1, x2, ..., xN) subject to

, 0 ” xi ” wi

where f(x1, x2, ..., xN) is a generic objective function6. The problem turns into the determination of a criterion agreeable to all members, i.e. to choose an appropriate function f. Since members do care about their own individual welfare ʊ likely, in the real world some authority's decision would be needed to ensure they renounce their excess wealth ʊ they would not hesitate to choose the maximization of utility as optimization criterion.

Fig. 3 Example of an (increasing and concave) utility function.

Utility functions are widely adopted by economists to measure the usefulness of economic variables (see e.g. (Gerber & Pafumi, 1998)). In general a utility function is increasing and concave, as depicted in Fig. 3: this reflects the idea that, taking x for instance as wealth, the utility u(x) increases with wealth but the corresponding marginal utility ʊ i.e., the utility brought by a further unit of x, measured by the derivative ʊ conversely decreases. From the utilitarian standpoint, the global optimization criterion is thus to maximize the sum of the individual utilities. In particular, all members wish to own a residual amount wi – xi that satisfies them as much as 6

The formulation is general since any maximization problem can be turned into a minimization problem by considering the objective function with the opposite sign, i.e. –f(x1, x2, ..., xN).

74

Chapter Four

possible, i.e. that brings the maximum utility given the constraints . identified earlier ʊ thus, In principle, the shape of the utility function u might depend also on parameters specific to each member. This is common in engineering systems, where individuals are purposely treated in a differentiated way: in networking, for instance, the objective function actually depends on variable technical aspects like network/channel conditions, level of congestion, temporary failures and ʊ not least ʊ billing rates. Conversely, in socioeconomic systems the dependence on memberspecific parameters appears as a violation of a basic principle of justice called horizontal equity, which states that people in similar circumstances should contribute the same to support government's public functions. In fact, supposing that members let the utility function depend on memberspecific parameters: evidently, they would never agree on the pattern of differentiation and the final result would be nothing else than the triumph of selfishness, since for each member “utility” would translate into a very subjective and customizable concept. In other words, it is difficult to argue that u should differ in shape across different members, given that all members have equal dignity and rights. But even if we accept the possibility of differentiating members according to individual parameters, there would always be great uncertainty in how to model the dependency from specific individual aspects, and any choice would reflect particularistic views. In that case, the most “neutral” choice would be again to let utility depend only on the level of wealth, instead of taking the risk of an excessive penalization for some of the members by wrong assumptions about more individual dependencies ʊ quoting one thought from the great inheritance left by Mandelbrot, “when exactitude is elusive, it is better to be approximately right than certifiably wrong” (Mandelbrot, 1997).

4. Shortening the tail in a fair way The problem formulation is now complete, and the optimization problem can be solved. Adopting the utilitarian objective function one obtains ʊ regardless to the particular shape of u ʊ a scheme called max-min fairness7. As anticipated, this is a fairness criterion adopted in network resource allocation problems. The rationale of max-min fairness, strictly tied up with Pareto optimality ʊ which is 7

The proof is an adaptation from (Coluccia, D'Alconzo, & Ricciato, 2011)

(Un)Fair Resource Sharing: A Networking Perspective

75

achieved when there is no possibility to make a member better off without making any other member worse off ʊ is simple and “egalitarian”: when dividing a scarce resource, everyone has an equal “right” but demands are different in size; hence, intuitively, a fair share would satisfy those with small demands first, and distribute evenly the remaining resources to the others. This procedure maximizes the satisfaction of the minimum demands, hence the label “max-min”.

Fig. 4 Excess wealth under two different fairness criteria (white part of the bar, the gray one represents the residual amount): utility maximization (left) and inequality minimization (right).

Mapping to the considered problem of wealth distribution, the optimization procedure reveals that it is optimal for the sake of utility maximization to equalize the wealth of better-off members. Fig. 4(left) depicts a clarifying graph where each member (N=10 in the example) maps to a vertical bar of height wi. Bars are split in two parts: the white one is the excess wealth xi (if any), while the grey one is the residual part wi – xi. The example shows that the max-min fair scheme is indeed fair, since better off members would give up an amount of wealth linked to their ability-to-pay (white part), while worse off members have no wealth “in excess”. It is worth noting that the optimality of drawing more from better off members is a consequence of the optimization procedure, not an a priori doctrinal axiom. The intuitive explanation is that, given the decreasing nature of marginal utility, renouncing a given amount causes a larger utility loss in worse off members than in better off ones. Remarkably, the result above is independent on the exact shape of the utility function u: it is sufficient the independence on specific individual parameters. All in all, it tells that wealth accumulation should be limited in order to guarantee a fair maximization of the whole socioeconomic system's utility.

76

Chapter Four

To summarise, the implication of this conceptual model can be stated as follows: if we agree that all individuals have equal rights, then the concept of utility ʊ anyhow defined ʊ should not depend on subjective parameters for the sake of distributive justice. In fact, due to the decreasing nature of marginal utility, the same amount of wealth does have more utility in worse off members than in better off ones but no distinction should be made among members in equal wealth conditions ʊ this is exactly the universally agreed principle of horizontal equity. In that case, no matter the particular shape of the adopted utility function, the utility of the whole socioeconomic system is maximized by the max-min fairness scheme, which is also Pareto optimal. This practically results in a limit to the wealth that members should be allowed to accumulate. Finally, consider a different reasoning. Since the ultimate aim of the optimization above is to eventually reduce inequality, one might argue that the best efficient solution would be to determine the scheme that maximally reduces inequality, i.e. that minimizes the Gini coefficient. In that case, it can be shown8 that the optimal scheme would simply deprive better off members of their whole wealth wi, i.e. xi = wi, without affecting all other members (ref. Fig. 4(right)). This is unjust, because it totally penalizes only top-ranked members by considering their wealth as entirely in excess9. The scheme is maximally efficient in reducing inequality but does not actually achieve fairness. Comparing Fig. 4(right) with the maxmin fair scheme of Fig. 4(left) ʊ both have the same constraints, hence the total white area corresponds to the same X ʊ the different fairness of the two cases is evident. Perhaps paradoxically, inequality reduction tout court would require to be unfair with the wealthiest part of society ʊ a kind of retaliation against the “tail that rules the world”?

5. Conclusions Inequality reduction is motivated by the great unevenness typically present in the distribution of wealth, which is generally seen as a bad thing and should be lessened, at least to some extent. We have addressed the abstract problem of determining, in a fair way that does not rest on political or doctrinal assumptions, the amount of “excess wealth” members could give up for solidarity. Assuming that the fundamental principle of 8 9

The proof is an application of constrained optimization, here omitted. Actually, as it can be noticed also in Fig. 4(right), one member contribute with a

share xi ” wi, in order to satisfy the constraint be neglected in our discussion.

. Such technicality can

(Un)Fair Resource Sharing: A Networking Perspective

77

horizontal equity is guaranteed, we have proved that the maximization of the total utility ʊ which would be a “greedy” optimization criterion ʊ actually turns into a limit to wealth accumulation. Simply stated, all members have equal rights hence the concept of utility should not depend on subjective parameters for the sake of distributive justice. In that case, no matter the particular shape of the adopted utility function, utility maximization is probably not conflicting with fairness and implies clipping top-ranked members' wealth. Remarkably, this is a consequence of the optimization procedure, not an a priori doctrinal axiom. Conversely, reducing inequality tout court would paradoxically lead to an unfair deprivation of the whole wealth of top-ranked members. On one hand, this means that the goal of inequality reduction should not be pursued blindly. On the other hand, it suggests that strong inequality calls for policies that limit the excessive concentration of resources, which is the ultimate responsible for the extremely uneven (heavy-tailed) distribution of wealth, a more dramatic aspect than inequality per se. Economic governance is undoubtedly a complex matter, and exposes to the risk of getting lost in details, failing to look at the big picture. We believe that thinking about very basic principles, not related to specific economic doctrines, can provide some “food for thought” useful also in the definition of real economic policies. Besides technicalities, the formal results above ʊ though they are not meant to suggest the “golden rules” of welfare or global fair governance ʊ collectively point to what one might easily expect using common sense and intellectual honesty: we will not go a long way towards a fairer world without unlocking wealth prominently from top-ranked people and countries, a very small percentage owning the vast majority of resources. To this aim, it would be important that politicians pay more attention to heavy-tails and fairness issues, as some scholars have been doing for several years.

References Amiel, Y., & Cowell, F. (1999). Thinking about inequality. Cambridge University Press. Coluccia, A., D'Alconzo, A., & Ricciato, F. (2011). On the optimality of max-min fairness in Resource Allocation. Annals of Telecommunications. Cornia, G., & Court, J. (2001). Inequality, Growth and Poverty in the Era of Liberalization and Globalization. UN University World Institute for Development Economics Research (UNU/WIDER). Cowen, T. (s.d.). The Inequality That Matters. Available at http://www.the-american-interest.com/article-bd.cfm?piece=907

78

Chapter Four

Gerber, H., & Pafumi, G. (1998). Utility Functions: From Risk Theory to Finance. North American Actuarial Journal, 2 (3). Le Baudec, J.-Y. (2007). Rate adaptation, Congestion Control and Fairness: A Tutorial. Ecole Polytechnique Fédérale de Lausanne (EPFL). Mandelbrot, B. (1997). Fractals and Scaling in Finance: Discontinuity, Concentration, Risk. Springer-Verlag. Mandelbrot, B., & Hudson, R. (2004). The (Mis)behavior of Markets. Basic Books. Porter, E. (2011). The Price of Everything: Solving the Mystery of Why We Pay What We Do. Portfolio Hardcover. Tuomala, M. (1990). Optimal income tax and redistribution. Oxford University Press. Wilkinson, R., & Pickett, K. (2009). The Spirit Level: Why More Equal Societies Almost Always Do Better. Allen Lane publisher. Willinger, W., Alderson, D., Doyle, J., & Lun, L. (2004). More "Normal" Than Normal: Scaling Distributions and Complex Systems. AQM.

SECTION II – MULTILATERAL INSTITUTIONS AT A CROSS-ROAD

CHAPTER FIVE THE G20 AT THE UN ECOSOC: A COMPLEMENTARY PERSPECTIVE CLAUDIA CINELLI

Abstract This paper proposes how to combine the G20 with the United Nations (UN) institutional-system. Namely, it advocates enhanced capacities of the ECOSOC within global economic governance in order to open new prospects for the G20 presence at the ECOSOC pursuant to a teleological interpretation and application of the UN Charter, i.e. an interpretation and application of the Charter in light of UN purposes and principles. Particular attention is paid in Chapters IX and X to ‘International Economic and Social Co-operation’ and ‘Economic and Social Council’ respectively.

1. Introduction This study deals with the role of the Group of Twenty (G20) within global economic governance and is concerned with the questions of its international legitimacy and effectiveness. It is particularly important for a forum such as the G20 to be restricted in order to ensure the effectiveness of its financial activity at a global level. Hence, the effectiveness of the G20 ultimately depends on its restricted and economically powerful membership, and its decisions do not carry the legitimacy, transparency or accountability enforceable on the international community. However, the

Claudia Cinelli, LL.M., Ph.D., is adjunct professor (International Law Institute, University of Pisa) and asistente honoraria (International Law Department, University of Seville)The manuscript was written in autumn 2011. Last updated: 31st October 2012.

The G20 at the UN ECOSOC: A Complementary Perspective

81

legitimacy solution should not be sacrificed for an effectiveness solution or vice versa. The United Nations (UN) is the only global group,i.e. the G192, with universal participation and unquestioned legitimacy whose effectiveness is necessary if global governance is to successfully tackle time-sensitive problems that can have serious global consequences, including those in economic and related fields. On 8th December 2010, the UN General Assembly passed a Resolution on ‘The United Nations in Global Governance,’ through which it requested the UN Secretary-General to submit, at its 66thSession, an analytical report focusing on ‘global economic governance and development,’ to be prepared in consultation with Member States and relevant organisations of the United Nations system.1 To gather material for the report, on 20th January 2011, the UN Secretary-General Ban Ki-moon circulated a letter to all Member States seeking their views on global economic governance and development. An informal summary of the responses has been recently published.2 This summary pays attention to, inter alia, the suggestions made by the Global Governance Group (3G) and includes its input on the interaction between the G20 and the United Nations system.3 Indeed, the 3G believes that the G20 –retaining its ability to muster the political will to advance difficult agendas– could provide valuable impetus for a broader economic strengthening and expanding consensus within the group, to address flaws in the global economic and financial system. At the same time, the 3G reaffirms that real and lasting reform of global governance can be achieved only in close collaboration with the United Nations pursuant to a ‘variable geometry’ of varying subsets of countries which either have specific interests or established expertise in the subject matter. Concluding, the 3G is of the view that the G20 could contribute to a stronger and more coherent framework of global governance by ensuring that the G20 process complements the United Nations system.4

1

A/RES/65/94, 8 December 2010. A/65/857 [annex], 3 June 2011. 3 Ibidem. As far as the 3G composition is concerned, it comprises the following Member States of the United Nations: the Bahamas; Bahrain; Barbados; Botswana; Brunei Darussalam; Chile; Costa Rica; Finland; Guatemala; Jamaica; Kuwait; Liechtenstein; Malaysia; Monaco; Montenegro; New Zealand; Panama; Peru; the Philippines; Qatar; Rwanda; San Marino; Senegal; Singapore; Slovenia; Switzerland; the United Arab Emirates; Uruguay and Vietnam. 4 A/C.2/66/3, 5 October 2011. 2

82

Chapter Five

As informally reported by the UN General-Secretary in June 2011,5 the main substantive features of the 3G inputs on the interaction between the G20 and the UN are, among others, related to the fact that several countries called for the strengthening of the United Nations Economic and Social Council (UN ECOSOC) to fully meet its mandates, further suggesting that: The annual meetings of the Economic and Social Council, the Bretton Woods institutions, the World Trade Organisation and the United Nations Conference on Trade and Development (UNCTAD) could ultimately result in a negotiated statement that includes the G20.6

A few months later, on 11th October 2011, the UN General-Secretary formally stated in its Report on ‘Global Economic Governance and Development,’ that: ECOSOC is the main UN body tasked with ensuring co-ordination, coherence and co-operation among the relevant economic and social bodies. However, the powers assigned to it have been weak and not fully exercised. While the UN Charter gives ECOSOC responsibility for making recommendations and taking decisions, these are not binding on Member States or specialised agencies. Consequently, while UN Member States repeatedly re-affirm the role of ECOSOC in promoting the overall coherence, co-ordination and co-operation of UN system activities in economic, social and related fields, the Council continues to face difficulties in effectively fulfilling this role. […] In view of its coordinating role, ECOSOC would be the ideal forum in which issues and gaps related to the global economic governance architecture are assessed. Options to increase the credibility and effectiveness of ECOSOC on the policy front include stronger relations with the BWIs [Bretton Woods Institutions], WTO [World Trade Organisation] and other relevant stakeholders, both at the secretariat and inter-governmental levels.7

Without forgetting that the UN function of efficacy depends ultimately on the will of the Member States, nothing seems to actually prevent a 5

Supra note 2. See, ‘Views provided by Member States on global economic governance and development,’ Informal summary by the Secretariat, par. 6.The informal summary and the views of Member States are available at the UN Section on ‘Financing for Development,’ Global Economic Governance official website: http://www.un.org/esa/ffd/economicgovernance/index.htm 7 Report on ‘Global Economic Governance and Development,’ 11t October 2011, advanced unedited version, available at Global Economic Governance official website, cit. [The emphasis is mine]. 6

The G20 at the UN ECOSOC: A Complementary Perspective

83

complementary interaction between the G20 and sections of the UN, particularly the ECOSOC. This paper proposes how to combine the G20 with the United Nations institutional system. Namely, it advocates enhanced capacities of the ECOSOC within global economic governance in order to open new prospects for the G20 presence at the ECOSOC pursuant to a teleological interpretation and application of the UN Charter, i.e. an interpretation and application of the Charter in light of UN purposes and principles. Particular attention is paid in Chapters IX and X to ‘International Economic and Social Co-operation’ and ‘Economic and Social Council,’ respectively. The study starts with a brief analysis of global economic governance focusing on the G20 representativeness and effectiveness (2), and follows with a reflection on current developments dealing with the next steps in the strengthening of ECOSOC, while at the same time it shows the need for complementary interaction between the ECOSOC and the G20 (3).

2. Global economic governance, soft law and the G20 The terms ‘global governance, ’‘soft law’ and G20 are very controversial terms within the legal strict sensu context of International (Economic) Law. According to the aforementioned UN General-Secretary report on ‘Global Economic Governance and Development,’ the term ‘global economic governance’ refers to the role of multilateral institutions and processes in shaping global economic policies, rules and regulations.8 Namely, global economic governance is characterised by the evolving system of political and economic co-ordination at different levels pursuant to the implementation of soft law rules, i.e: Rules which are neither strictly binding nor completely void of any legal significance.9 8

Report on ‘Global Economic Governance and Development,’ cit, par.3. Bernhardt, ‘Customary International Law,’ 7 Encyclopaedia Public International Law (1984), p. 62; R. Baxter, ‘International law in ‘her infinite variety’, 29 ILCQ (1980) 549. See, among others, Chinkin, ‘The challenge of soft law: development and Change in international law,’ 38 International & Comparative Law Quarterly (1989) at 850-866; Weil, ‘Towards Relative Normatively in International Law?’, 77 AJIL (1983) at 413-442; Charney, ‘Universal International law,’ 87 AJIL (1993) at 529-551; Hillgenberg, ‘A fresh look at Soft Law,’ 10 EJIL(1999) at 499-515. See, among other, McNair, Law of Treaties (Oxford: OUP, 1961) at 501-509 and 513-14; Shelton, Commitment and Compliance. The role of non-binding norms in 9

84

Chapter Five

There is no consensus on what soft law stands for, but in the context of this study it is a convenient label for a variety of non-binding tools that State and non-State actors resort to in order to regulate their interactions in the international arena. It permits a dialogue of all concerned entities in a process of transnational economic law-making without requiring the ceding of formal State sovereignty and, in so doing, draws on one of the major advantages not available to the political and economical structures of traditional hard law-making. Therefore, soft law can and does play a crucial role in establishing global economic networks: the institutional aspects of global economic governance, particularly, those of the G20. But, what is the G20 in International Law? As early as 2009 the former Soviet leader, Mikhail Gorbachev, affirmed that: [the G20] is now an established forum, a recognition, belated in my view, that the world has changed and that the old institutions have not kept pace with rapidly evolving needs. […]. What is this group: a “global politburo,” a “club of the powerful,” a prototype for a world government? How will it interact with the United Nations? I am convinced that no group of countries, even if they account for 90% of the world economy, could supersede or substitute for the United Nations. […]. To avoid mistakes the G20 must be transparent and work closely with the UN At least once a year, its summit meetings should be held at UN headquarters. It should submit a report for substantial discussion to the General Assembly.10

Furthermore, from the Norwegian perspective the G20 is: One of the greatest setbacks since World War II.

Just like the other 173 countries, Norway has no voice (or a very weak voice) within the G20, although it is the largest contributor to development programmes in the World Bank and the United Nations, but it is not a member of the European Union (EU) and is thus not represented in the G20, even indirectly.

the international legal system (Oxford: OUP, 2000); Sztucki, ‘Reflections on International Soft Law’ in Ramberg, Festeskrift till Lars Hjerner, Studies in International Law (Stockholm: Norstedts, 1990) at 549-575; Boyle, ‘Soft law in international law-making’ and Shelton, ‘International law and ‘Relative Normativity’ in Evans, International Law 2ed. (Oxford: OUP, 2006) at 141-187. 10 ‘What Role for the G20,’New York Times, 27 April 2009. Text available at http://www.nytimes.com/2009/04/28/opinion/28iht-edgorbachev.html [The emphasis is mine].

The G20 at the UN ECOSOC: A Complementary Perspective

85

Recently, the Norwegian Foreign Minister, Jonas Gahr Støre, argued that the G20 undermines the legitimacy of international institutions set up in the aftermath of World War II, particularly organisations like the International Monetary Fund, the World Bank and the United Nations, and considers that: The G20 is a self-appointed group. Its composition is determined by the major countries and powers. It may be more representative than the G7 or the G8, in which only the richest countries are represented, but it is still arbitrary. We no longer live in the 19thcentury, a time when the major powers met and re-drew the map of the world. No one needs a new Congress of Vienna.11

Against this background, the next sections deal with G20 representativeness (2.1) and effectiveness (3.1).

2.1 G20 representativeness This Section offers an overview of the G20 membership and its composition (2.1.1), and focuses on the representativeness of such a forum of the world’s most powerful major industrial democracies which is serving de facto as an (un)representative, and thus (il)legitimate, subset of the global economic governance it seeks to lead (2.1.2). 2.2.1G20 Membership and its Composition The G20 is a group of Finance Ministers and Central Bank Governors from twenty major industrial economies with systemic significance for the international financial system12. It is composed of 19 States, including 11 ‘Norway Takes Aim at G20,’ Spiegelonline, 22 June 2010. Text isavailable at: http://www.spiegel.de/international/europe/0,1518,702104,00.html 12 The G20 was created in response to the G7 Finance Ministers’ Report to Heads on Strengthening the International Financial Architecture, which was endorsed by G7 leaders at the Köln Summit in June 1999, in order ‘to establish an informal mechanism for dialogue among systemically important countries within the framework of the Bretton Woods institutional system’. Since 1986, the G7 finance ministers’ grouping has proven to be an effective forum for informal and substantive discussion of important international economic issues, leading to greater understanding and co-ordination among policy makers in the G7 countries. Cf, among others, P. I. Hajnal, The G8 system and the G20. Evolution, Role and Documentation, Ashgate, 2007; R. Samans, M. Uzan and A. Lopez-Carlos, The International Monetary System, the IMF, and the G20, Palgrave, 2007; L. Martinez-Diaz and N. Woods (eds) Networks of Influence: Developing Countries

86

Chapter Five

those which compose the G7/8, i.e. Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, the Republic of Korea, Turkey, the United Kingdom and the United States of America, and the EU which is represented by the rotating Council presidency and the European Central Bank.13 The G20 held its inaugural meeting on December 15-16th1999 in Berlin. The meeting was chaired by Canada’s Finance Minister, Paul Martin, and hosted by German Finance Minister, Hans Eichel. After the aforementioned meeting, the 1999 Communiqué was published, i.e. a consensus soft law document, which records the agreements reached and the measures outlined to establish the G20 as an informal forum at an international level.14 At present, it is still not an institutionalized forum15and as such doesn’t have any permanent staff. The G20 meets once a year and its chair rotates between members and is selected from a different regional grouping of countries each year.16 The incumbent chair establishes a temporary secretariat for the duration of its term, which co-ordinates the expert groups –particularly financial expert groups, trade finance expert groups and energy expert groups– and organises its meetings in order to ensure continuity in the G20’s work and management across host years.17 The Ministerial meetings of the G20 include the Finance Ministers, Deputy Finance Ministers and Central Bank Governors of the member countries. In addition, the Finance Minister of the country holding the Presidency of the European Union as well as the President of the European Central Bank participate along with the Managing Director of the IMF, the in Networked Global Order, OUP, 2009; J. Kirton (ed.), The G20 at Ten: Growth, Innovation, Inclusion, Newsdesk, 2008; J. Kirton, J. Daniels and A. Freytag (eds), Guiding Global Order. G8 Governance in the twenty-first century, Ashgate, 2001. 13 Cf. the G20 official website: http://www.g20.org/. As far as the EU and the G20 is specifically concerned, information are available at: http://eeas.europa.eu/g20/ . 14 The text of the mentioned Communiqué is available at the G20 official website, cit.: http://www.g20.org/Documents/1999_germany.pdf 15 Cf. -8/G20 France 2011: http://www.g20-g8.com/g8 g20/g20/english/home.9.html 16 G20 Chairs: 1999-2001 Canada; 2002 India; 2003 Mexico; 2004 Germany; 2005 China; 2006 Australia; 2007 South Africa; 2008 Brazil; 2009 the United Kingdom; 2010 the Republic of Korea, 2011 France, 2012 Mexico. 17 Ministers’ and governors’ deputies meet from time to time to prepare extensive technical work which takes the form of workshops, reports and case studies on specific subjects. Cf. G20 Workshop and Conference at: http://www.g20.org/pub_case_studies.aspx

The G20 at the UN ECOSOC: A Complementary Perspective

87

President of the World Bank, and the Finance Ministers of the countries chairing, respectively, the International Monetary and Financial Committee, and the Development Committee of the IMF and World Bank. On November 14-15th 2008, US President George W. Bush invited the leaders of the G20 members –creating the first ever G20 summit– to Washington DC to respond to the financial crisis that began in the United States in that September. Since then, there has been a summit every year.18 Spain and the Netherlands have been invited to participate at summits19 and the World Bank and International Monetary Fund are usually invited as well. At the discretion of the host, other international organisations have been invited, including the United Nations, the Financial Stability Board, the World Trade Organisation, the Organisation for Economic Co-operation and Development (OECD) and the International Labour Organisation (ILO), as well as the countries holding the chair of several regional organisations.20 Even though the G20 is a group of large countries representing a large part of the world economy and world population, that is not enough to give it legitimacy as a ‘steering committee’ for the global economy, thereby excluding 173 minority countries from having a voice and influence on equal terms within deliberations that ultimately shape and frame their future. 2.2.2 Remarks on the G20’s representativeness The G20 reflects a troubling trend towards ‘plurilateralism of the big.’21 It has no legal standing, binding authority or secretariat, yet it is a result of the combined economic weight of its member States.

18

Washington Summit, November 14-15, 2008; London Summit, April 1-2, 2009; Pittsburg Summit, September 24-25, 2009; Toronto Summit, June 26-27, 2010; Seoul Summit, November 11-12, 2010; Cannes Summit, November 3-4, 2011; and Los Cabo Summit, 18-19 June 2012. See, also, G20 Summits Bibliography available at: http://www.g20.utoronto.ca/g20leadersbook/bibliography.htm 19 España ante el G20: una propuesta estratégica sobre una inserción en la nueva gobernanza global, Working paper, 31 March 2009, quoted by JA Carrillo Salcedo, ‘Formaciones G en las Relaciones Internacionales contemporáneas’, Real Academia de Ciencias Morales y Políticas, 23 November 2010. 20 For example, at the Seoul Summit, Vietnam was invited as chair of the Association of South East Asian Nations (ASEAN), Malawi as the chair of the African Union (AU) and Ethiopia as chair of the New Partnership for Africa’s Development (NEPAD). 21 JakobVestergaard, The G20 and Beyond. Towards effective global economic governance, Danish Institute for International Studies Report, 2011.

88

Chapter Five

It is against this background, that the following two matters need to be examined as concluding remarks on the G20’s representativeness. Firstly, there are no formal criteria for G20 membership, and the composition of the group has remained unchanged since it was established although, for example, the representation of Africa in the G20 is still almost non-existent, despite the fact that the recent G20 Ministerial Meeting on Development (Washington DC, 23rd September 2011) aims, inter alia, at improving global food security through a set of concrete actions in Africa.22 Moreover, it welcomes the proposal to open its membership of the Infrastructure Consortium for Africa (ICA). The ICA is not a financing agency but acts as a platform for Africa, despite having almost no African representatives, in order to catalyse donor and private sector financing of infrastructure projects and programmes in developing countries of that Continent.23 Secondly, there is no formal authority to make rules or resolve disputes, no formal process for decision-making, such as votes or resolutions on the basis of fixed voting shares or economic criteria. Every G20 member has one ‘voice’ with which it can take an active part in G20 activities for achieving consensus in the context of global economic governance. Beyond the representativeness of legitimized international entities, the G20 is currently producing global pluralistic measures as a self-organised process of structural coupling of ‘law’ with on-going globalized processes of a highly specialized and technical nature. As Shaw suggested: Globalization must be the way in which things are made global.24

Mutatis mutandis, global economic governance should be characterized by global representativeness, i.e. the UN as G192. In stark contrast, the G20 pretends to lead global economic governance while it is composed of just twenty of the selected major industrial economies, so far excluding the rest of the world and its emerging economies. 22

G20 Ministerial Meeting on Development-Communiqué, 23 September 2011, Washington DC, USA, par 5. 23 In fact, ICA members include the G8 countries, the World Bank Group, European Commission, European Investment Bank, the African Development Bank Group and the Development Bank of Southern Africa. More information available at: http://www.icafrica.org/en/about-ica/ 24 Shaw, Theory of the Global State. Globality as an unfinished revolution, CUP, 2000, at 9.

The G20 at the UN ECOSOC: A Complementary Perspective

89

2.3 The G20’s effectiveness Taking into account the unclear distribution of competences given by hard law and soft law within global regulatory regimes and the highly political nature of international economic forums, the following sections focus on the impact of the G20’s soft law instruments on global economic governance (2.3.1) and to what extent such instruments are effective for accomplishing tasks with good governance standards (2.3.2). 2.3.1. The G20 and soft law: ‘the strength of the weak ties’ The G20 is not an international organisation and par nature it cannot adopt legally binding instruments. However, to be not legally binding does not mean to be ineffective. Its effectiveness may be measured in terms of the operational capacity of a more permissive financial structure which permits cheating when necessary. Basically, the G20 transmits its soft law documents to the Governments of the States that compose it, and to the financial institutions for implementation. Just like any rule, soft law is only effective to the extent that there is a political will to give effect to it at national and international levels. So ultimately the G20 is a voluntary and informal tool for global governance, which lacks the means to enforce its decisions, while showing ‘the strength of the weak ties’ in so far as it does not supply States with as much diversity of interactions among them (strong ties) as between them and other international forums (weak ties).25 Accordingly, the G20 may be able to enhance its influence on States’ behaviour (as uti singuli and/or uti universi through universal international financial organisations) by creating or maintaining ‘weak ties’ that allow them to achieve results that are otherwise not accessible via ‘strong ties.’ Finally, the G20 seemingly aims at designing and implementing a global regulatory regime where twenty entities use their power and tools to restructure financial institutions. As is shown by the progress report on economic and financial actions prepared by Korea in advance of the Seoul Summit, the last decade seems to illustrate important changes that States have endured in their evolution from a State-centric approach to an international capital market approach

25

The wording is borrowed from the American sociologist Mark Granovetter’s work, The strength of weak ties (1973).

90

Chapter Five

in light of global economic pressures under the G20 leadership.26 At the Seoul Summit, through the Seoul Development Consensus for Shared Growth, the G20 sought to both add value to, and complement, existing development commitments,particularly those made at the recent HighLevel Plenary meeting on the Millennium Development Goals, and in other forums.27Moreover, concrete actions and outcomes were set out to be delivered and developed over the medium term with progress to be monitored, in the Multi-Year Action Plan, including a G20 Agenda for action on combating corruption, promoting market integrity and supporting a clean business environment, as is shown by a table on policy commitments of G20 members.28 Indeed, after more than ten years of practice, it seems that the G20 has become a world leader in managing global economic governance.29

26 Progress report on the economic and financial actions of the London, Washington, and Pittsburgh G20 Summits prepared by Korea on 20 July2010, in advance of the November 2010 Seoul Summit. Available at: http://www.g20.org/Documents2010/07/July_2010_G20_Progress_Grid.pdf. See also, C. Stoltenberg, ‘The Past Decade of regulatory change in the US and EU capital market Regimes: An evolution from National Interests toward International Harmonization with emerging G20 leadership’, Berkeley Journal of International Law, vol. 29, n. 2, 2011, pp. 577-648. 27 The Seoul Development Consensus for Shared Growth, Annex I of the Seoul Declaration of 11-12 November 2010. Available at: http://www.g20.org/Documents2010/11/seoulsummit_annexes.pdf 28 Annex II and Annex III of the Seoul Declaration of 11-12 November 2010, ibidem. 29 The G20 were tasked by the Pittsburg Summit to progress work in the following areas: A Framework for Strong, Sustainable, and Balanced Growth; Strengthening the International Financial Regulatory System; Modernising our Global Institutions to Reflect Today’s Global Economy; Reforming the Mandate, Mission, and Governance of the IMF; Reforming the Mission, Mandate, and Governance of Our Development Banks; Energy Security and Climate Change; Strengthening Support for the Most Vulnerable; Putting Quality Jobs at the Heart of the Recovery; An Open Global Economy. However, in the words, for example, of Vicente Palacio, Subdirector del Observatorio de Política Exterior Española, ‘los exclusivos ‘clubs-G’ de poderosos realmente gobernaban muy poco; en las finanzas, las migraciones globales o el cambio climático se han mostrado ineficientes. El fracaso al abordar asuntos como la repentina escalada de los precios del petróleo, la crisis alimentaria, el sida, el hambre en África, la ayuda al desarrollo o la eliminación de la deuda de los más pobres, ha puesto de manifiesto un sistema con el aire viciado’ [‘¿Presentes en la creación?España tras la Cumbre del G20’, in Política Exterior, nº127, January-February 2009, pp. 81-92, p. 84].

The G20 at the UN ECOSOC: A Complementary Perspective

91

Mutatis mutandis, at the Cannes Summit on 3-4th November 2011, the G20 reaffirmed its commitments to working together and has taken decisions on the reform of BWIs and on the agreement on international banking regulations, including decisions on creating jobs, re-invigorating economic growth, promoting social inclusion and making globalization serve the needs of people.30 2.3.2 Remarks on the G20’s effectiveness To devise legitimate and effective solutions, a decision-making mechanism must be a truly representative body. In reality, the locus of the effective economic power seems to be in fact no longer that of the UN legitimised system in accordance with an institutionalized international economic order which could better meet the needs of people in developing countries. Even the European Parliament in its Report on Global Economic Governance, adopted on 12th October 2011, underlines, to some extent, the effective role played by the G20 when showing its support to: The work and commitments of G20 States to implement properly phased growth-friendly fiscal consolidation plans in the medium term while supporting domestic demand at a pace determined by each country’s circumstances, pursuing appropriate monetary policies, enhancing exchange rate flexibility to better reflect underlying economic fundamentals, and undertaking structural reforms to foster job creation and contribute to global rebalancing.31

However the European Parliament: [n]otes that these institutions and forums, in particular the G20, lack a certain parliamentary legitimacy at the global level, and consequently calls on them to involve parliaments in their decision-making processes; deplores the democratic shortcomings of some partners.32

30

Cf, Cannes Summit Final Declaration, Building our Common Future: Renewed Collective Action for the Benefit of all, 4 November 2011. Cf. also the British Prime Minister David Cameron’s proposals to strengthen the G20, the Financial Stability Board and the World Trade Organisation and to make global governance more focused on delivering global growth. [http://www.number10.gov.uk/news/pm-launches-global-governance-report/] 31 European Parliament, Committee on Economic and Monetary Affairs, 12 October 2011, par. 9. More information at:http://eeas.europa.eu/g20/ 32 Ibidem.

Chapter Five

92

Remarks on the G20’s effectiveness were briefly expressed in comments delivered by the founder of the G20 research group, Professor J. Kirton. In 2011, on the occasion of the second annual Princeton Global Governance Conference on Rivalry and Partnership: The Struggle for a New Global Governance Leadership, Professor J. Kirton, asked: [j]ust how effective are global governance institutions?

and he continues: [n]ow that the reform of international institutions and their overall architecture has risen to the top of the G20 and global governance agenda along with proliferating proposals for reform, a better understanding of which ones are effective and why is needed to arbitrate the competing claims33.

Finally, he concludes that: [t]o enhance effectiveness through improved monitoring and accountability, several steps stand out as requiring immediate action, both by the institutions themselves and by those outside with a critical contribution to make in this domain. These steps involve better measures, better concepts and better mechanisms.34

Given its broad and general scope, it seems to be convenient to suggest that within the UN Charter there exists a feasible way to fulfil the progressive goals of legitimacy, and effectiveness within good global economic governance. The UN is the only forum capable of guaranteeing universal participation and universal acceptance which provides, under one of the principal sections –the ECOSOC– an institutionalized mechanism for global economic and financial policy-making as a viable alternative to decision-making based on quotas and financial contributions.

33 Paper prepared for a panel on ‘From Commitment to Compliance: The Challenge of Effectiveness — UN Security Council, IFIs and Gx — Global vs. Regional Organisations’ at the second annual Princeton Global Governance Conference on ‘Rivalry and Partnership: The Struggle for a New Global Governance Leadership,’ Princeton University, Princeton, New Jersey, January 1415, 2011. Version of January 7. 34 Ibidem.

The G20 at the UN ECOSOC: A Complementary Perspective

93

3. The United Nations, the ECOSOC and the G20 Since 2006 the UN Secretary General Reports on the work of the organisation has begun to show how all of the international actors should be trying to collaborate so as to achieve what none of them areable to achieve on its own. The former Secretary-General Kofi A. Annan added a fifth section on ‘Global Constituencies’ to the four sections of the 2005 World Summit Outcome to cover, for the first time, the area regarding civil society – including academia– and the business community that has not previously been classified as central to the UN’s work35. The idea is not new as the attempt of the Commission of Global Governance at the beginning of the nineties showed, (as will be analysed infra). What is new is the official UN recognition. The current Secretary-General, Ban Ki-moon, reiterated what had been stated by his predecessor, pointing to some important results achieved in the business sector, such as the revised guidelines on co-operation between the United Nations and the business sector36 and the United Nations business website37 which, in the Secretary-General words: are milestones and essential to the modernisation of the Organisation.

At the same time, the Secretary General underlines that: The 2010 session of the multi-stakeholder Development Co-operation Forum of the Economic and Social Council […] permitted an open debate among Member States, civil society, the private sector, parliamentarians and local Governments on promoting and improving development cooperation for the achievement of the Millennium Development Goals.38

ECOSOC actually has a UN Charter mandate to be a policy-making and policy-monitoring body on issues of economic and social development (3.1). Applying the UN Charter, nothing prevents an interaction between the ECOSOC and the G20 to enhance the voice and representation of developing countries within global economic governance (3.2).

35

Official Records of General Assembly, 2006, at 1 and 40-46. The aforementioned Guidelines are available at: http://www.unglobalcompact.org/docs/ 37 Cf. the Official Website: http://business.un.org/en 38 Official Records of General Assembly, 2010, par 162. 36

94

Chapter Five

3.1 Towards the strengthening of ECOSOC At its 3rd plenary meeting, on 10th February 2006, the ECOSOC Council decided that the President of the Council should convene consultations of the Council, on an as available basis, to adapt its agenda and current work methods in pursuance of the World Summit Outcome and the related General Assembly Resolution in this regard, with a view to implementation beginning in 200739. Notwithstanding these efforts, there is still the need to strengthen ECOSOC with a view to enhancing its authority and efficiency as well as its capacity to manage effectively, and in accordance with the purposes and principles of the Charter of the United Nations, operational activities for development of the United Nations system. Looking over the last two decades at the growth of multipolar world economics, the following three sections will briefly describe the failed proposal of a Commission on Global Governance (3.1.1) and a new Economic Security Council (3.1.2), concluding with an overview of the current developments towards the strengthening of the ECOSOC (3.1.3). 3.1.1 A failed proposal: The Commission on Global Governance The Commission on Global Governance (CGG) was established in 1992 in order to enforce global co-operation on pressing international problems, inter alia, securing peace, democracy and sustainable development. The Commission, consisting of 28 individuals, was not an official body of the UN. It was, however, endorsed by the UN Secretary General, Boutros Boutros-Ghali, and funded through two trust funds of the United Nations Development Programme (UNDP). Aside from all the various world conferences,40 in 1995 (the th 50 anniversary of the UN Charter) the CGG filed the report ‘Our Global Neighbourhood’41 in which it advocated the imminent need of: 39

ECOSOC Decision 2006/206. Among others, the Conference on Human Rights (1993); the World Trade Organisation Charter (1994); the UN's World Summit on Social Development (1995), the third meeting of the UN Commission on Sustainable Development held its third World meeting (1995) and the fourth UN World Women's Congress (1995). 41 The report of the Commission on Global Governance, Our Global Neighbourhood, OUP: New York, 1995. See, Chapter I of report of the Commission of Global Governance available from: http://www.sovereignty.net/p/gov/gganalysis.htm. 40

The G20 at the UN ECOSOC: A Complementary Perspective

95

Achieving a higher level of co-operation in areas of common concern and shared destiny.42

For that reason, the Report may be considered the vanguard of emerging global governance led by the UN. The CGG in fact made an unprecedented international effort to draw up the framework for global economics and politics pursuant to the conviction that: Although States are sovereign, they are not free individually to do whatever they want.43

The CGG released its aforementioned report ‘Our Global Neighbourhood’ in preparation for a World conference on Global Governance -in principle scheduled for 1998 - at which official world governance treaties had expected to be adopted for implementation by the year 2000. On 17th September 1999, 56 UN representative Member States (the US excluded) gathered in Vienna where they wrote and signed the UN’s Charter for Global Democracy (commonly known as Charter 99). The first question they asked was: Where should we start? We believe that the answer has to be at the United Nations.

Charter 99 consists of twelve principles regarding openness and accountability, environmental sustainability, equality and justice and establishes procedures for governing nations to interact with each other pursuant to economic security. The twelve principles replaced the recommendations of the CGG’s 1995 report and called directly for global (economic) governance.

42

The report dealt with specific proposals to expand the authority of the United Nations to provide for global taxation, a standing UN Army, an economic Security Council, UN authority over the global commons, including the power of veto of the permanent members of the Security Council. At the same time, it deals with the establishment of new procedures and organs as new ‘Petitions Council’; a new parliamentary body of ‘civil society’ representatives (NGOs); a new Court of Criminal Justice (accomplished in July, 1998 Rome), binding verdicts of the International Court of Justice. Finally, it expanded authority for the Secretary General. See, the report of the Commission of Global Governance, Our Global Neighbourhood, op. cit. 43 Report of the Commission of Global available from: http://www.sovereignty.net.

96

Chapter Five

On 8th September 2000 the UN General Assembly adopted the United Nations Millennium Declaration which recognised the changing international structure and started to proceed with implementing global governance. In order to translate common values into actions,44 the GA identified key objectives to carry out regarding inter alia, peace, security, disarmament, protection of human rights, democracy and good governance. Unfortunately, such common values have not all been translated into actions as yet. 3.1.2 …and the new Economic Security Council Inter alia, the CGG designed a new body for centralising and consolidating policy making for not only world trade, but also for the international monetary system and world development. In particular, the CGG proposed to create a new ‘apex body,’ i.e. a high level steering deliberative-policy group and not an executive agency: the Economic Security Council (ESC),with: The standing in relation to international economic matters that the Security Council has in peace and security matters.

However, the new ESC would have been worked by consensus without veto power by any member in order to continuously assess the overall state of the world economy, to provide a long-term strategic policy framework to promote sustainable development, as well as to secure consistency between the policy goals of the international economic institutions (the World Bank, the International Monetary Fund, the World Trade Organisation, the Global Environment Facility, and others). The Commission recommended that the ESC have no more than 23 members and that it be headed by a new Deputy Secretary-General for Economic Co-operation and Development. Without such a high-level ESC, the Commission feared that: The global neighbourhood could become a battleground of contending economic forces, and the capacity of humanity to develop a common approach will be jeopardized.

The ESC proposal remained just words. However, the UN has never abandoned the idea of providing global leadership as a global economic forum opened up to a plurality of constituencies and international actors 44 With regards to UN Millennium Declarations, all relevant documents are available from http://www.un.org/millennium/

The G20 at the UN ECOSOC: A Complementary Perspective

97

that furnishes opportunities for States to exchanges ideas and positions between themselves and other relevant international entities on almost any issue affecting international relations. For the UN, as for international organisations and for each of its 192 Member States, that basic political fact will remain the challenge in determining the effectiveness of the UN global governance pursuant to the words of the UN Charter Preamble where: ‘We the people’ re-affirm ‘faith in fundamental rights’ pursuant to ‘international machinery for the promotion of the economic and social advancement of all people.

At the end, therefore, the implementation of contributions made by the UN to a just and lasting international legal order ultimately depend upon the political will of its Member States to make the law work and in so doing to adapt international law to the present era of global economic governance. The failed ESC proposal is a good example of such a lack of State political will. 3.1.3 Current developments for the ECOSOC On 7th March 2011, the UN General Assembly had its first round of informal consultations to review the implementation of Resolution 61/16 of the General Assembly on ‘Strengthening of the Economic and Social Council,’ adopted on 9th January 2007.45 This reform process has been on-going since its initial implementation at the World Summit in 2005. In paragraphs 155 and 156 of the World Summit Outcome document, leaders agreed that ECOSOC should function as a: Quality platform for high-level engagement among all actors (Member States, international financial institutions, the private sector and civil society),

and that it should: ‘develop its ability to respond better and more rapidly’ to developments.46 45

See also, the General Assembly Resolution 62/208 and other relevant resolutions. Cf. the Official Website: http://www.un.org/en/ga/president/65/issues/ecosoc.shtml 46 The World Summit Outcome document and related documents are available at: http://www.un.org/summit2005/documents.html

98

Chapter Five

To this end agreement was reached on four points: firstly, hold a biannual, high-level Development Co-operation Forum to review trends in international development and strengthen the link between normative and operational work; secondly, hold Annual Ministerial Reviews for substantive evaluation of progress on the outcomes of UN conferences and summits, including the Millennium Development Goals; thirdly, promote an: Improved, co-ordinated response..

..to humanitarian emergencies; and, finally: play a major role in the overall co-ordination of funds, programmes and agencies..

...ensuring coherence and avoiding duplication of mandates and activities.47 Some days later, on 10th and 11thMarch 2011, the special high-level meeting of ECOSOC with the Bretton Woods institutions, the World Trade Organisation (WTO) and the UNCTD, took place in the UN headquarters, New York. Pursuant to ECOSOC resolutions 2010/26 and 2009/30, the overall theme of the aforementioned meeting was ‘Coherence, co-ordination and co-operation on Financing for Development.’ It consisted of informal thematic debates on, inter alia, the role of the UN system in global economic governance and the need for genuine reform to enhance its transparency and effectiveness and ensure effective accountability and implementation of commitments made in UN processes.48 Finally, in its concluding remarks, the president of ECOSOC underlines that: [t]he UN system is uniquely placed to promote the international development agenda and serve as the major forum for global economic governance. [...] The contribution of the G20 in co-ordinating the global response to the recent world financial and economic crisis was recognised. However, there were real concerns about the lack of representation of most developing countries, particularly the least developed countries. Further steps need to be taken to build on recent measures for constructive engagement between the G20 and the UN, at both secretariat and

47

Cf. the official website: http://www.reformtheun.org/ Cf. the official website: http://www.un.org/esa/ffd/ecosoc/springmeetings/2011/index.htm 48

The G20 at the UN ECOSOC: A Complementary Perspective intergovernmental complementary.49

levels,

and

to

ensure

that

their

roles

99 are

During the substantive session of ECOSOC 2011,50on 11th July, in Geneva at the Palais des Nations, a panel discussion took place. It was chaired by the Vice-President of ECOSOC and concerned ‘Global Economic Governance and Development: Enhancing the coherence and consistency of the international monetary, financial and trading systems.’ The objective of the panel discussion was to explore reforms, initiatives and proposals that could pave the way for a more effective global economic governance system, underpinned by greater legitimacy and accountability. These would include a discussion of ways to forge stronger institutional links between the G20 and the United Nations, as well as ensuring that the efforts of the G20, the UN and other multilateral entities are complementary. During the meeting, the existence of a deficit in coherence and consistency within the existing international monetary, financial and trading systems was underlined. It was pointed out that Member States had proposed that the coherence and consistency of existing multilateral arrangements could be strengthened through the incorporation of a new Global Economic Council that is part of the United Nations system, or through a more pervasive reform of the United Nations Economic and Social Council. Whatever the precise mechanism, the discussion panel underlined that it is essential that the system of global economic governance become more effective, transparent and legitimate in its coherence, co-ordination and oversight of concerted responses to global challenges. At the same time, the panel discussion focused on concerns relating to informal arrangements and ad hoc groupings, i.e. the G7, G8, G10, G20,to deal with demands for a more formal institutional relationship between the UN and the G20. Conscious that the G20 has demonstrated an increased willingness to involve non-Member States and foster engagement with

49

Concluding Remarks by the President of ECOSOC, ibidem, at 4 and 5. As shown by the closing remarks at the substantive session of ECOSOC 2011, the session was primarily under the theme ‘Implementing the internationally agreed goals and commitments in regard to education’ to underscore the importance of education to the attainment of all Millennium Development Goals, and to the sustainable existence of humanity and the environment. See, Statement by H.E. Mr. Lazarous Kapambwe, closing of the substantive session of the Economic and Social Council, 29th July 2011, Geneva. 50

100

Chapter Five

relevant stakeholders within the UN system and beyond, the panel put forward the following for discussion: What should be the modalities of engagement between the UN and the G20?51

The answer is not yet clear.52 Recent proposals for reform deals with the creation of a new mechanism entail establishing a ‘Global Economic Co-ordination Council’ at a level equivalent to that of the General Assembly and the Security Council, while other proponents would preserve the current composition of ECOSOC, but increase its political impact through a Global Leaders Forum of ECOSOC, or L27. The L27 would comprise the leaders of half of ECOSOC’s members, rotating on the basis of equitable geographic representation, or a combination of designated seats plus constituency-based seats.53 According to the General-Secretary: [w]hereas there seems to be widespread agreement on the need for reform of UN bodies such as ECOSOC, there is far less consensus on what needs to be done to achieve this objective. For instance, proposals for instituting a co-ordination and policy-making mechanism either call for the creation of new mechanisms or argue for strengthening ECOSOC and/or other existing bodies.54

However, it seems there is a consensus both on the recognition of the efforts made to improve coherence, co-ordination and harmonization in the United Nations development system facing the complexity of the international economic governance architecture and on the need to explore ways to engage with other forums, e.g. the G20,in order to strengthen their complementarities.

51 Substantive session of ECOSOC 2011, co-ordination segment, Item 6 (a): Follow-up to the International Conference on Financing for Development, panel discussion, ‘Global Economic Governance and Development: Enhancing the coherence and consistency of the international monetary, financial and trading systems’ Monday, 11 July 2011, 3:00 p.m. – 6:00 p.m. Geneva, Palais des Nations, concept note, at 2. 52 Report of the Economic and Social Council for 2011, United Nations, Department of General Assembly Affairs and Conference Services, June 2011. 53 Report of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, 21st September 2009 (A/63/838). 54 See, par 32.

The G20 at the UN ECOSOC: A Complementary Perspective

101

3.2 New prospects for the G20 presence at the ECOSOC These reflections on the possible G20 presence at the ECOSOC are based on, firstly, a brief analysis of the UN objectives in economic and related fields (3.2.1) as well as complementary prospects for the G20 at ECOSOC (3.2.2). 3.2.1 Setting forth the objectives of the UN in economic and related fields Some paragraphs of the Preamble, the Articles 1 (3), 13 (1) (b), 55, 56 and article 62 (1) y (2) may be considered the main provisions of the UN Charter relating to the objectives of the UN in the economic, social and human rights fields. The words ‘shall promote’ in article 55, particularly, set forth the promotion, inter alia, of full economic policy. The problem of economic development in general and, more specifically, the problem of economic development in under-developed countries, has remained in the foreground of the problems with which the United Nations has been concerned from its early days. At its twelfth session, the ECOSOC, in referring to its responsibility for the promotion of economic policy, affirmed that ‘under Articles 55 and 56 of the Charter, the United Nation is under obligation to use all means at its disposal to ensure the steady growth of the world economy and to prevent the emergence of those factors of economic disequilibrium which impair general economic stability and disturb the economic development of under-developed countries.’55 Annual consideration of the world economic situation by ECOSOC became a procedure of ECOSOC after the General Assembly had, at its second session, recommended that the Council: Consider a survey of current world economic conditions and trends annually, and at such other intervals as it considers necessary, in light of the responsibility under Article 55.56

The General Assembly further recommended that the Council make recommendations for action by the General Assembly, Member Governments and the specialised agencies. Pursuant to the request of the General Assembly for:

55 56

GA Resolution 406 (V), 12t December 1950. GA Resolution 118 (II), 31s October 1947.

102

Chapter Five factual surveys and analysis of world economic conditions and trends..

...the Secretary-General has issued an annual World economic Report. At the same time, annual regional economic surveys wereprepared by the secretariats of the regional economic commissions of current economic conditions in their respective regions. Other periodic and special surveys have been prepared on request of the Council such as, for example, a request for an annual survey on economic problems in Africa,57 or for a report concerning the obstacles to the development of international trade.58 It should be noted that on the occasion of the celebration of UNCTAD, a vast group of States –commonly known as the Group of 77– employed the UN as ‘international machinery’ for the integration of developing countries into the world economy, thus progressively obtaining the adoption of the Charter of Economic Rights and Duties of States by the General Assembly at its regular session in 1974.59 Since then the Group of 77 continued, to some extent, to pay attention to economic development matters in light of the current need for global governance. Recently, on 15th March 2011, Argentinean Minister Marcelo Suarez Salvia, on behalf of the Group of 77 and China, convened informal consultations on the review of the implementation of Resolution 61/16 of the General Assembly, on the strengthening of the Economic and Social Council. It was stated that it is important that t ECOSOC has a strengthened role inside the UN –namely, in its relationship with the General Assembly, its subsidiary organs and the Peace Building Commission (PBC)– and outside of the UN in improving its relevancy by exploring its relationships with other interested actors, even though there is no specific reference to the G20.60 The repertory of the practice between 2000 and 2009 of the UN organs on the first part of Article 55 (a) and (b) show the UN’s efforts to realise the idea of global partnership born from the outcome of the 2005 World Summit. The General Assembly has continued to stress that efforts to meet challenges of global governance could benefit from enhanced co-operation 57

ECOSOC Resolution 367 B (XIII), 14t August 1951. ECOSOC Resolution 531 C (XVIII), 4t August 1954. 59 A/RES/29/3281, 12t December 1974. 60 Statement on behalf of the Group of 77 and China by Minister Marcelo Suárez Salvia, permanent Mission of Argentina to the United Nations, at the informal consultations on the review of the implementation of Resolution 61/16 of the General Assembly on the strengthening of the Economic and Social Council. Text available at http://www.g77.org/statement/getstatement.php?id=110315 58

The G20 at the UN ECOSOC: A Complementary Perspective

103

between the United Nations and all relevant partners’ and reaffirmed the central role of the United Nations in the promotion of partnership in the context of global governance.61 3.2.2 The complementary role of the G20 and the ECOSOC As the main problem is the lack of implementation of existing institutional mechanisms, the most appropriate solution seems not to lie in the creation of more legal procedures towards the G20’s institutionalisation, which would probably remain lettera morta. A solution might be to make use of a principal organ of the UN –the ECOSOC– and to effectively place the G20 inside it pursuant to a complementary perspective. The United Nations system and the G20 can complement each other in the field of global economic governance. On one hand, ‘the strength of weak ties’ of the G20 lies in its flexibility, its impetus and its ability to reach consensus and, thereby, facilitate decision-making within the strong ties of the principal organs of the United Nations system, namely ECOSOC. Generally speaking, indeed, the strength of the United Nations lies in its universality, its legitimacy and, where necessary, the binding commitments that unite its Member States. Complementarity between the United Nations and the G20 could be strengthened by making the most of their respective advantages. Hence, it is not a question of a substantive reform of ECOSOC, but of its ‘revitalisation’ pursuant to a full application of the UN Charter under a teleological interpretation of the existing rules which regulate the institutionalised mechanism of economic co-operation. The ECOSOC was founded as the principal forum to formulate policy and co-ordinate economic, social, and related work of the UN system pursuant to the UN Charter, namely Chapter IX on ‘International Economic and Social Co-operation’ and Chapter X on the ‘Economic and Social Council’. Their respective articles, 57 and 63, actually stipulate that the specialised agencies (including the Bretton Woods institutions): shall be brought into relationship with the UN

by entering into agreements to define the terms of the relationship, and that ECOSOC:

61 Repertory of Practice of United Nations Organs, Supplement No. 10, Article 55 (first part: Article 55 (a) and (b), United Nations, 2010.

104

Chapter Five may co-ordinate the activities of the specialised agencies through consultation with, and recommendations to, such agencies and through recommendations to the General Assembly and to the Members of the United Nations.

To ensure the complementary role of different entities within global economic governance, the benefits of a legitimate forum (ECOSOC), constituency system-based specialised agencies (the Bretton Woods institutions) and the ad hoc informal Groups (G20)would be combined. On one hand, nothing prevents the Bretton Woods institutions from remaining specialised agencies, but they could employ a mechanism to report to ECOSOC on the steps taken to give effect to ECOSOC’s own recommendations and to recommendations made by the General Assembly on matters falling within the ECOSOC competence62. Furthermore, ECOSOC observations on these reports may be communicated to the UN General Assembly63 and, at the same time, ECOSOC may furnish information to the UN Security Council and could assist the Security Council upon request64. On the other hand, the G20 could be transformed into an integrated standing and ad hoc high-level ministerial committee of ECOSOC pursuant to its rule of procedure (Rules 24-27). In that respect, the G20 (Chair) would engage in the high-level dialogue that opens the Council’s annual substantive session, along with the International Monetary Fund and the World Bank. The Council would formally acknowledge the agenda of the G20 Chair and the President of the Council would participate in the work of the G20. Mutatis mutandis, in order to integrate the G20 into ECOSOC, it would be sufficient – jointly with the Member States’ political will–to construct a teleological interpretation and application of the UN Charter, namely under the: view to creation of conditions of stability and well-being

as established by article 55 of the UN Charter in accordance with one of the UN Charter Preamble’s aims: to employ international machinery for the promotion of the economic and social advancement of all people65. 62

Articles 58, 64 and 66 UN Charter. Article 64.2 UN Charter. See also article 13 (1) (b) UN Charter. 64 Article 66 UN Charter. 65 UN Charter Preamble, paragraph 8. 63

The G20 at the UN ECOSOC: A Complementary Perspective

105

In this sense, the aforementioned article 55 is intended to reinforce and implement the third purpose of the UN, i.e: to achieve international co-operation in solving international problems of an economic […] character66.

4. Conclusion Global economic governance should fit into the UN international legal order. The impact of globalisation on the UN legal order, as informal groups like G20 become relevant and powerful, does not result necessarily in the increasing irrelevance and powerlessness of States as such within the international context of institutional economic co-operation; quite the contrary, since International Economic Law has the potential to strive towards new ways and means for enforcing economics within States and combining the interests of civil society with the power of business. The G20 has become de facto one of the main international forums for economic and financial issues. However, the ‘Global Constituencies’ formula, introduced by Kofi-Annan for the first time in the 2006 UN Work Report as mentioned above, would be an effective tool of multilateralism at the UN as it enables international actors to freely associate with each other, according to the criteria and modalities of their choice. Particularly, ECOSOC provides a forum for such unique combinations thus improving co-ordination and efficiency at inter-agency and operational levels, and enhancing engagement with non-state actors. According to the UN General-Secretary: [t]here is need for enhanced engagement between the UN and the G20. Due consideration should be given to measures to ensure the complementarity of efforts involving the G20 and established multilateral organisations. More appropriate roles for the UN Secretary-General, heads of UN intergovernmental bodies and their representatives in G20 meetings would enable them to more effectively advocate in the broader interests of the world community and enhance relations between the UN and the G20.67

On the other hand, it has to be noticed that on 10th November 2011 the ambassador Jean-David Levitte, diplomatic advisor to the President of France,at the UN General Assembly’s informal meeting on the outcome of the G20 Cannes Summit, stated that: 66 67

Article 1 (3) UN Charter. Report on ‘Global Economic Governance and Development,’ cit., par.78.

106

Chapter Five At the last lesson drawn from our Presidency [...] [t]he G20 has decided to remain an informal body, a body listening to every country, involving the main international organisations and in particular the UN SecretaryGeneral.68

So far, as the body responsible for co-ordinating policy at the level of heads of agencies (including the Bretton Woods institutions), the Chief Executives Board could become a body for promotion and implementation through the Secretary-General. The last would then be responsible for submitting the Board’s proposals to the Economic and Social Council. While ECOSOC cannot adopt any binding instruments, in accordance with article 62 paragraph 3 of the UN Charter, it: may prepare draft conventions for submission to the General Assembly.

At the same time, paragraph 4 of the aforementioned article gives ECOSOC the ability to call: international conferences on matters falling within its competence.

In other words, ECOSOC could recommend new international economic legal instruments and have its 54 members convene international conferences which would take into account several interests between States, financial institutions, the G20 and civil society. In this way, the complementary integration of the G20 into ECOSOC could provide a legitimate and efficient channel to address global economic governance towards the progressive development and codification of International Economic Law.

68 Outcome of the G20 Summit - New York - 10 November 2011, available at the website France at the United Nations: http://franceonu.org/spip.php?article5886

CHAPTER SIX TOWARDS A NEW BRETTON WOODS? THE FINANCIAL CRISIS, THE DOHA ROUND AND THE FUTURE OF THE WTO ROBERTO SOPRANO

Abstract The economic crisis has challenged the role of international organisations and in particular the “Bretton Woods institutions” which have often been criticized for not having provided solutions to economic troubles. The role of the World Trade Organisation in keeping markets open and in avoiding the adoption of protectionist measures has obviously been put under scrutiny. The measures adopted by WTO and non-WTO Members during the crisis offered an opportunity to reflect about possible changes to the WTO system. Crises typically open the door to self-reflection and, thus, to musings about one’s own path. They provide time to reflect about the choices one has taken and not taken and the changes in the environment which require something to be done. Thus, the crisis offered the opportunity to further reflect on the role of the WTO in contemporary society. The world has drastically changed since the end of the Second World War and also (partially) from the 1995 period when the WTO was created. New actors have emerged as China, Brazil, South Africa (and

Post-doc and PhD in international law (University of Salerno) and MILE (WTI). Email: [email protected]. I am extremely grateful to Prof. Giorgio Sacerdoti and Dr Biagio Bossone for the helpful comments and suggestions I received during the conference on “Legitimacy and Efficiency in Global Economic Governance” held in Lecce at the University of Salento. All errors, of course, remain mine.

108

Chapter Six

Russia), which are raising their voice during the Doha Round and the links between trade, and non-trade concerns have become more evident.

1. Introduction Since the end of 2008 we assisted in growing of one of the most profound financial and economic crisis in the history of the world. In many countries around the globe stock markets have fallen, financial institutions have collapsed and governments adopted rescue packages to bail out their financial systems. At the time of writing this contribution, domestic economies and international trade did not recover completely from the crisis and several of the so called “developed” countries are facing the risk of defaults due to their huge sovereign debts. The financial turmoil has been an interesting stress test for international economic rules and international economic organisations. It offered a chance to analyse the role and effectiveness of international economic law and institutions. Since the start of the crisis, governments have adopted several trade and financial measures to counter the negative effect of the crisis which might hide protectionist intents. As the case of Argentina demonstrated in 2002, at periods of crises, countries may more easily be found in breach of trade and investment treaty obligations. The financial turmoil has challenged the functioning and usefulness of international organisations to provide prompt and effective responses to crises. The “Bretton Woods institutions” have often been criticized for not having provided solutions to current economic troubles. The World Trade Organisation has been put under scrutiny as its rules should limit states from adopting protectionist measures. The analysis of the amount and type of trade measures adopted by states since October 2008 provides the opportunity to evaluate whether or not international economic rules had a positive role in limiting the protectionist willingness of governments and to reflect about possible changes of the WTO system. This paper will briefly analyse the trade and trade related measures adopted by WTO and non-WTO Members since October 2008, describe the role of the WTO, its rules and the dispute settlement mechanism activities during the crisis and offers a stimulus for reflection about possible amendments to the WTO legal system. This paper would like to contribute to further the work of the Group of Lecce in proposing economic and institutional reforms, ‘while strengthening economic and financial multilateralism, by reviving the international co-

Towards a New Bretton Woods?

109

operative spirit that inspired the Bretton Woods agreements of 1944 within the global context of our times’.1

2. Trade Restrictive Measures and the Financial Crisis Although G20 leaders agreed on 15th November 2008, to ‘refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing WTO inconsistent measures to stimulate exports’,2 since the end of 2008 states have adopted tariff and non-tariff measures to respond to the financial crisis.3 Several countries have implemented different kinds of measures to restrict trade at the expense of other countries. Emerging economies have resorted mostly to border barriers while the use of stimulus packages or government procurement measures has been most widespread amongst developed countries.4 A joint study of the WTO, UNCTAD and OECD underlined that trade measures were concentrated mainly in the agriculture, textile and automotive industries and that Russia, Argentina and Indonesia have been the most intensive users of trade barriers.5

1

The Group of Lecce, http://www.thegroupoflecce.org/gol/index.php. G20, Declaration Summit on Financial Markets and the World Economy, November 15, 2008. 3 WTO, Overview of Developments in the International Trading Environment, Annual Report by the WTO Director-General, WT/TPR/OV/12, 2009, at A-21, hereinafter the “Annual Report”. 4 In general, measures were applied in the trade in goods sector while services and investment appeared not to be so affected by trade policy. In the area of trade in services, countries are maintaining their trade policies and levels of market access. As for investments, since the crisis began not many potentially trade-distorting investment measures have been adopted although the number of restrictions increased at the end of 2010. Major concerns arose from the fact that some countries (e.g. China and Russia) have recently launched policy measures based on local content, in particular in the automotive sector, attempt to oblige foreign investors to transfer technology to local infant industries. The European Commission, Seventh Report on Potentially Trade Restrictive Measures, October 2010 (hereinafter the “Seventh Report”) at 22. 5 Sectors listed above are traditionally protected industries. The WTO/UNCTAD/OECD report explains that the reason for such protection is due to the fact that these sectors are relatively labour intensive and [...] particularly vulnerable to pressures resulting from job losses and unemployment. The WTO/UNCTAD/OECD Joint Report on G20 Trade and Investment Measures, 2010. 2

110

Chapter Six

Borders measures have been enforced only by some WTO Members though represent the most adopted instruments.6 According to a WTO study, the increase in the use of tariff measures has been relatively rare when considered across the whole WTO membership, even where significant gaps between bound and applied rates have provided scope for increases.7 A report of the OECD underlined that no country has resorted to a general increase in tariffs across multiple sectors (as it occurred after the 1929 crisis) and that they were increased selectively (mainly in the agricultural field). Developing and emerging countries generally have more scope to increase tariffs in this way because the gap between their bound and applied tariffs tends to be greater and because tariffs can be an important source of tax revenue.8 Other border measures adopted include licensing schemes, additional pre-shipment inspections and customs clearance and are generally aimed at creating additional obstacles to imports. According to the European Commission, these measures are mainly used by developing countries as they proved to be the most efficient and simple tool to protect domestic production.9 In addition, export restrictions were increasingly applied by WTO Member countries primarily by developing and the least developed countries, and were mostly applied on agricultural products, minerals and metal products.10 These measures are directed at reducing the domestic export of raw materials or food so as to increase the quantity of these goods in the internal market and thus lower their price to the benefit of domestic users or consumers. On the other hand, these measures reduce the quantity of goods in the international market and thus raise their prices. Some Asian countries (China, Indonesia, India, Pakistan and Russia) adopted export restriction measures. One of the main examples is China who cut export quotas on rare earth minerals which are used in the

6

Cf. the Seventh European Commission Report at 17. WTO Annual Report, at A 23 8 OECD, Trade, Policy and the Economic Crisis, May 2010, at 3 and WTO, Overview of Developments in the International Trading Environment Annual Report by the Director-General, 24th November 2010 WT/TPR/OV/13 (hereinafter “WTO Director General Report”) at 110. 9 European Commission, Fifth Report on Potentially Trade Restrictive Measures, November 2009, at 20. 10 Jeonghoi, K., “Recent Trends in Export Restrictions”, OECD Trade Policy Working Papers n. 101, 19th July 2010, available at: http://www.oecdilibrary.org/trade/recent-trends-in-export-restrictions_5kmbjx63sl27-en 7

Towards a New Bretton Woods?

111

production of high-tech products by 30%.11 As China produces about 97% of the global supply of rare earth minerals this decision has created concerns among other states where producers of high-tech products are located.12 Export restrictions are also of particular evidence in the agricultural field. During the recent food crisis many governments in developing and least developed countries limited the export of food products to ensure food access to the local population but at the same time contributed to increasing international prices.13 According to WTO data, TBT measures have also increased in 2008 and 2009. Developing countries in East Asia and Africa accounted for 80% of all the notification, with China representing the most intensive user as part of a long-term trend that lasted for five years.14 Furthermore, as WTO Members use the TBT Committee as a forum to discuss specific measures adopted by other Members, WTO data has also demonstrated that the number of concerns rose in 2008 and reached its pick in 2009 but decreased in 2010.15 Developed countries have mainly resorted to government procurement and subsidy measures. Government procurements are instruments commonly used during periods of crisis. In the period following the 1929 crisis as well as during downturn economic periods, states have stimulated the demand by enhancing public expenditure through procurement. However, these instruments may hide protectionist intents when aimed at 11

Korinek, J. and Jeonghoi K., “Export Restrictions on Strategic Raw Materials and Their Impact on Trade”, OECD Trade Policy Working Papers n. 95, 29 March 2010, available at: http://www.oecd-ilibrary.org/trade/export-restrictions-onstrategic-raw-materials-and-their-impact-on-trade_5kmh8pk441g8-en. 12 See, China — Measures Related to the Exportation of Various Raw Materials, complaints brought by the United States of America, European Union and Mexico DS 394/395/398. Other examples of export restrictions on raw materials include Kazakhstan (aluminium and oil), Russia (oil) and Turkey (scrap copper). 13 Export restrictions were introduced by Egypt (rice) and Indonesia (cocoa). 14 WTO Annual Report at A 32. 15 The significant increase in specific trade concerns raised in the TBT Committee over the last few years may, to a certain extent, be an indication of the increasingly active participation of Members in the work of the TBT Committee; it may also indicate an enhanced awareness of the importance of the implementation of the requirements in the TBT Agreement. The most frequently invoked reason for raising a concern in the TBT Committee is the need for more information or clarification about the measure at issue. The review of specific trade concerns in the Committee is thus an important monitoring mechanism. WTO, Report to the TPRB from the Director-General on Trade-Related Developments, WT/TPR/OV/W/3, 14th June 2010, at 23 and WTO Director-General, at 34.

112

Chapter Six

excluding foreign firms from contracts. Despite the efforts made on the conclusion of the plurilateral GPA, barriers and lack of transparency remain difficult to monitor. Since the end of 2008, the main (or more evident) concerns were created by the adoption of the so-called ‘buy domestic acts’ that contained provisions on local content. The United States but also China, Russia, Algeria, Brazil and other states introduced internal rules aimed at favouring the conclusion of state’s contracts with domestic entrepreneurs.16 As a part of the stimulus packages implemented in the context of the global financial crisis, developed countries had also recourse to domestic and export subsidies. National producers have received high amounts of subsidies, in particular in the automotive sector. In the banking sector, state interventions were deemed necessary to avoid the collapse and thus restore normal functioning of financial markets (many countries expanded deposit insurance guarantees of bank debt and provided injections of capital).17 Yet Export Credit Agencies supported the export of national entrepreneurs in foreign markets (countries agreed at the OECD to help boost trade and investment through increasing export support mainly through short term programmes).18 Accordingly, as the number and amount of subsidies granted by states increased, the number of countervailing investigations in importing countries followed a similar trend. Countervailing investigations increased in the period October 2008October 2009 and were mainly initiated by developed countries, in particular the United States and almost entirely addressing Chinese products.19 Other trade remedies (anti-dumping ‘AD’, and safeguard ‘SA’ measures) also deserve special attention as they always play a role in period of crises. The WTO reported that after a period of decline (2001-2007), the number of new anti-dumping investigations increased in 2008 and in particular during the end of 2008 and in 2009 but declined in 2010. According to WTO data, in the period July 2008-June 2009, WTO Members initiated 16

European Commission, Seventh Report, at 21-22. OECD, Trade, Policy and The Economic Crisis, at 4; Claessens, S., Dell’ Ariccia, G., Igan, D. and Laeven, L., Lessons and Policy Implications from the Global Financial Crisis, IMF Working Paper WP/10/44 February 2010, at 30 18 OECD, The Global Financial Crisis and Export Credits, TAD/PG (2009) 14/REV 24th July 2009. See also Soprano, R., ‘Doha Reform of WTO Export Credit Provisions in the SCM Agreement: the Perspective of Developing Countries’, Journal of World Trade, 2010 at 612. 19 Data available at the WTO website: http://www.wto.org/english/tratop_e/scm_e/scm_e.htm. 17

Towards a New Bretton Woods?

113

217 new anti-dumping investigations, ‘a 15% increase over the 189 investigations initiated over the previous year-on-year period’.20 The products investigated continued to be metals, chemicals and plastics and China has been the most targeted state. WTO data confirmed that India has been the main user of AD instruments followed by Argentina, Pakistan, China, the US and the EU. Around 80% of the investigations were initiated by developing countries mainly addressing imports from other developing countries.21 Under normal circumstances, safeguards are the least used measures among trade remedies. These instruments are aimed at ‘protecting’ domestic industry in the case where a sudden and unforeseen increase in imports causes or threatens to cause serious injury to the domestic producers of a like product. Differing from anti-dumping and countervailing measures, safeguards are remedies against ‘fair’ trade and thus their use should be strictly limited. Instead, during the period under consideration WTO Members initiated 26 SA investigations, India being the main user of these instruments. In particular, the number of special safeguards against Chinese products has risen due to the increase of investigations by India.22 Similar to other trade remedies, the number of SA investigations decreased in 2010. Last but not least, monetary devaluations have contributed to alter the level playing field in the market. Exchange rate adjustments were substantial and most of the major central banks cut interest rates in order to ease the flow of credit and investment in the markets.23 The EU, US and Brazil have criticised China for keeping its currency artificially low and thus destabilising the global economy.

3. The Role of the WTO during the Crisis The financial crisis has put more emphasis on the role of the WTO as an international organisation whose primary function, in broad terms, is to provide the common institutional framework for the conduct of trade relations among its matters.24 20

WTO, Annual Report, at A-26. WTO, Annual Report, at A-27. 22 Global Anti-dumping database available at http://econ.worldbank.org/ttbd/ (accessed 20 April 2011) 23 OECD, Trade, Policy and the Economic Crisis, at 4. 24 Article II of the Agreement Establishing the WTO. See also, Van den Bossche, P. (2005), The Law and Policy of the World Trade Organisation: Text, Cases and Materials, Cambridge, Cambridge University Press, at 88. 21

114

Chapter Six

The establishment of a permanent fully-fledged organisation is one of the greatest achievements of the Uruguay Round as the ‘predecessor’ of the WTO, the GATT 1947, did not have a formal structure. After the Second World War, the United States initiated negotiations with other countries to create an international trade organisation to complement the existing Bretton Woods institutions.25 The opposition to the creation of the International Trade Organisation coming from the US Congress, which shifted to a stance less liberal on trade matters, impeded its establishment.26 Consequently, the GATT 1947 that was intended to be for temporary use and contained only general principles became (and still is) the backbone of international trade law for almost fifty years. The GATT 1947 did not establish an international organisation (which was supposed to be the ITO) and thus had not a permanent structure and secretariat. However, as noted by Jackson, the GATT was not intended to be a proper international organisation, though it was forced to assume an institutional role.27 State parties used the GATT as a de facto organisation and used the Interim Commission for the International Trade Organisation as its secretariat.28 The creation of the WTO in 1995 as a permanent organisation is based on the insight that an accompanying institutional framework is useful for international law to be effective.29 Accordingly, the WTO has a permanent structure supporting the achievement of the objectives of the organisation. The WTO has different functions listed in Article III of the WTO Agreement: (1) it shall facilitate the implementation, administration and operation, and further the objectives of the WTO agreements; (2) provide a forum for negotiations; (3) administer the Dispute Settlement System30 and (4) the Trade Policy Review Mechanism and (5) co-operate with other institutions to achieve greater coherence in global economic policymaking. 25 Von Bogdany, A. and Wagner, M. (2006), Article I WTO Agreement, in Wolfrum, R., Stoll, P., and Kaiser K. (eds.), WTO: Institutions and Dispute Settlement – Max Planck Commentaries on World Trade Law, Martinus Nijhoff Publishers, at 17. 26 Jackson, J.H., Dawey, W.J. and Sykes, A.O. (2002), Legal Problems of International Economic Relations – Cases, Materials and Text, St. Paul: West Group, 2002, at 211-218. 27 Jackson, J.H. (1997), The World Trading System: Law and Policy of International Economic Relations, Cambridge (MA): MIT press at 59. 28 Von Bogdany and Wagner, supra note 25, p. 18. 29 Ibid., p. 17. 30 The WTO Dispute Settlement System will be analysed in the next paragraph.

Towards a New Bretton Woods?

115

Apart from the first function which is hampered by the very limited powers of the WTO to adopt a legally binding act, the financial crisis has underlined the relevance of the other mentioned functions to preserve trade openness. The WTO Director General has repeatedly stressed the importance of concluding the Doha Round and invited state Members to resume and conclude talks.31 This is important for speeding the recovery of national economies and in particular as a message of reassurance for world financial markets. Concluding the Doha Round would likely have a positive economic and “moral” impact. By agreeing on a final text, countries would give a positive message to the markets reaffirming their intentions to overtake the crisis and their willingness to open up their markets. The WTO lost a chance to become a forum for discussion for the civil society.32 Since the crisis began, the WTO hosted a global forum on the crisis and gave participants the opportunity to present their opinions on the role of trade and the financial turmoil.33 However, apart from this sporadic event, greater openness to NGOs and the general public still remain an issue of concern for the WTO. Since the Ministerial Conference in Seattle civil society has paid much more attention to WTO issues due to the

31

Financial crisis makes the Doha Agreement still more vital, chiefs of UNCTAD, world trade organisation say, 16th September 2008, available at: http://www.unctad.org/templates/Page.asp?intItemID=4609&lang=1 (accessed 20 October 2011) and Lamy: Doha Round conclusion will reassure world financial markets, 12th April 2008, available at: http://www.wto.org/english/news_e/sppl_e/sppl88_e.htm (accessed 20 October 2011). For a contrary opinion see, Meyn, M. et al. “Pursuing a Doha Trade Deal Is a Low Priority”, Overseas Development Institute Opinion 129, February 2009. 32 Van den Bossche, P., ‘NGO Involvement in the WTO: A Comparative Perspective’ Journal of International Economic Law, 2008, 11(4), at 717-749; Blue Jeffords, M., ‘Turning the Protestor into a Partner for Development: The Need for Effective Consultation between the WTO and NGOs’, Brooklin Journal of International Law, 2003, 28 at 937 and Sapra, S., ‘The WTO System of Trade Governance: The Stale NGO Debate and the Appropriate Role for Non-State Actors’, Oregon Review of International Law, 2009, 11, at 71-107. 33 Global Problems, Global Solutions: Towards Better Global Governance, available at: http://www.wto.org/english/forums_e/public_forum09_e/public_forum09_e.htm (accessed 20th October 2011).

116

Chapter Six

intrusiveness of WTO in our lives and the highly sensitive topics discussed in 154, Rue de Lausanne for the entire world.34 The Trade Policy Review Mechanism (TPRM) increased vigilance during the crisis on all WTO Members as ‘protectionist pressures remain and are being generated by stubbornly high levels of unemployment in many countries, persistent global imbalances, and macro-economic concerns’.35 The TPRM is mainly aimed at contributing ‘to improved adherence by all Members to rules, disciplines and commitments made under the multilateral [and plurilateral] trade agreements [...] and hence the smoother functioning of the multilateral trading system, by achieving greater transparency in, and understanding of, the trade policies and practices of all Members’.36 It is a good system of ‘early warning and allows peer pressure to operate before problems evolve into disputes’.37 Although the TPRMs main function is to increase transparency of countries’ trade policies and not to assess their compliance with WTO law (which can only be done through the Dispute Settlement Mechanism), Member states increasingly used the TPRM to express their concerns over the increase in trade restrictions, and called on the WTO to continue with its regular trade monitoring reports. Since 2009, the WTO also started a very useful monitoring of the trade and trade-related measures, adopted by WTO Members and observers, which became a regular function that further strengthens the transparency aims of the Trade Policy Review Mechanism by providing comprehensive information on recent trade policy changes.38 34

Cho observes that “WTO’s engagement and dialogue with NGOs and civil society is a double-edged sword: while it certainly enhances the WTO’s legitimacy through nurturing transparency and promoting PRs, it may also strain the WTO’s resources, distract the Secretariat from its main responsibilities, and even risk undermining the integrity of the WTO through unnecessary and even harmful over-politicization”. Cho, Sungjoon, ‘A Quest for WTO’s Legitimacy’, World Trade Review, 2005, 4, at 391. 35 Trade restrictions on the rise - Lamy, 21st June 2011, available at: http://www.wto.org/english/news_e/sppl_e/sppl196_e.htm (accessed 20th October 2011). 36 Annex 3 of the Agreement Establishing the WTO, Trade Policy Review Mechanism, lit. A (i). 37 Cottier, T. and Oesch, M., (2005), International Trade Regulations: The Law and Policy in the WTO, the European Union and Switzerland, Berne: Staempfli Publisher, at 194. 38 The monitoring exercise further strengthens the transparency aims of the Trade Policy Review Mechanism by providing information on recent policy changes. It is overseen by the Trade Policy Review Body (TPRB), which also conducts detailed

Towards a New Bretton Woods?

117

As for the co-operation with international organisations with the view of achieving greater coherence, the Marrakesh Agreement establishing the WTO explicitly mentions the WB39 and the IMF.40

reviews of members individually. Five comprehensive reports on global trade developments in 2010 were prepared by the WTO Secretariat on behalf of the Director-General. Three of these reports, covering trade and investment measures taken by the Group of 20 (G20) economies, were prepared jointly with the Secretariats of the Organisation for Economic Co-operation and Development (OECD) and the United Nations Conference on Trade and Development (UNCTAD). The other two covered relevant measures taken by all WTO members and observers, and were discussed at TPRB meetings. The Director-General stressed at these meetings that the global crisis and the WTO’s trade-monitoring exercise underlined the importance of increased transparency for the smooth functioning of the multilateral trading system. See, WTO Annual Report 2011, at 78. 39 A good example is the strengthening of the WTO and the WB (and other donors) relations within the Enhanced Integrated Framework for aid for trade in order to achieve Millennium Development Goals. The Enhanced Integrated Framework (EIF) is the flagship of trade-related assistance programmes specifically dedicated to the least developed countries (LDCs). It is an international partnership combining the efforts of the LDCs with those of the six core EIF agencies (the International Monetary Fund, the International Trade Centre, the United Nations Conference on Trade and Development, the United Nations Development Programme, the World Bank and the WTO), donors and other development partners (such as the United Nations Industrial Development Organisation). The EIF sets out to respond to the trade capacity building needs of LDCs and enable them to become full and active players and beneficiaries of the multilateral trading system. Supported by the overarching principle of country ownership, the EIF is the principal mechanism LDCs can call upon to assist them in mapping out their trade priorities, mainstreaming trade into their national development strategies and presenting these to donor partners for funding and implementation. Ibid at 109. 40 Decision adopted by the General Council at its meeting on 7th, 8th and 13th November 1996; Agreements between the WTO and the IMF and the World Bank, Doc. WT/L/194, 18th November 1996. See also the negotiating mandate contained in the General Council Decision on the Relationship between the WTO and the IMF and World Bank, Doc. WT/GC/M/5; Declaration on the Contribution of the World Trade Organisation to Achieving Greater Coherence In Global Economic Policymaking, available at: http://www.worldtradelaw.net/uragreements/coherencedecision.pdf (accessed 20th October 2011); and Auboin M., “Fulfilling the Marrakesh Mandate on Coherence: Ten Years of Co-operation between the WTO, IMF and World Bank”, Discussion paper 13, available at:

118

Chapter Six

The relationships with the IMF on exchange rates have acquired greater importance due to the recent monetary devaluations artificially adopted by some states to enhance domestic export.41 As mentioned in the Coherence Declaration ‘exchange rate stability, based on more orderly underlying economic and financial conditions, should contribute towards the expansion of trade, sustainable growth and development, and the correction of external imbalances’.42 However, trade related aspects of monetary devaluations remain an issue out of the scope of the WTO rules as the agreement concluded by the WTO and the IMF cannot add or modify the rights and obligations of Member states under the WTO Agreements or the IMF commitments.43 In addition, the WTO has often worked with other regional and international organisations, including WIPO, WHO and FAO. With the financial crisis the WTO increased its synergies with other organisations such as UNCTAD and OECD to monitor the attitudes of states in using trade and investment measures.44 Last but not least, the WTO Director-General Pascal Lamy has been very active during the crisis and should not be considered as a “mere spokesperson or market executive”.45 He participated in several meetings http://www.wto.org/english/res_e/booksp_e/discussion_papers13_e.pdf, (accessed 20th October 2011), and Siegel, D., “Legal Aspects of the IMF/WTO Relationship: The Fund’s Articles of Agreement and the WTO Agreements”, available at: http://www.imf.org/external/np/leg/sem/2002/cdmfl/eng/siegel.pdf (accessed 20th October 2011). 41 Provisions referring to the manner in which contracting parties should behave when dealing with monetary issues and the IMF were already included in the GATT 1947, II.6 (a); VII.4 (a and b), XII:2 (a ) (i), XII:3 (d), XIV:1, XIV:3, XIV:3, XIV:5 (a), XV:1, XV:2, XV:4, XV:7 (b), XV:8 and XV:9 (a). However, these provisions do not constitute an institutional structure linking the GATT 1947 and the IMF. Von Bogdany and Wagner, supra note 25, at 29. 42 Coherence Declaration, supra note 39. 43 Appellate Body Report, Argentina — Measures Affecting Imports of Footwear, Textiles, Apparel and other Items, WT/DS56/AB/R, paras. 70-73. 44 WTO/UNCTAD/OECD, ‘Report on G20 Trade and Investment Measures (April 2009 to August 2009)’, (available at: http://www.unctad.org/en/docs/wto_oecd_unctad2009_en.pdf); WTO/UNCTAD/OECD, ‘Report on G20 Trade and Investment Measures (September 2009 to February 2010)’, available at: http://www.unctad.org// en/docs/wto_oecd_unctad2010d1_en.pdf (both accessed 20th October 2011). 45 Reports of the Consultative Board on the Future of the WTO, available at http://www.ipu.org/splz-e/wto-symp05/future_WTO.pdf (accessed 20th October 2011), at 74. See also, WTO Secretariat, (2007) Analytical Index: Guide to WTO Law & Practice, Vol. 2 Cambridge: Cambridge University Press, at 27.

Towards a New Bretton Woods?

119

and conferences with the aim of reminding Member states of the importance of respecting international trade commitments. He also set up monitoring and surveillance mechanism reports addressing the use of trade restrictive measures during the crisis, alone or jointly with other DGs of other international organisations.46 Similarly, the WTO Secretariat, by monitoring trade policy measures enacted by Members in compliance with the principles of independency, impartiality and loyalty, had a more active role in contributing to foster the respect of WTO rules.47 The influence of the WTO Director General’s words, WTO studies and reports (as well as other reports prepared by other international, NGOs and Think Tanks)48 that monitored the behaviour of the states during the crisis, contributed to enhance ‘peer pressure’ on WTO Members and so avoid a rapid escalation of the use of protectionist measures.

4. WTO Law at Time of Crises During periods of crisis it is a common tendency of states to adopt protectionist measures. It is difficult for politicians not to listen to 46 See, Director-General of the World Trade Organisation, ‘Report to the TRPB from the Director-General on the Financial and Economic Crisis and Trade Related Developments’, WT/TPR/OV/W/2 (15th July 2009). 47 It must be the case that the Secretariat has a duty of absolute neutrality, care and respect in dealing with the rights and obligations of Members. The secretariat may not take decisions or act in a manner that prejudices those rights and obligations. However, [...] the Secretariat has a parallel responsibility, as guardian of the system–“Guardian of the Treaties” might be an appropriate expression–to act in the common interest of members. Reports of the Consultative, supra note 44 at 73. Prof. Shaffer stated that “there are reasons to favour enhancing an independent role for the WTO secretariat, at least incrementally. Yet significant checks on such a development remain on account of the WTO’s more politically sensitive policy coverage, its more prominent public profile, and on-going challenges to the legitimacy of its decisions”. See, Gregory C. Shaffer, “The Role of the WTO Director-General and Secretariat”, World Trade Review, 2005, 4:3 at 438 and Footer, M.E., (2006) An Institutional and Normative Analysis of the World Trade Organisation, Martinus Nijhoff Publishers, at 306. 48 See for example, the Global Trade Alert whose objective is ‘to provide real-time information on state measures taken during the current global downturn that are likely to affect foreign commerce, and to identify the trading partners likely to be harmed by these measures, available at: http://www.globaltradealert.org; the EU Commission reports, available at: http://trade.ec.europa.eu/doclib; Global Antidumping Database available at: http://people.brandeis.edu/_cbown/global_ad, (all accessed 20th October 2011)

120

Chapter Six

proclamations of entrepreneurs about possible falls in employment and production. At the same time, governments are aware that protectionist measures would hurt economies, hamper recovery and that trade would be an important tool for lifting the world out of the crisis. It is common practice to compare the current crisis with the Great Depression of the 1930s.49 The 1929 crisis disrupted international economic relationships and unsettled frictions among states after the First World War and did not help the recovery of international trade. A typical example of this era is the 1930 Hawley-Smoot Tariffs Act by which the United States raised average tariffs by 51% and across all sectors. Following the adoption of the aforementioned act, more than sixty nations retaliated against the United States by raising tariffs on all goods and sectors.50 What we have learned from that period is that when states are not bound by rules and thus free to pursue their economic objectives without limitations, they could protect their domestic interests at the expense of other countries. Frictions in international economic relations have often been the main cause of disputes between states and the import restrictive measures enacted in the inter-war period have often been blamed for World War II.51 However, there are several differences between 1929 and the 2009 crisis: states know that ‘beggar-thy-neighbour’ policies have disruptive effects for trade and international relations, economies are more linked and dependent by international trade and, in particular, international organisations and international rules enacted in the post conflict period contribute to prevent the adoption of protectionist measures. As briefly described before, when representatives of states met at Bretton Woods in 1944 they created international economic and financial institutions and rules with the intent to regulate international monetary and commercial relations and prevent the repetition of a possible escalation of protectionist measures.52 They projected a multilateral system in which 49 Ruddy, B., “The Critical Success of the WTO: Trade Policies of the Current Economic Crisis”, Journal of International Economic Law 2010, 13(2), pp. 475495. 50 Jones, J.M. (1934), Tariff Retaliation - Repercussion of the Hawley-Smoot Bill, Philadelphia, University of Pennsylvania Press. 51 In 1944, Howkins stated that “trade conflict breeds non co-operation, suspicion, bitterness. Nations which are economic enemies are not likely to remain political friends for long” quoted in Cottier, T. and Hoesch, M., supra note 36, at 1. See, also Jackson, J.H. (2006), Sovereignty, the WTO and Changing Fundamentals of International Law, Cambridge: Cambridge University Press, at 91. 52 Jackson, J.H. (1968), World Trade and the Law of GATT, Indianapolis: Bob Merrils, at 38.

Towards a New Bretton Woods?

121

states had to abstain from acting by unilaterally pursuing their own interests. One of the main achievements of these theories was represented by the GATT (after the failure of the International Trade Organisation) and subsequently by the WTO.53 The (basic) purpose of GATT and WTO rules is to reduce trade barriers and avoid the use of protectionist measures to ensure markets remain opened. This is mainly based on economic theories under which the lower the number of trade barriers used the more the growing of trade flows, which spreads their potential economic benefits among participants. The role of GATT and the WTO on markets has generally been seen as positive. Multilateral and pluri/bilateral liberalization in the period following the enactment of GATT contributed to the growing of global integration and expansion in international trade. 54 International economic rules are considered ‘a necessary precondition for the proper functioning of markets and for avoiding both market failures as well as government failures directly at their source’.55 According to Van den Bossche, one of the reasons for having international trade rules is that states refrain from adopting trade restrictive measures, so they avoid using mercantilist approaches to protect domestic industry from international competition.56 As Petersmann remarked, international law gives states a chance to resist the ‘song of sirens’ of internal interest groups and lobbies asking for protection.57 In sum, current international rules were (and are) aimed at preserving liberalism and favouring the growth of international trade. Crises are important opportunities to assess the strength of international rules. During crises international trade norms are put to the test and if they fail to resist to stress they probably need to be reformed. The analysis of the measures adopted by states since October 2008 offers stimulus to reflect upon the role and effectiveness of WTO norms. By analysing the 53 Lowenfeld. A.F., (2002), International Economic Law, Oxford: Oxford University Press, at 23-26. 54 According to Lash, “The WTO cannot solve all of our ills. It cannot grow hair, bring about world peace, or whiten your smile. But the economic prosperity of a stable multilateral framework can improve the standards of living around the globe”. William H. Lash III, “The Limited but Important Role of the WTO”, Cato Journal, 2002, 19(3) at 376. 55 Petersmann, E.U (1997), The GATT/WTO Dispute Settlement System: International Law, International Organisations and Dispute Settlement, Boston, Martinus Nijhoff Publishers, at 2. 56 Van den Bossche, P. (2005), The Law and Policy of the World Trade Organisation: Text, Cases and Materials, Cambridge, Cambridge University Press, at 36. 57 Petersmann, supra note 55, at 36.

122

Chapter Six

type and amount of measures adopted by WTO Members, it seems that WTO contributed to keeping markets open even under the stress of the financial crisis. Obviously, it is not possible to assert that all the measures adopted are WTO compliant without a deep case by case evaluation but it seems that Member states have not had recourse to wide economic barriers as in 1929 and used trade policies and instruments within the boundaries set by WTO. WTO agreements have increased legal stability of trading relations.58 The judicial body of the WTO also plays an important role in preventing violation of WTO rules.59 The WTO Dispute Settlement Body (hereafter the ‘DSB’) is one of the main examples of international dispute settlement mechanisms and arguably the most important international tribunal.60 Under article 23 of the Understanding on Rules and Procedures Governing the Settlement of Disputes (hereafter the ‘DSU’) states agreed to settle their WTO disputes through the DSB. The principle of exclusivity of the DSU precluded the possibility for states to act unilaterally to solve their disputes. The DSB has always been very active in settling trade disputes and, due to the crisis the number of controversies and the willingness of unilateral retaliation might arise. However, not all the measures challenged since October 2008 are crisis-related as many cases refer to measures entered into force before the crisis started. It should also be considered that not all the measures adopted during the crisis will be challenged before the DSB. The decision by a WTO Member to bring a lawsuit against another WTO Member is based on legal arguments but also on economic and political reasons. Members should take into account the possible consequences of the lawsuit on the economic and political relationship

58

Gamberoni, E. and Newfarmer, R., Trade protection: Incipient but Worrisome Trends, 2009 available at http://www.voxeu.org/index.php?q=node/3183#fn (accessed 20th October 2011). 59 Sacerdoti, G., “The Dispute Settlement System of the WTO: Structure and Function in the Perspective of the First 10 Years”, Bocconi Legal Studies Research Paper No. 07-03, March 2007. 60 Matsushita, M., Schoembaum, T.J. and Mavroidis, P.C. (2006), The World Trade Organisation – Law, Practice, and Policy, Oxford: Oxford University Press and Sacerdoti, G., Yanovich, A. and Bohanes, J. (2006), The WTO at Ten The Contribution of the Dispute Settlement System, Cambridge, Cambridge University Press.

Towards a New Bretton Woods?

123

with the respondent state. In addition, they should also pay attention to possible retaliations through the use of the DSB by the respondent state.61 Anyway, the mere presence of an effective and rapid dispute settlement system contributes to ensure the respect of WTO rules. The WTO dispute settlement mechanism forces Members to respect binding commitments. The increasing number of disputes brought by developing countries also demonstrates that the DSB is not only an instrument for ‘rich members’ and that they are increasingly investing in the WTO system.62

5. The Financial Crisis and the Doha Round WTO Doha negotiations were already in a period of stall when the crisis emerged in 2008. Thus, the financial crisis cannot be considered as the main cause of the failure of Doha negotiations. There were (and are) disagreements among Members mainly relating to market access formulas for agriculture and non-agriculture products and on the negotiating text on services which create obstacles in the reaching of the consensus necessary for the WTO ‘single undertaking’ decision making system.63 Different positions among states have led to the creation of different groups, in particular between developing countries. If we compare the Doha Round with the Uruguay Round we could probably notice that developing countries, and in particular new emerging economies such as China, India, Brazil (and South Africa), play a more important role in the negotiating process. Furthermore, these countries have also been less hit

61

Van Aaken and Kurtz noted that this assumption is not entirely stable for WTO members -including Argentina, Brazil and India- who have not resorted to largescale bailouts. In fact, the Brazilian Foreign Minister has indicated that Brazil may initiate a WTO challenge to the legality of a ‘Buy American’ clause in the recently approved US economic stimulus package. Van Aaken, A. and Kurtz, J. ‘Prudence or Discrimination? Emergency Measures, The Global Financial Crisis and International Economic Law’, Journal of International Economic Law 2009 at 860. See also Hufbauer G.C. and Schott, J.J. Buy American: Bad for Jobs, Worse for Reputation, Peterson Institute Policy Brief No. PB09-2, 2009 and Soprano, R, ‘WTO and Financial Crisis: What Lessons Should We Learn?’, Journal of World Investment and Trade, 2011. 62 Bown, C. The WTO dispute settlement system would survive without Doha, 19th June 2010 available at http://www.voxeu.org/index.php?q=node/5207 (accessed 20th April 2011). 63 Adler, M., Brunel, C., Hufgauer, G.C. and Schott, J.J., “What’s on the Table? The Doha Round as of August 2009”, Peterson Institute for International Economics, 2009.

124

Chapter Six

by the crisis and are currently driving the growth of international trade.64 With the financial crisis, hierarchy in international economics has definitively changed. The so-called ‘Quad’ economies (Canada, the European Union, Japan, and the United States) cannot take any decisions without consent. Following Russia’s accession to the WTO, BRICS would definitely create a stronger group with a deep influence on many developing countries around the world. The difficulties in concluding the Doha Round demonstrates that it is no longer possible for developed countries to reach an agreement and then impose it on other WTO Members. 65 The financial turmoil had contributed to slow the progress of the Doha Round. It reduced the willingness of states to reform existing rules and further liberalization. States are so concentrated on reducing unemployment, saving domestic banks and companies from bankruptcy that they are reluctant to impose new limits on their policy space and open up their market to foreign competitors. Following the re-start of negotiations, there was widespread support of public opinion on the possible conclusion of the deal before the end of 2011. However, there is no reason to be optimistic at this moment on the possibility to reach a positive output for the negotiations, as differences between positions of developing and developed countries persist.66 This is in contrast with the efforts of the WTO Director General Lamy who has reminded WTO Members the importance of concluding the Doha Round to speed the recovery of international economies and achieve Millennium Development Goals.67 The crisis had demonstrated that WTO might be amended to provide effective responses to crisis. It is of utmost importance that the WTO facilitates the rapid accession of other states and in particular of Russia. As reported in the study of the European Commission, Russia (and Algeria) have adopted among the highest number of trade-restrictive measures during the financial crisis. The accession of these countries would 64 Gushue, K.M., “BRIC Rebounding From the Global Financial Crisis”, KMG Advisors Papers, June 2009. 65 Partially as a consequence of the impasse in multilateral negotiations, the number of regional trade agreement has increased. For detailed data on the RTAs concluded by WTO Members see, the WTO Annual Report, at 54. 66 De Gucht, K. Commissioner De Gucht's INTA Speaking points Committee for International Trade, European Parliament Brussels, 12th April 2011. 67 Lamy, P. Doha Success Will Rebalance Trade Rules in Favour of the Poor, 15th September 2010 and Lamy Stresses Importance of Concluding the Round to G20 Business Leaders, 26th June 2010.

Towards a New Bretton Woods?

125

contribute to bind important economic players to WTO rules. A more global WTO is definitely needed. Although the bulk of WTO rules resisted to the shacking of the financial earthquake and contributed to avoid protectionism and decline in trade flows, the crisis has evidenced the necessity to amend some of the existing rules.68 Firstly, the Agreement on Government Procurement should be extended to new participants. As described before, procurements are widespread instruments used during period of crises which might hide protectionist intents. The progress in the accession of China in the plurilateral agreement makes an important step toward the liberalization in an interesting market for investors.69 Similarly, other WTO Members and in particular, India, South Africa and Brazil should join the agreement. States behaviour during the crisis also underlined the rising importance of non-tariff barriers. The crisis put into major evidence the increasing recourse to non-tariff barriers TBT and SPS by states which might hide protectionist intents. These are the new forms by which protectionism takes place. Not any longer duties and ban over imports but indirect instruments which protect and support domestic producers. These technical instruments are also strictly linked to the increased necessity of aid for trade, in particular, for the support to exporters in developing and least developed countries to meet the standards of conformity required by technical regulations of importing states. As for 68 In its conclusion Prof. Evenett stated: “the creators of the post-war international economic institutions sought to avoid the economic calamity of the 1930s. In light of this, it is natural to ask what the current systemic economic crisis bodes for the future of the multilateral trading system. Having considered both the events over the past 12 months and numerous possible reform proposals, one is tempted to answer "not much." The current global economic crisis has exposed two fundamental mismatches; first, between the capacity and desire of governments to react very quickly (and not necessarily wisely) against the slow-moving WTO dispute settlement system; second, between the wide range of policies available to governments to discriminate against foreign commercial interests and the narrower range of policies subject to WTO disciplines. Unless disciplines across the broad range of policymaking are negotiated and incentives for compliance strengthened then we should not expect much more from the WTO during future crises. So long as the piecemeal structure of the WTO exists, loopholes will continue to exist and will continue to be exploited by desperate officials in times of economic distress”. Evenett, S., “The Role of the WTO During Systemic Economic Crises, Conference Draft”, 10th September 2009, Thinking Ahead on International Trade (TAIT), The Graduate Institute, Geneva. 69 Experts hail China's procurement offer, China Daily, 17th July 2010.

126

Chapter Six

trade remedies, further clarifications on the use of these measures should be included as to avoid their possible misuse.70 With reference to the DSB, we are all aware that the DSB is the ‘jewel in the crown’71 of WTO and that a crisis of the dispute settlement mechanism would lead to a crisis of the whole WTO. The DSU offers an effective response to a violation of WTO norms and is, thus, a deterrent against breaches of WTO rules. The reform of the WTO DSU has started before the crisis begun. However, the crisis offers an opportunity to reflect about its role and possible improvements. One of the main critics to the DSU is related to the effectiveness of dispute settlement process in particular when the disputes oppose weak to strong states. When a Member fail to comply with the report adopted by the DSB, it is possible to ask for retaliatory measure to be imposed against the non-compliant state. However, disagreement on the WTO-consistency of implementing measures and the amount of retaliation remain and delay the end of the dispute. The “sequencing issues” (whether trade retaliatory measures for non-compliance with a ruling could be invoked without first going through a compliance panel process) and the suspension and concession of other obligations should be agreed at the Doha Round. The possibility for the winning state, in particular for less powerful state, to have recourse to effective retaliatory measures would raise confidence in the system and reduce the willingness of states to look for unilateral measures. This procedural improvement would reduce the ‘length of trial’.72 Other amendments might go toward the direction of reducing the duration (in particular for panels) of the proceedings as the creation of a permanent panel body and the adoption of the report in only one language (starting the translation of the reports in the other two official languages after the date of public release). Prompt reports would surely raise the confidence in the WTO and contribute to limit the violation of WTO rules even during

70

Soprano, R., ‘The Threat of Material Injury in Anti-dumping Investigations: A Threat to Free Trade’, Journal of World Investment and Trade, 2, 2010. 71 Broude, T., (2004) International Governance in the WTO: Judicial Boundaries and Political Capitulation London, Cameron May, at 343. 72 See generally, Georgiev, D. and Van der Borght, K. (eds.) (2006), Reform and Development of the WTO Dispute Settlement System, London, Cameron May. According to Van den Bossche, the reasons for exceeding the (six) and nine months time limits are several: selection of the panellists, complexity of the case, availability of experts, scheduling of meetings, translation of the reports. Van den Bossche, at 270. See also, Clough, M., ‘The WTO Dispute Settlement System—A Practitioner Perspective’, Fordham International Law Journal, 2000, at 271

Towards a New Bretton Woods?

127

crises. If Members can rely on a prompt reply from the WTO they would not be attracted by fast unilateral retaliatory measures. In sum, a more effective and rapid system would reinforce the credibility of the WTO system and remind to powerful states that any violation of WTO norm would be promptly and effectively sanctioned.

6. From the Doha Round Towards a New Bretton Woods The financial crisis has challenged the role of international economic and financial institutions. Scholars, heads of states and practitioners have considered the necessity to modify the current international economic and financial system and have called for a new ‘Bretton Woods’.73 Existing organisations have been criticized for not being able to prevent and rapidly intervene in crises. The International Monetary Fund (IMF) has been at the centre of the storm. The financial institution has been accused to not having provided effective remedies to limit the spreading of the negative effects of the crisis. Over the past decades, the international finance has evolved and its legal framework has not followed its development. In addition, the lack of enforcement legitimacy of its rules weakened its powers and role during crises. Everyone is aware that no strategy will be successful if international finance will not be profoundly reformed. A stricter co-operation between the IMF and the WTO would probably contribute to avoid currency manipulation and thus increase financial stability. By enacting new financial rules and linking them to the WTO dispute settlement mechanism would give predictability to the financial management.74 73

As noted in the proposal to Members of the G20 by the Group of Lecce, “The on-going international and financial crisis has raised the issue of reforming the governance of the global economy. The epochal nature of the undertaking has led many observers to evoke the onset of a new ‘Bretton Woods’ era”. The Group of Lecce, Reforming Global Economic Governance, A Proposal to Members of the G20, ISUFI, Lecce 2009, at 12. See also: Mattoo, A. and Subramanian A., ‘From Doha to the Next Bretton Woods - A New Multilateral Trade Agenda’, Foreign Affairs, 2009 and Schwartz, A.J. ‘Do We Need a New Bretton Woods?’, Cato Journal, 2000. 74 Mattoo A. and Subramanian, A., “Currency Undervaluation and Sovereign Wealth Funds: A New Role for the World Trade Organisation”, Peterson Institute Working Papers P08-2, January 2008 and Bergsten, C.F., “Needed: A Global Response to the Global Economic and Financial Crisis”, Testimony before the Sub-committee on Terrorism, Non-proliferation & Trade, Committee on Foreign Affairs, US House of Representatives, March 12th, 2009, at 3.

128

Chapter Six

In comparison with the IMF and the World Bank, the WTO has probably been less criticized. Furthermore, it seems that the WTO had a positive role in keeping market open and avoid rush to the bottom of protectionism.75 The WTO has a complete different role than the WB and the IMF. It does not provide loans or finances or guarantees investment but creates rules for the international trade. During this crisis the WTO had demonstrated to be effective, have a structure and a dispute settlement mechanism that exerted pressure on Members and enable it to prevent states to infringe its rules and thus limit the negative effect of the crisis. Anyway, in addition to amendments discussed during the Doha round, the crisis offered a chance to reflect about the role of the WTO and an opportunity to ameliorate it and to adapt the mandates of international organisations to the challenges of the modern society. After a period of shock, it is time to reflect about what should be changed. The institutions created at Bretton Woods were mainly aimed at regulating economic and financial issues. In the post-war period words as ‘climate change’ and ‘sustainable development’ were not in the mind of funding fathers when drafting international rules. Their intentions were to preserve peace by enhancing financial and economic stability and building a new world trading order. In 2011 we have different necessities, however. The gravest danger to mankind comes from over exploitation of natural resources, scarcity of water and food for a growing population, pollution and climate change. Labour conditions of millions of people in the world are also cause of concerns for our society. These issues should be the subject of international negotiations within the existing organisations. A new conference on WTO should address the points of enabling the WTO to provide responses to new trade and trade related problems. Scholars and practitioners have already started to think about the right manner to introduce trade-related human rights and environment concerns within the WTO context. A new WTO round should include the protection of so called ‘non-trade concerns’ without undermining the effectiveness and reliability of this organisation. It is now time to see whether concepts as ‘development’ and ‘sustainability’ can fit in the WTO context. The WTO should begin to pay more attention to developmental, environmental, human rights, labour standards and other societal concerns. Without a fundamental change in WTO system which ensures that markets serve people and society, any slight reform will merely adjust a nonupdate system and will not address the real needs of our modern society. 75

As noted in the WTO Annual Report 2010, report, despite a number of ‘slippages’, in general terms the world economy is about as open to trade today as it was before the crisis started. WTO Annual Report 2010, p.74

Towards a New Bretton Woods?

129

7. Final Remarks Crises typically open the door to self-reflection and, thus, to musings about one’s own path. They provide time to reflect about the choices one has taken and not taken and the changes in the environment which require something to be done. The financial turmoil is the first global stress test for the WTO since its creation and provides a chance to evaluate the strength and effectiveness of WTO rules. The crisis, which emerged in October 2008, had spread its negative effects around the world and WTO Members have had recourse to the flexibility conceded by WTO rules in order to counter its negative consequences. The measures adopted by WTO Members since October 2008 have challenged the WTO and more in general international economic and financial institutions. It is probably not possible to affirm that all trade restrictive measures adopted during the financial crisis are WTO compliant without a case-bycase evaluation. However, the kind and amount of measures adopted offer a clue to presume that WTO has passed the biggest stress-test and Members respected at least the main bulk of WTO rules. The turmoil showed us that some of the existing measures needed to be amended to avoid disguised restrictions to international trade. The crisis offered also the opportunity to further reflect on the role of WTO in contemporary society. The world has drastically changed since the end of the Second World War and also (partially) from the 1995 period when the WTO was created. New actors have emerged as China, Brazil, South Africa (and Russia), which raised their voices during the Doha Round and the links between trade, and non-trade concerns have became more evident. The new Bretton Woods requested by some scholars and Heads of State, would probably push us to reflect upon new issues that should be addressed by international economic and financial institutions. New states commitments on trade related aspects of human rights, development and environment will contribute to updating the WTO and enlarge its trade strict mandate.

CHAPTER SEVEN CREDIT RATING AGENCIES AND THE EUROPEAN SOVEREIGN DEBT CRISIS: FROM OVERRELIANCE TO (HAZY) REGULATION? LIBORIA MAGGIO  

Abstract Market turmoil, since the wake of the 2007-2008 financial crisis, and then the European sovereign debt crisis, has raised questions about the legitimacy and efficiency of credit rating markets, their accuracy and their conflicts of interest; in particular, it has been questioned the legitimacy of rating agencies to play the role of watchdogs of sovereign issuers in an effective manner and, more generally, to contribute to the efficient functioning of financial markets. In particular, the major international credit rating agencies (CRAs) – “Moody's”, “Standard & Poor’s” (S&P’s) and “Fitch” – are at the core of the current debate regarding their central and controversial role and how to reform sovereign rating markets. We will here focus on the chance to globally reform CRAs’ regulation, trying to overcome regulatory gaps, which should mainly be due to a lack of uniformity in legal frameworks, but especially to a substantial abdication of public authority in respect of private companies, with regard to market surveillance mechanisms aimed at assessing sovereign PhD in Law and Economics at the Scuola Superiore ISUFI – University of Salento and Lecturer in International and European Law at the Faculty of Law University of Salento (Lecce, Italy). Email: [email protected] I am extremely grateful to Prof. Giorgio Sacerdoti and Dr. Domenico Lombardi for the helpful comments and suggestions I received during the International Workshop on “Legitimacy and Efficiency in Global Economic Governance”, held in Lecce at the University of Salento on 6th-7th May 2011.

Credit Rating Agencies and the European Sovereign Debt Crisis

131

borrowers’ creditworthiness. Starting from the basic premises regarding the role of information and trust in financial markets, this paper will firstly focus on the CRAs role in evaluating sovereign issuers, with a special focus on the European case. Then we will examine the new after-crises regulatory framework, especially regarding the European context, highlighting gaps and discrepancies and claiming for a comprehensive multilateral solution involving international fora. ‘There are two superpowers in the world today in my opinion. There’s the United States and there’s the Moody’s Bond Rating Service. The United States can destroy you by dropping bombs, and rating agencies can destroy you by downgrading your bonds. And believe me: it’s not clear sometimes who’s more powerful.1’

1. Introductory remarks International financial crises arisen at the beginning of the twenty-first century have questioned the alleged capacity of the market and its operators of efficiently self-regulating. Following legislative interventions have expanded and strengthened compulsory rules on financial markets, both from a quantitative and qualitative perspective, with the aim to restore investors’ confidence in the securities’ market. In this view, the regulatory framework governing the role and the activity of some key players in financial market has been re-designed and improved, both in the United States and the European Union.2 1 The News Hour with Jim Lehrer: Interview with Thomas L. Friedman (PBS television broadcast, Feb. 13th, 1996, cited in F. PARTNOY, The Paradox of Credit Ratings (2001). U San Diego Law & Econ Research Paper No. 20. Available at: http://ssrn.com/abstract=285162. 2 See, A. MAZZONI Osservazioni in tema di responsabilità civile degli analisti finanziari, in Governo dell’impresa e mercato delle regole, Scritti Giuridici per Guido Rossi, Giuffrè, Milan, 2002, I, 621-2. The Author affirms that searching for a ‘guilty party’ has always been a tool aimed at restraining and exorcising the main issue, which bother policy-makers (even more than the turmoil or the scandal itself): the risk of an uncontrolled spread of distrust in the investment market. In fact, trust is the nourishment without which the assumption underpinning contemporary capitalism would be in crisis, that is the market capability to attract investments and, consequently, to perform its function of their efficient allocation. According to M.C. MALAGUTI, ‘[…]la chiave della fiducia risiede in massima parte nella trasparenza: più il mercato è trasparente, ovvero più gli indici sono conosciuti (anche se non interpretati) e le informazioni rese “pubbliche”, cioè potenzialmente acquisibili da chiunque (anche appunto se incapace di decifrarle o

132

Chapter Seven

In this context, rating agencies are undergoing a stronger regulation process today because they are widely numbered among the major actors having provoked or contributed to the deepening of the crisis, by operating without the necessary fairness and transparency. According to a widespread opinion, this has also been caused by a too hazy and sometimes absent regulation, in a situation where rating on financial products or issuers is the main (and sometimes the only) element for the evaluation of an investment risk.3 At the same time, the onset and increasing severe sovereign debt crisis in Europe4 have generated a new wave of debate on the role and influence of CRAs and about the value and reliability of their evaluations, especially on sovereign issuers. This debate has been further accentuated by the reinforced centrality of credit ratings in the reform and by the implementation of financial regulation, starting from Basel II and persisting, with some different nuances, in Basel III.5

di usarle), più si creano le premesse per la fiducia.’ See, M.C. MALAGUTI, Fiducia e Mercati Finanziari, in ApertaContrada – Riflessioni su Società, Diritto, Economia, 30th January 2009, available at: http://www.apertacontrada.it/2009/01/30/fiducia-e-mercati-finanziari/ 3 See, F. CAPRIGLIONE, I «prodotti» di un sistema finanziario evoluto. Quali regole per le banche? (Riflessioni a margine della crisi causata dai mutui subprime), in Banca e borsa, 2008, I, p.53 ff. 4 The European sovereign debt crisis is an ongoing financial crisis (started in 2009) that has made it difficult or impossible for some countries in the euro area to repay or re-finance their government debt without the assistance of third parties. As regards the European sovereign debt crisis, see ex multis: P. SWARTZ, Greek Debt Crisis—Apocalypse Later, Centre for Geoeconomic Studies, Council of Foreign Relations, 2010; D. ZANDSTRA, The European sovereign debt crisis and its evolving resolution, Capital Markets Law Journal, 6 (3): 285-316, 2011; L. SANDOVAL et al., The European Sovereign Debt Crisis: Responses to the Financial Crisis, New Voices in Public Policy, George Mason University School of Public Policy, Spring 2011; M. GÄRTNER et al., PIGS or lambs? The European Sovereign Debt Crisis and the Role of Rating Agencies, University of St. Gallen School of Economics and Political Science, Dept. of Economics, March 2011 Discussion Paper No. 2011-06; A. AFONSO, P. GOMES and P. ROTHER, What ‘Hides’ Behind Sovereign Debt Ratings?, ECB Working Paper Series, No. 711, January 2007; S. SGHERRI and E. ZOLI, Euro Area Sovereign Risk During the Crisis, IMF Working Paper, No. 222, 2009 5 See, infra, § 4

Credit Rating Agencies and the European Sovereign Debt Crisis

133

Rating has taken over time a proper ‘public function’6 with respect to markets and countries, affecting their choices and fortunes significantly: this is reflected in the increased visibility of the CRAs’ activity and, therefore, in the burden of their responsibility. The purpose for which rating agencies were born and developed was to constitute a third party than the market, able to ensure a support to investors through a judgement on the borrowers’ creditworthiness and to eliminate, or at least reduce, such inefficiencies arising from information asymmetry. Evidence has shown that CRAs inevitably exert a sort of interference in international financial market while carrying out this task, which is at odds with their ‘thirdness.’7 What is now perceived as topical is the legitimacy of rating agencies’ activity to effectively play the role of ‘watchdogs’ of sovereign issuers and, more generally, to contribute to the efficient functioning of financial markets, as well as the regulation of sovereign credit ratings mechanisms. Therefore, there has been a lively debate among scholars about what could be the best action to make credit rating activities the most efficient (and regulated) possible. This topic has been scarcely considered in the past by legal scholars, because too long regarded as economic/financial matter, in spite of the unrestricted power of such agencies in the global financial 6

See, at this regard, L. PIANESI, Le agenzie di rating tra privatizzazione di funzioni pubbliche e opinioni private «geneticamente modificate», Riv. Trim. Dir. Pub., Giuffrè, no.1/2011, pp. 179-213. 7 See, G. DI GASPARE, Teoria e critica della globalizzazione finanziaria. Dinamiche del potere finanziario e crisi sistemiche, Cedam, Padova, 2011. Please consider also the opinion expressed by Italian Judges of the Procura della Repubblica di Trani (Italy), who on 12th November 2012 requested the commitment for trial of some Standard & Poor’s and Fitch managers after the investigation regarding credit rating agencies’ misconduct in Italy. In fact, according to Italian Judges, ‘artifici, posti in essere anche a carattere informativo, hanno fornito intenzionalmente ai mercati finanziari una informazione tendenziosa e distorta, e come tale anche falsata, in merito alla affidabilità creditizia italiana e alle iniziative di risanamento e rilancio economico adottate dal governo italiano.’ This would have occurred in order to ‘disincentivare l’acquisto di titoli del debito pubblico italiano e deprezzarne, così, il loro valore.’ Moreover, these managers ‘ponevano in essere una serie di artifici tanto nell’elaborazione, quanto nella diffusione dei rating sul debito sovrano italiano concretamente idonei a provocare una destabilizzazione dell’immagine, prestigio e affidamento creditizi dell’Italia sui mercati finanziari, una sensibile alterazione del valore dei titoli di Stato italiani, segnatamente un loro deprezzamento, un indebolimento dell’ Euro.’ See, http://www.lastampa.it/2012/11/12/economia/chiusa-l-inchiesta-sulle-agenzie-dirating-la-procura-chiede-sette-rinvii-a-giudizioJSWjkNAeH8dtAIMJv4ExrJ/pagina.html

134

Chapter Seven

market and of the related challenges that it poses on the ground of the principles of legitimacy, accountability and transparency. Our main goal is to highlight those aspects relating to the role and activity of CRAs, with particular regard to their judgements towards sovereign issuers, and regulation of their activity, both at regional and global levels, trying to understand if we should consider them as helpful and necessary actors in financial markets in order to reduce information asymmetries or simply ‘plague-spreaders’ of the financial and economic crisis ; in particular, should we consider rating as a global public good having effects on international financial stability or a mere ‘photograph’ of national/regional economic and financial contexts? In other words, is rating simply the ‘world’s shortest editorial’?8

2. Information and rating: the relevance of trust and certainty in financial markets Markets, not only financial ones, as well as a large part of economic relations are characterized by a lack of information. Relations between players and operators on open, complex and global markets cope with uncertainty, largely generated by insufficient information, although suitable information is a necessary condition to make decisions and choices or to implement rational economic behaviours. Information asymmetry is generally considered as a traditional condition for recurring to regulation by public authority. In fact, the information gap can be reduced through regulatory mechanisms aimed at achieving certainty or, rather, reducing uncertainty, as well as through transaction costs to obtain the information needed by individuals or economic and social groups. The typical regulatory action is the mandatory disclosure and the related enforcing power assigned to the regulators.9 In fact, the establishment of an informed financial market cannot be mainly attributed to investors, especially because of high costs and difficult coordination among them; and it cannot even be a voluntary 8

G. PRESTI, Introductory speech at the Conference ‘Il Rating: mito, realtà, narrazioni’, Associazione Disiano Preite - AGE, Venezia, 5th October 2012. Provisional proceedings available at: http://www.associazionepreite.it/. The Author mentions G. HUSISIAN, What Standard of Care Should Govern the World’s Shortest Editorial? An Analysis of Bond Rating Agency Liability, 75 Cornell L. Rev., 1990. 9 See, A. OGUS, Regulation: Legal Form and Economic Theory, Hart Publishing, Oxford and Portland, 1994, 121 ff.

Credit Rating Agencies and the European Sovereign Debt Crisis

135

action of issuers not ensuring efficient solutions and creating similar conditions of asymmetry regarding the accuracy of the disclosed information. In view of these behaviours, mandatory disclosure is imposed by the regulator, as third party to the financial transaction, not having conflict of interest with the dissemination of complete and good quality information. Since the 90s, the American literature has set up a discussion on a governance mechanism intended to facilitate market transactions through information aimed at reducing uncertainty. The model herein referred regards Gatekeepers10 or Reputational Intermediaries, which could be considered as synonymous terms. These intermediaries have a particular authority, especially for two reasons: firstly, they are considered highly sophisticated and therefore able to provide high quality information; secondly, they are paid for their service and their permanence in financial markets, so as the continuity of their business depends on the quality of the services provided and their correct behaviour. A controversial typology of such intermediaries is represented by Credit Rating Agencies, whose main function is to analyze the creditworthiness of issuers of (private or public) debt securities in order to assess their risk level. They are also related to reputation, which should be provided with the aim of guaranteeing the quality of the information.11 The reputational effects of their behaviour are relevant with regard to continuously operating on the market, and if they provided inadequate performances, they would be sanctioned by the same market.12 10 CRAs are traditionally qualified as genuine gatekeepers, i.e., as defined by J.C. COFFEE, ‘reputational intermediaries who provide verification and certification services to investors.’ See, J.C. COFFEE, Understanding Enron: It’s about the Gatekeeper, Stupid, Columbia Law School Working Paper n. 207, 2002, p.5. 11 ‘We’re in the integrity business: People pay us to be objective, to be independent and to forcefully tell it like it is’, John Bohn, Jr., President, Moody’s (1995); ‘Ratings are of value only so long as they are credible’, S&P Debt Ratings Criteria (1986), cited in F. PARTNOY, Historical Perspectives on the Financial Crisis: Ivar Kreuger, the Credit-Rating Agencies, and Two Theories About the Function, and Dysfunction, of Markets, University of San Diego Law School Legal Studies Research Paper Series 02/2010, available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1547201. ‘Indeed, the only reason that rating agencies are able to charge fees at all is because the public has enough confidence in the integrity of these ratings to find them of value in evaluating the riskiness of investments’, Jonathan R. Macey, Wall Street Versus Main Street: How Ignorance, Hyperbole, and Fear Lead to Regulation, 65 U. CHI. L. REV. 1487 (1998). 12 With regard to ‘reputational systems’ and their role of aggregating and disseminating information to ‘users’, see E. GOLDMAN, The Regulation of

136

Chapter Seven

CRAs’ function results in ratings, representing an information tool for investors aimed at assessing credit risk. In general and non technical terms, the term rating relates to a solicited or unsolicited13 judgement (opinion or evaluation), expressed succinctly within a predetermined alphanumeric scale (see below Chart 1), which is issued by a private individual, specialized and independent, with regard to the credit worthiness of a debtor, especially a business (company) or a government. Depending on the position along the alphanumeric scale, ratings should be distinguished among investment grade (low risk) and speculative grade (high risk). The former includes top ten evaluation notches (from AAA to BBB-, or from Aaa to Baa3 for Moody’s). The latter comprises notches from BB+/Ba1 onwards. A short-term rating is a probability factor of an individual going into default within a year. This is in contrast with longterm rating which is evaluated over a long time frame. In addition, ratings incorporate an outlook, indicating the expected rating trend, which could be stable, positive or negative, depending on its perspective. In any case, a positive or negative outlook does not necessarily imply a rating might be modified (rating action). If it is not possible to indicate the expected rating trend, the outlook would be indicated as evolving.14 When rating is at a very low qualitative level to be kept under surveillance, it is inserted into the credit watch. A credit watch is a type of notice indicating some factors have occurred or are highly likely to occur which will have an impact on credit rating of a business, or sovereign entity, and it may appear on the credit report for the entity. A credit watch may serve as means of alerting the entity to an impending change, as well as serving as a warning to any investor.

Reputational Information, (TechFreedom, Washington, D.C., 2010), Santa Clara Univ. Legal Studies Research, Paper No. 1754628 p. 293 ff., available at: http://ssrn.com/abstract=1754628. See also, A. BENEDETTI, Certezza pubblica e ‘certezze’ private. Profili pubblici e certificazioni di mercato, Giuffrè, Milan, 2010, especially p. 32 ff. and 73 ff. 13 In case of solicited ratings, companies pay a rating agency to be rated upon their request, while, according to Financial Times Lexicon, the term unsolicited rating relates to ‘[a] rating agency’s assessment of a borrower’s creditworthiness without any involvement of the borrower itself. In particular, the borrower does not pay for the rating assessment. Unsolicited ratings are usually based only on publicly available information about a borrower’s credit quality.’ http://lexicon.ft.com/Term?term=unsolicited-rating. 14 See, G. FACCI, Le agenzie di rating e la responsabilità per informazioni inesatte, Contratto e Impresa, 2008, p.166 ff.

LOWER NON INVES TMENT GRADE

NON INVES TMENT GRADE

LOWER INVES TMENT GRADE

UPPER INVES TMENT GRADE

CATEGORY

S &P

FITCH

Not Prime

CC C D

C

D

CCC-

Caa3

Ca

CCC

Caa2

CCC+

B-

B3

Caa1

B

B2

BB-

Ba3 B+

BB

B1

BB+

BBB-

Ba2

P-3

BBB

Ba1

Baa3

Baa2

BBB+

A-

A3 P-2

A

A2

Baa1

A+

A1

AA-

AA

Aa2

Aa3

AA+ P-1

AAA

Aaa

Aa1

/

C

B

A-3

A-2

A-1

A-1+

D

DD

DDD

C

CC

CCC

B-

B

B+

BB-

BB

BB+

BBB-

BBB

BBB+

A-

A

A+

AA-

AA

AA+

AAA

D

C

B

F3

F2

F1

F1+

Long Term Short Term Long Term Short Term Long Term Short Term

MOODY’S

/

33,00%

25,00%

20,00%

16,00%

13,00%

7,52%

4,46%

2,64%

1,57%

0,93%

0,53%

0,32%

0,18%

0,13%

0,09%

0,07%

0,05%

0,05%

0,03%

0,02%

0,01%

DEFAULT PROBABILITY

/

Closely monitored/ doubtful outcome

Specific attention with continuous monitoring

Acceptable with attention

Acceptable

M edium-tolow

M edium

M inimum

RIS K

In default

In default with little prospect for recovery

Extremely speculative

Substantial risks

Highly speculative

Non investment grade speculative

Lower medium grade

Upper medium grade

High grade

Prime

DES CRIPTION

Credit Rating Agencies and the European Sovereign Debt Crisis 137

Chart 1: Credit Rating Tiers15

15 Source: Author’s elaboration based on F. CHIAPPETTA, Diritto del governo societario, Padova, CEDAM, 2007, p.205.

138

Chapter Seven

In essence, rating is an evaluation of the debtor's ability to pay back the debt and the likelihood of default and it represents the agency's evaluation of qualitative and quantitative information for a company or government; including non-public information obtained by the credit rating agencies analysts.16 Given its nature of summary information on the quality of a financial product or issuer - and in the light of the structural information asymmetry between issuer and investor - rating significantly improves efficiency in allocating savings, since it is easily understandable for investors without presenting specific usage costs and reducing the issuers’ cost for raising capital.17 However, to date, despite the unitariness of the phenomenon, it emerges with evidence that, both at the regulatory level and at the hermeneutic level, there is not a univocal definition of rating; on the contrary, we can find different notions of rating, partially dissimilar from each other and with different significance depending on the referring context.18 16

In their activities, CRAs are thus at the centre of a twofold flow of information: a first flow of information ‘goes to’ agencies, because their judgements are based on information that rated subjects provide to CRAs and on information publicly available; a second flow ‘starts from’ agencies to the market and it is a summary concentrated in the rating, issued on the basis of the information received. 17 In the words of L. J. WHITE, A New Law for the Bond Rating Industry – For better or for Worse?, February 2007, Law&Economics Research Paper Series, Working Paper No. 07-09, NYU School of Law, available at www.ssrn.com, p.7 ff., ‘[t]he bond ratings help lenders (bond investors) pierce the fog of asymmetric information so as better to determine the creditworthiness of potential borrowers (bond issuers), while also providing the opportunity for the more creditworthy borrowers to stand out from (and pay lower interest than) their less creditworthy peers.’ As the Tribunale di Firenze observed on 6th July 2006 (www.ilcaso.it), ‘[i]l rating costituisce un’informazione se non determinante, quanto meno indicativa del tipo di investimento che si è in procinto di effettuare e la sua mancata indicazione rappresenta la violazione dei più elementari obblighi informativi. L’intermediario pertanto ha il preciso obbligo di segnalare al risparmiatore in modo non generico ed approssimativo la natura dell’investimento alla stregua della valutazione operata dalle maggiori agenzie di rating, trattandosi di dato che costituisce fattore idoneo ad influenzare in modo rilevante il processo decisionale dell’investitore.’ See also, Tribunale di Pinerolo, 14th October 2005, Tribunale di Catania, 5th May 2006, Tribunale di Cagliari, 2nd January 2006, in Resp. Civ. prev., 2007, IV, p.912. 18 See, C. KRONWALD (2009), Credit Rating and the Impact on Capital Structure, Norderstedt, Germany: Druck und Bingdung. p.3. The notion of rating can be also found in several legislations. For example, it is mentioned in the Communication from the European Commission (EC) on Credit Rating Agencies 2006/C59/02. Art. 2.1 states that ‘[c]redit rating agencies issue opinions on the

Credit Rating Agencies and the European Sovereign Debt Crisis

139

Credit ratings, unlike opinions of financial analysts, do not constitute investment recommendations, but rather they are mere judgements19. creditworthiness of a particular issuer or financial instrument. In other words, they assess the likelihood that an issuer will default either on its financial obligations generally (issuer rating) or on a particular debt or fixed income security (instrument rating).’ Another example is the Commission Directive 2003/125/EC of 22nd December 2003 implementing Directive 2003/6/EC of the European Parliament and of the Council as regards the fair presentation of investment recommendations and the disclosure of conflicts of interest considerando No. 10 affirms that ‘[c]redit rating agencies issue opinions on the creditworthiness of a particular issuer or financial instrument as of a given date. As such, these opinions do not constitute a recommendation within the meaning of this Directive. However, credit rating agencies should consider adopting internal policies and procedures designed to ensure that credit ratings published by them are fairly presented and that they appropriately disclose any significant interests or conflicts of interest concerning the financial instruments or the issuers to which their credit ratings relate’). We should also mention Regulation (EC) No. 1060/2009 of the European Parliament and of the Council of 16th September 2009 on credit rating agencies, art.3.1 a), ‘‘credit rating’ means an opinion regarding the creditworthiness of an entity, a debt or financial obligation, debt security, preferred share or other financial instrument, or of an issuer of such a debt or financial obligation, debt security, preferred share or other financial instrument, issued using an established and defined ranking system of rating categories.’ In the 1934 U.S. Securities and Exchange Act, we can read as follows: ‘[t]he term ‘‘credit rating’’ means an assessment of the creditworthiness of an obligor as an entity or with respect to specific securities or money market instruments.’ In conclusion, with regard to the Italian legislation, we should mention: 1) ‘Circolare della Banca d’Italia no. 263 of 27th December 2006 (Fascicolo «Nuove disposizioni di vigilanza prudenziale per le banche» – 13° aggiornamento del 29 maggio 2012). Title II, Chapter 1, Section VIII, although it does not specifically define rating, clearly explains which activities CRAs should perform so as their evaluations can be used for prudential supervision. CRAs must meet a set of requirements - which necessarily are reflected on their ratings - including the following: objectivity, independence, regular check system, market reputation and transparency; 2) CONSOB Regulation no. 11971 of 14th May 1999 - Implementing the provisions on issuers of Legislative Decree 58 of 24th February 1998 (as amended by CONSOB resolutions no. 18210 of 9th May 2012 and no. 18214 of 9th May 2012), art.65.2 c), ‘credit ratings shall mean judgments of the creditworthiness of securities referred to in Article 180.1a) of the Consolidated Law or of an issuer of such instruments, intended for distribution channels or for the public, produced using a predefined classification system.’ 19 Art.3.2 of the Regulation (EC) No 1060/2009 of the European Parliament and of the Council of 16th September 2009 on credit rating agencies, states that: ‘[…]shall not be considered to be credit ratings: (a) recommendations within the meaning of Article 1(3) of Commission Directive 2003/125/EC(3) OJ L 339, 24.12.2003, p.

140

Chapter Seven

Therefore, they are not an accounting certification, nor a guarantee for the concrete debt repayment, neither a recommendation to buy, sell or hold securities, nor an assessment of an investment adequacy. They are rather a judgement not simply based on the qualities of a financial product or a performance, but on the degree of probability of a future event (predictive judgement); secondly, they directly influence mechanisms for a proper allocation of savings; in addition, they are typical example of derivative information20, because they are not formulated through a direct perception of the evaluator but on the basis of data submitted to the agency by the rated entity. The agency has legitimate expectations on such data, by presuming their accuracy, completeness and correctness. Furthermore, since rated entities tend to be sensitive to the dynamics and evolution of markets, credit ratings are in continuous evolution, susceptible to be updated in order to reflect any change in the degree of risk connected with the investment. Credit ratings have now assumed importance in many regulatory instances and they are considered suitable to create legitimate expectations in investors. Therefore, they are opinions having a mixed value, both private and public, and rating agencies now have a quasi-regulatory role in financial markets.21 This peculiarity is certainly very important, because, on the one hand, it justifies the attention legislators have dedicated to credit rating and, on the other hand, it requires the analyst to

73; (b) investment research as defined in Article 24(1) of Directive 2006/73/EC of 10th August 2006 (implementing Directive 2004/39/EC of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive - OJ L 241, 2.9.2006, p. 26) and other forms of general recommendation, such as ‘buy’, ‘sell’ or ‘hold’, relating to transactions in financial instruments or to financial obligations; or (c) opinions about the value of a financial instrument or a financial obligation.’ 20 C. RABITTI BEDOGNI defines derivative information as ‘quei flussi informativi che non sono prodotti dagli emittenti ma da soggetti “terzi” in ciò specializzati: principalmente gli analisti finanziari e le società di rating.’ In L’informativa derivata. Le previsioni degli analisti e i giudizi delle agenzie di rating. Problemi attuali e possibili sviluppi regolamentari, available at http://w3.uniroma1.it/dirittomercatifinanziari/Rating.pdf. See also, M.T. PARACAMPO, L’informativa finanziari derivata. Ruolo e responsabilità degli analisti finanziari, Bari, Cacucci Editore, 2008. 21 W. BEAVER, C. SHAKESPEARE and M. SOLIMAN, Differential Properties in the Ratings of Certified vs. Non-Certified Bond Rating Agencies, June 2006, in www.ssrn.com, p.6.

Credit Rating Agencies and the European Sovereign Debt Crisis

141

take into account the para-public nature of such judgements whenever it should investigate on duties or responsibilities of rating agencies.22 In our opinion, it seems necessary, in an after-crisis regulatory perspective, to adopt a clear and comprehensive legal definition of credit rating, which should be closer and adhering to the concept of information service - based on objective data and justified analysis -, at the same time standardizing rules governing agencies’ activities, in terms of transparency and suitability of analysis processes, both as regards the proper judgement of creditworthiness (rating) and the rating outlook, so as to steer the legislation, not for subjects issuing rating, but for the concrete compliance of provisions in relation to the service provided. Rating, as expressed in a simple and immediately noticeable way23, has partially modified its value on market, thanks to the growing trust reputational mechanisms have allowed against market uncertainties. Therefore, it has started to play the role of main propagator of systemic trust.24 And this happened especially in those areas where regulation was weaker or where regulation mechanisms authorized agencies to provide rating with a normative value for market regulation.25

3. The role of rating agencies and their evaluation of sovereign issuers: a focus on the European sovereign debt crisis As we have stated above, rating agencies are private companies, born one century ago in the United States26, with the aim of reducing the 22

At this regard, see P. VALENSISE, La responsabilità delle società di revisione. Considerazioni dopo le prime pronunzie giurisprudenziali, in Giur. Comm., 1996, II, p.501 ff. 23 Moody’s in 2010 affirmed that the main target of rating is ‘to provide investors with a simple system of gradation by which relative creditworthiness of Securities may be noted…’ (Moody’s, Ratings Definitions, at http://v3.moodys.com/ratingsprocess/Ratings-Definitions/002002). 24 See, G.A. AKERLOF and R.J. SHILLER, Animal Spirits, Princeton Univ. Press, Princeton and Oxford, 2009; It. transl. Spiriti animali, Rizzoli, 2009, 25 ff. 25 The most significant aspects of regulation concerning rating agencies as laid down in the United States and the European Union are highlighted by F. PARMEGGIANI, La regolazione delle agenzie di rating tra tentativi incompiuti e prospettive future, in Giurispr. Comm., 2010,1, 1 -34. 26 The origin of rating could be dated back to the document ‘History of Railroads and Canals in the United States’, published by Henry V. Poor in 1860, regarding a detailed account of operational and financial information of all railway companies

142

Chapter Seven

problem of asymmetric information which occurs in financial markets between issuers of private and public debt securities and investors: the latter can't autonomously gather all the necessary details to define the issuers’ financial soundness, except at very high costs and therefore they need someone to provide them with the information they need. CRAs should therefore not only be specialized for this purpose, but especially credible, because investors, issuers, investment banks, broker-dealers, and governments finance them for their activities. According to the definition provided in 2004 by the International Organisation of Securities Commissions (IOSCO), credit rating agencies are

operating in the U.S. Poor’s aim was to ensure that such companies were required to disclose their balance sheets, in particular to potential investors. His son, Henry William, along with Luther Lee Blake, a financial analyst, drew up understandable and transparent financial indexes and founded the rating agency Standard & Poor’s. At the same time, a financial journalist, John Moody, interested in companies’ financial transparency (which, according to him, had caused a financial crash), published in 1900 the ‘Manual of industrial securities’ and then founded in 1909 Moody’s rating agency. About a decade later, in 1924, the rating agency Fitch started its activities. For more details on rating’s origins, please refer to F. DITTRICH, The Credit Rating Industry: Competition and Regulation (Inauguraldissertation zur Erlangung des Doktorgradesder Wirtschafts- und Sozialwissenschaftlichen Fakultät der Universität zu Köln), 2007, available at: http://ssrn.com/abstract=991821, 16 ff.; G. FERRI and P. LACITIGNOLA, Le agenzie di rating, Il Mulino, Bologna, 2009, 19 ff. In this respect, the term ‘agency’ is borrowed by ‘mercantile agency’ and ‘credit rating agency’, identifying since mid-nineteenth century private companies measuring credit rating of firms. See, F. DRIGO, La responsabilità delle agenzie di rating per il danno all’informato. L’esperienza statunitense, in Rass. dir. civ., 2006, p.488, fn.1 Reference to the term ‘agency’, used to identify private commercial companies engaged in credit rating, has its roots in historical tradition and it has no legal value. In fact, rating agencies are ‘private independent companies that attribute and publish such credit ratings’, and therefore ‘the name “agency” is in this regard misleading, incorrectly suggesting these entities are in any way different from commercial companies, and suggests to call them “credit rating firms”’. See, E. WYMEERSCH, M. KRUITHOF, Regulation and Liability of Credit Rating Agencies under Belgian Law, in The Belgian Reports to the 2006 Utrecht Congress of the International Academy of Comparative Law, 2006, available at www.ssrn.com, p.1, fn.3; L.J. WHITE, The Credit Rating Industry: An Industrial Organization Analysis, in R.M. LEVICH, G. MAJNONI and C.M. REINHART (eds.), Ratings, Rating Agencies and the Global Financial System, Boston, Kluwer Academic Publishers, 2002, pp.41-64.

Credit Rating Agencies and the European Sovereign Debt Crisis

143

those entities whose business is the issuance of credit ratings for the purposes of evaluating the credit risk of issuers of debt and debt-like securities.

Rating agencies have today assumed a central role in the functioning of financial systems, in particular following the adoption of regulatory measures (such as the European capital requirements on brokers or managers). These legal entities are members of a new set of [largely, though not exclusively, private] intermediary strategic agents [that] have absorbed some of the international functions traditionally carried out by states in the past.27

The position gained over time by CRAs has led to a relevant increase in the diversification of the activities they provide, now including prerating assessment or sometimes an agency’s involvement in the construction of the financial product on which a rating will then be issued. However, a radical change in their economic structure is the outcome of a substantial reversal of the original model providing that investors should pay for their services. This model has been replaced by the issuer paid model, where the issuer pays for being rated. This change is crucial since one of the most common typologies of rating is the issuer rating, related to the issuer’s financial suitability and stability. In fact, CRAs provide basically two types of rating: the instrument rating, regarding a judgement on a single security issue, and the sovereign rating, which occurs when the issuer is a sovereign state. For our purposes, we will now focus our attention on the latter category. From the rating point of view, the sovereign issuer is the government (usually national or federal), which actually carries out the primary authority of a recognized jurisdiction. Since the sovereign is the highest authority and it has the power to impose its will on the jurisdiction it governs, creditors have a very limited power to take a legal action if the sovereign is unable or unwilling to repay its debt. This also happens at the international level, given boundaries of the international law and its application in sovereign nations. Consequently, in terms of both local and foreign currency debt, the judgement of a sovereign credit risk should take into account the will to pay, as well as the financial stability.

27

S. SASSEN, De-Nationalized State Agendas and Privatized Norm-Making, Inaugural Lecture, Division of Social Sciences, University of Chicago, April 28th 1999, available at http://cgt.columbia.edu/files/papers/Sassen.pdf

Source: Author’s elaboration based on information of CRAs criteria reports available at www.fitch.com, www.moodys.com and www.standardandpoors.com See also, International Monetary Fund (IMF), World Economic and Financial Surveys, Global Financial Stability Report (GFSR), Sovereigns, Funding, and Systemic Liquidity, October 2010, chap. III, The Uses and Abuses of Sovereign Credit Ratings, pp.100-101.

28 1) Effectiveness of government, 2) Openness to international capital flows and trade, 3) Strength of business environment, human capital, and governance, 4) Rule of law, respect for property rights, 5) Control of corruption

1) Savings ratios, 2) Openness of economy to trade, 3) Commodity dependence

1) Efficiency of public sector, 2) Institutional factors, such as central bank independence, 3) Timeliness, coverage, and transparency in reporting, 4) Competitiveness and profitability of private sector

1) Prosperity, diversity, and degree of market orientation, 2) Income discrepancies, 3) Protectionism and other nonmarket influences, 4) Labor flexibility

OTHER

1) Earthquakes, 2) Hurricanes, 3) Speculative crises

Transparency STRUCTURAL/ 1) Level of innovation, 2) Investment in INSTITUTION human capital, 3) Respect for property AL rights

1) War risk, 2) Legitimacy of political regime, 3) Relations with international community and institutions

1) Stability and legitimacy of political institutions, 2) Popular participation in political processes, 3) Orderliness of leadership succession, 4) Transparency in economic policy decisions and objectives, 5) Public security, 6) Geopolitical risk

1) War, 2) Degree of political consensus, 3) Political chaos, 4) Efficiency and predictability of government action, 5) Level of policy transparency

POLITICAL

1) Exchange rate regimes, 2) Indexation and dollarization

1) Compatibility of exchange-rate regime and monetary goals, 2) Indexation and dollarization

1) Exchange rate regime, 2) Indexation and dollarization

EXCHANGE RATE

1) Capital flows, 2) Willingness of nonresidents to extend 1) Balance of payments dynamics, 2) 1) Impact of fiscal and monetary policies on external accounts, 2) credit and purchase domestic assets, 3) Share of current Foreign exchange reserves, 3) Access to Structure of the current account, 3) Composition of capital flows, 4) output devoted to servicing external debt, 4) Reserve foreign exchange, 4) External Reserve adequacy adequacysector vulnerability indicator

1) Macro-prudential risk indicators, 2) Quality of banking sector and supervision, 3) Contingent liabilities of banking sector, 4) Foreign ownership of banking sector

EXTERNAL FINANCES

1) Robustness of financial sector, 2) Effectiveness of financial sector

1) Financial sector strength, 2) Contingent liabilities of banking sector

FINANCIAL SECTOR

DEBT

Government’s ability to raise taxes, cut spending, sell assets, or obtain foreign currency (e.g.,from official reserves)

PUBLIC FINANCE

1) Size and growth rate of public debt, 2) Composition of 1) Level of debt, 2) Interest payments 1) General government gross and net debt, gross and net external government debt (maturity, interest rate, and currency), 3) and revenues, 3) Structure of debt, 2) Share of revenue devoted to interest, 3) Debt service Contingent liabilities of government, 4) Maturity and government debt, 4) Debt repayment burden, 4) Maturity profile and currency composition, 5) Access to currency structure of foreign liabilities and assets, 5) burden, 5) Debt dynamics, 6) concessional funding, 6) Debt and breath of local capital markets Distribution of foreign liabilities and assets by sector, 6) Conditional liabilities, 7) Financial depth Payment record

1) General government revenue, expenditure, and surplus/deficit 1) Financial assets of government, 2) Sovereign net foreign trends, 2) Compatibility of fiscal stance with monetary and external asset position, 3) Volatility of government revenue, 4) Revenue-to-GDP ratio, 5) Medium-term public debt factors, 3) Revenue-raising flexibility and efficiency, 4) Expenditure effectiveness and pressures, 5) Size and health of nonfinancial dynamics, 6) Credibility of fiscal policy framework and institutions, 7) Financial flexibility public sector enterprises

1) GDP per capita, 2) Long-term volatility of nominal output, 3) Scale f economy, 4) Integration in economic and trade zones

FITCH

MACRO/ GROWTH

S&P 1) GNP and GDP per capita, 2) Consistency of monetary 1) Rate and pattern of economic growth, 2) Range and efficiency of and fiscal policies and credibility of policy framework, 3) monetary policy tool, 3) Size and composition of savings and Sustainability of long-term growth path, 4) investment, 4) Money and credit expansion, 5) Price behavior in Competitiveness of economy, 5) Depth of demand for local economic cycles currency, 6) Capacity to implement countercyclical macro policies, 7) Composition of current account

MOODY'S

144 Chapter Seven

Chart 2: Sovereign Credit Rating Criteria28

Credit Rating Agencies and the European Sovereign Debt Crisis

145

The CRAs determine sovereign ratings based on a range of quantitative and qualitative criteria with which they ‘measure’ a country’s ability and will to repay its debt (see Chart 2, below). Among qualitative factors, we should mention institutional strength, political stability, fiscal and monetary flexibility, and economic soundness. In addition, a country’s track record of honouring its debt is an important criterion of compliance to pay, a characteristic that is otherwise not easy to measure without bias. These qualitative factors are accompanied by quantitative elements, such as the level of debt and official international reserves, the composition of debt (in particular the currency composition and maturity outline), and the extent of the debt burden, especially with regard to interest costs. With reference to Chart 2, we should affirm that although there are considerable overlaps in the criteria that CRAs use, there are discrepancies in the comparative weightings of factors, not only between CRAs, but also between categories of countries. In essence, a sovereign debt rating is an evaluation of the country’s soundness to meet on time and in full its obligations, or, in other words, a forward-looking estimation of a country default probability. The term ‘default’ means, in this case, non-compliance with the terms of a loan agreement.29 CRAs evaluate the sovereign risk, political risk (will to pay) and country risk, which respectively relate to the risk of the sovereign defaulting on its commercial debt obligations, and the risks of an issuer doing business in a particular country.

3.1 CRAs’ involvement in the European sovereign debt crisis The European crisis rests upon the issue of sovereign risk assessment and mainly a new issue, the risk prediction in an integrated (currency) area. Faced with the globalization process, there have been at the same time several integration phenomena, thus accentuating interdependencies among neighbouring countries. CRAs have always independently rated sovereign issuers30, according to the assumption that each country could be considered as ‘isolated’ in the international economic arena and that then an ‘austerity therapy’ could be employed in too indebted countries, so as to spare their neighbours. This option is absolutely not applicable in the 29 Default: Failure to fulfil the terms of a loan agreement. http://www.economist.com 30 In 1918, rating agencies started evaluating sovereign and sub-sovereign issuers, when Moody’s published its first Governments and Municipals Handbook. Moody’s sovereign ratings were almost immediately followed by other CRAs that already existed or were starting their activities. We have sovereign ratings from Standard&Poor’s since 1922, and from Fitch and Standard Statistics since 1924.

146

Chapter Seven

EU (and even less in the euro area). The adoption of a common currency has inextricably connected European economies, most importantly by preventing devaluation policies. Risk assessment of an integrated area raises several questions. If a default of an ‘independent’ country can certainly cause a financial stress, a default of a country which is member of a regional economic area could be more tricky, especially for contagion and system risks. The financial turmoil that Greece, Spain, Portugal, Italy are experiencing, but also more sound economies such as France and the United Kingdom, show that being a member of the euro area can in no way guarantee a risk default. The crisis has highlighted the interdependence between financial markets, including the impact of downgrades on the credit default swaps (CDS) market, driven by the digging of spread indicators. Although focused on four countries (the ‘PIGS’, Portugal, Ireland, Greece and Spain), downgrades have put under pressure all European economies (see Chart 3 below) CRAs did not properly evaluate the developments in the Euro zone economies and so they did not provide accurate sovereign credit ratings on time and later they have made successive not gauged downgrades with the aim to counterbalance the precedent undone downgrades. Therefore, they have been a key factor in the ongoing sovereign debt crisis turning so awful, firstly by the delayed rating action and then by the following unmeasured downgrades for correction. On the other hand, many investors who made investments in these countries taking account of their ambiguous sovereign ratings have made loss. Downgrades have been at the origin of increases in the cost of borrowing, these in turn negatively influenced risk perceptions of these countries, rising risk lead to more downgrades. CRAs have consequently produced a downgrade escalation. Therefore, they have equally influenced the Euro zone member countries in crisis and the investors with their downgrades. In particular, sovereign rating notices have statistically and economically noteworthy spill over consequences both across countries and financial markets entailing that rating agencies announcements could encourage financial volatility. The symptom and the extent of the spill over effects rely both on the type of CRAs’ statements, the country facing the downgrade and the rating agency from which rating derives. However, downgrades to near speculative grade ratings for rather big economies such as Greece have a systematic impact transversely Euro zone countries.31 31

See, R. AREZKI, B. CANDELON and A.N.R. SY, Sovereign Rating News and Financial Markets Spillovers: Evidence from the European Debt Crisis, IMF Working Paper, WP/11/68, March 2011, available at http://www.imf.org/external/pubs/ft/wp/2011/wp1168.pdf

32

Luxembourg

Malta

Netherlands

LU

MT

NL

Spain

Italy

IT

ES

Ireland

IE

Slovenia

Greece

GR

SI

BB

Germany

FR

DE

Portugal

France

FI

Slovakia

AAA

Estonia

Finland

EE

PT

AA+

Cyprus

CY

SK

AAA

Belgium

BE

BBB-

A

A

A-

AAA

BBB+

BBB+

B-

AAA

AA-

CCC+

AA

AA+

Austria

AT

A2

Ba3

Aaa

A3

Aaa

Baa2

Ba1

C

Aaa

Aa1

Aaa

A1

Caa3

Aa3

Aaa

Baa3

NEGATIVE

Bold: junk, Underscored: under observation, Regular: top notch

NEGATIVE

NEGATIVE

NEGATIVE

NEGATIVE

NEGATIVE

NEGATIVE

NEGATIVE

NEGATIVE

NEGATIVE

-

NEGATIVE

NEGATIVE

STABLE

STABLE

NEGATIVE

NEGATIVE

NEGATIVE

BBB

A-

A+

BB+

AAA

A+

AAA

A-

BBB+

CCC

AAA

AAA

AAA

A+

BB-

AA

AAA

NEGATIVE

NEGATIVE

STABLE

NEGATIVE

STABLE

STABLE

STABLE

NEGATIVE

STABLE

STABLE

NEGATIVE

STABLE

STABLE

NEGATIVE

NEGATIVE

STABLE

MOODY's RATING MOODY's OUTLOOK FITCH RATING FITCH OUTLOOK

CreditWatch Negative Baa2

STABLE

NEGATIVE

NEGATIVE

NEGATIVE

NEGATIVE

NEGATIVE

NEGATIVE

STABLE

STABLE

NEGATIVE

NEGATIVE

STABLE

NEGATIVE

NEGATIVE

NEGATIVE

S&P RATING S&P OUTLOOK

ISO CODE COUNTRY

Credit Rating Agencies and the European Sovereign Debt Crisis

Source: Author’s elaboration of data available at www.guardian.co.uk

147

Chart 3: Euro-zone credit ratings by agency and country - Updated 10th January 201332

148

Chapter Seven

Chart 4: S&P Ratings vs. Greek sovereign spread33

The sovereign debt crisis in Europe is dominated by an exceptional trend (negative) in rating actions (see above Chart 4, with regard to Greece) and, even with complexity since the contagion and spillover effects, it seems to demonstrate a proof, at least qualitative, that rating notices have some effects on the market behaviours, sensibly more relevant than in the past, even if these data are not adequate to provide a statistical confirmation of this correlation.

4. From overreliance...to a still hazy regulation CRAs relevance has increased over time and, despite some noteworthy defaults, starting from the 70s, which have been cause for reflection on the reliability of credit ratings on debt instruments, the great power of CRAs on financial markets has never really been brought into question.34 In recent years, CRAs have been strongly criticized as considered likely of heavily destabilizing financial markets with their incorrect 33

Source: OECD, S&P, Datastream, in A. BLUNDELL-WIGNALL, Ratings Agencies Issues, presentation at the French Senate, March 2012. 34 C. A. HILL, Regulating the Rating Agencies, Business, Georgetown University Law Center Economics and Regulatory Policy Working Paper No. 452022 (2004), available at http://ssrn.com/abstract=452022, at 5 ff.

Credit Rating Agencies and the European Sovereign Debt Crisis

149

judgements35 and even making the capital market ‘neurotic’. In fact, although ratings are probabilistic opinions on issuers’ reliability or not, the ‘sensitivity’ with which traders respond to CRAs’ continuous outputs for buying or selling securities, shall determine a market speed not only following real economic factors (in determining the value of sovereign bonds or the value of securities of listed companies), but rather characterized by political lobbying and speculative institutional dynamics. Criticism towards CRAs is not a novelty. On May 5th, 1936, a Resolution of the Missouri Bankers Association at its 46th Annual Convention, (Kansas City, Mo.) stated that [w]e further believe that the delegation to these private rating agencies of the judgment as to what constitutes a sound investment is unprecedented in our history and wholly unwarranted by their records in the past.36

Since the 1997-98 Asian crisis, CRAs have been under scrutiny for their activity considered having pro-cyclical effects and hence for their lack of ability in predicting issuers’ failures. Such a criticism has grown in recent times, especially as a consequence of the European sovereign debt crisis: in fact, critics are no longer only limited to the rating of securities in structured credit markets (as happened during the subprime crisis), but now the legitimacy of the sovereign rating activity comes into question. A critique, often invoked, concerns the lack of transparency in credit rating activities: this is related to the issue of the conflict of interest. This depends on the type of business model CRAs use. Ratings, in fact, are usually required and paid by rated issuers (as we mentioned above, there has been a transition from the investor-pay model to the issuer-pay model). In this case, ratings are based on both publicly available data and information not accessible to the public, but voluntarily disclosed by the issuer.37 35

We should bear in mind the cases of Enron, Parmalat, Lehman Brothers, where a positive forecast assessment was followed by the bankruptcy of these companies, with devastating global economic effects. 36 Mentioned in F. PARTNOY, Historical Perspectives on the Financial Crisis, op. cit., p.440. 37 It can also happen that CRAs publish ratings on their own initiative, without an issuer’s request (see above mentioned unsolicited rating). In this case, ratings are usually prepared without having access to non-public information. In this respect, see the Communication from the Commission on Credit Rating Agencies (2006/C 59/02), according to which issuing unsolicited ratings may be considered as unfair, if the agency would take advantage from having new assignments by those issuers unsolicitedly rated. See also, art.10.5 of the Regulation (EC) No. 1060/2009 of the

150

Chapter Seven

Other criticisms have focused on these following key aspects: the oligopolistic structure of ratings’ market, CRAs’ ownership, the procyclical nature of ratings, the disproportionate dependence (over-reliance) on ratings, the potential conflicts of interest which could arise, the failure of agencies to correctly predict defaults. To our purposes, we would concentrate our thinking on one of such criticisms: in our opinion, CRAs’ power does not come from rating itself, but from over-reliance (and over-dependence) on rating by policy-makers and legislators, having used subjective opinions of private companies for regulatory purposes. In fact, over the years, governments, without being fully aware, have incorporated the rating agencies’ assessments in their public systems of surveillance. Therefore, rating agencies have not gained themselves the power they have today: they received it through practices, norms and rules, laws and directives, often laid down by the public authorities which are now criticizing them.38 According to F. Partnoy39, who for the first time has questioned the above mentioned reputational theory, after the 1929 financial turmoil, European Parliament and of the Council of 16th September 2009 on credit rating agencies, stating that ‘[w]hen a credit rating agency issues an unsolicited credit rating, it shall state prominently in the credit rating whether or not the rated entity or related third party participated in the credit rating process and whether the credit rating agency had access to the accounts and other relevant internal documents of the rated entity or a related third party.’ 38 The earliest reference to a regulation regarding rating agencies dates back to September 11th, 1931, at the initiative of the U.S. Office of the Comptroller of the Currency (OCC), the American main regulatory body. Such rules stated that any U.S. bank would value the portfolio securities it held according to their rating. Ironically, the 1929-1932 Great Depression was not the chance to restrict CRAs’ power, but instead it was at the origin of the 1931 and 1936 regulations, officially making reference to ratings, thus constraining banks to sell securities considered speculative by CRAs and to keep only those belonging to investment grade – Aaa, Aa, A, or Baa. See, N. GAILLARD, Les agences de notation : au cœur du système financier…et des critiques, in La Documentation française (ed.), Mondialisation et crises financières, 2008. 39 F. PARTNOY, The Siskel and Ebert of Financial Markets?: Two Thumbs Down for the Credit Rating Agencies, in Washington University Law Quarterly, Vol. 77, no. 3, 1999, 619 ff. PARTNOY introduced ‘[…]a different view of the creditrating agencies as providing, not information, but “regulatory licenses,” a term I used to describe the valuable property rights associated with the ability of a private entity, rather than the regulator, to determine the substantive effect of legal rules. I documented how the value associated with credit ratings grew, beginning in the mid-1970s, as regulations came increasingly to depend substantively on ratings. Over time, some scholars have shifted from the “reputational capital”

Credit Rating Agencies and the European Sovereign Debt Crisis

151

CRAs have been appointed by the U.S law and the Securities and Exchanges Commission (SEC) rules the task of certifying (through their ratings) legal minimum capital requirements related to the suitability of the issuer’s securities, specifying that only the Nationally Recognized Statistical Rating Organizations (NRSROs), classified on the basis of a general and discretionary recognition of indexes (such as organizational structure, size, financial soundness and staff expertise), should be considered as qualified agencies.40 Therefore, CRAs’ regulation established by the SEC and the U.S. Federal Reserve has removed competition between CRAs and basically required market participants to view to the “regulatory license” view, as have some legislators and regulators.’ In F. PARTNOY, Historical Perspectives on the Financial Crisis, op. cit., p.438. In other words, CRAs are today ‘a watchdog paid by the persons they are to watch.’ See J.C. COFFEE, Turmoil in the U.S. Credit Markets: The Role of the Credit Rating Agencies, Testimony Before the United States Senate Committee on Banking, Housing and Urban Affairs, April 22nd, 2008, available at http://banking.senate.gov/public/_files/OpgStmtCoffeeSenateTestimonyTurmoilint heUSCreditMarkets.pdf, p.2 40 In the United States, since 1975, NRSROs recognition has been established by means of a No Action Letter sent by the SEC Staff. According to this approach, if a rating was needed for regulatory purposes, the SEC Staff would explore the market to verify if that particular rating could be broadly used and considered reliable and credible. In a positive case, SEC Staff deliver a letter to the CRA suggesting that if a regulated body was to refer to the CRA's rating, the SEC Staff will not advise to take a legal action against that CRA. These letters are publicly available and can be used by other regulated entities. The SEC then further defined the criteria it recurs to in making this evaluation, and in March 2005 published a proposed regulation to this outcome (available at http://www.sec.gov/rules/proposed/33-8570.pdf). On September 29th, 2006, US President George W. Bush issued the Credit Rating Reform Act. This law requires the SEC to explain how NRSROs recognition is settled, removes the No Action Letter approach and makes NRSROs recognition a Commission pronouncement, and demands NRSROs to enrol with, and be controlled by, the SEC. In 2007, the SEC issued regulations executing the act, demanding CRAs to have guiding principles to avoid abuse of non-public information, revelation of conflicts of interest and sanctions against unfair practices (see, J.S. SACK and S.M. JURIS (2007), Rating Agencies: Civil Liability. Past and Future, New York Law Journal, 238(88)). As of April 2011, ten organizations were designated as NRSROs, including the ‘Big Three’ (Standard & Poor's, Moody's Investors Service and Fitch Ratings). This number was reduced to nine in October 2011 after the Japanese firm Ratings (Japan Credit Rating Agency Ltd) and Investment Information, Inc. withdrew its registration with the SEC. Others NRSROs are: Kroll Bond Rating Agency, A. M. Best Company, Dominion Bond Rating Service Ltd, , Egan-Jones Rating Company, Morningstar, Inc. and HR Ratings. Source: www.sec.gov.

152

Chapter Seven

utilize the services of the three big agencies, Standard and Poor's, Moody's and Fitch.41 Regulators have always made use of credit ratings, or permitted ratings to be employed for regulatory purposes. For example, according to the Basel II agreement, banking regulators can permit banks to utilize credit ratings from some certified CRAs (called ‘ECAIs’, or External Credit Assessment Institutions) with relation to their net capital reserve requisites.42 In the United States, the SEC have authorized investment banks and broker-dealers to use credit ratings from NRSROs for analogous reasons. The assumption is that banks and other financial institutions should not need to maintain as stock the same amount of capital to safeguard the organization, if the latter has seriously invested in highly reliable securities (such as U.S. government bonds or short term debt (