39642 Trade Note April 11, 2007 Financial Services Liberalization and Trade Agreements in Latin America and the Caribbean International trade in agreements take the form of financial services has emerged as the FTAs, while some South-South The result of intense global integration agreements aim for a higher level World Bank trends and the widespread use of of economic ­ and potentially Group information technology. Nowadays, political ­ integration at a sub- www.worldbank.org it represents an increasingly regional level via the important dimension of domestic establishment of customs unions financial system activities. Countries and common markets. The four have achieved trade liberalization of main South-South PTAs in LCR financial services in three main are the Southern Cone Common ways: (i) unilaterally, by opening Market (MERCOSUR, their financial systems to established in 1991), the Andean international competition in the Community (CAN, established in context of autonomous domestic 1969), the Caribbean Community International reform efforts; (ii) at the multilateral and Common Market Trade level under the auspices of the (CARICOM, established in 1973) Department WTO's General Agreement on and the Central America Common Trade in Services (GATS); and (iii) Market (CACM, originally on a reciprocal or preferential basis established in 1960 and reinstated by concluding bilateral or in 1991). plurilateral preferential trade agreements (PTAs). This note Financial services are typically By Constantinos analyzes the trade liberalization of covered via provisions included Stephanou financial services via PTAs that was in a separate, self-contained undertaken by countries in the Latin chapter. This chapter is, for America and Caribbean Region analytical purposes, the principal (LCR). vehicle for influencing the operations of the domestic Regional integration and financial financial system although, strictly services liberalization in Latin speaking, it does not fully capture These notes summarize America and the Caribbean all such activitiesi. The coverage recent research on global of financial services by PTAs in trade issues. They reflect solely the views of the author Since the 1990s, the world economy LCR follows 3 main approaches: and not necessarily the views has witnessed an unprecedented of the World Bank Group or proliferation of PTAs. Almost every no coverage because of its Executive Directors. · WTO Member is party to at least the specific exclusion of services one PTA, and LCR has been in general, or of financial services particularly active in this regard with in particular, from the scope of a a different level of economic particular trade agreementii integration, ranging from free trade · direct coverage via the agreements (FTAs) to custom unions introduction of dedicated Trade Note 31 and common markets. North-South provisions in a separate chapter or Trade Note April 11, 2007 annex dealing exclusively with financial Most LCR countries are net importers of services financial services and have few ­ if any ­ · indirect coverage via `horizontal' perceived `offensive' interests linked to a provisions of a more generic character "demandeur" or domestic constituency, both covering services and/or investment that of which lessen the scope for striking partly apply to financial services as well. reciprocal bargains within the sector. As can be seen in Figure 1, the proliferation Conversely, the inclusion of financial of PTAs in recent years has contributed to services in most North-South agreements greater financial services liberalization likely reflects the fact that the majority of commitments for many LCR countries and foreign financial institutions in LCR led to an increasingly complex regional countries are headquartered in developed `commitments map' (or financial services countries (see Figure 2), as well as the `spaghetti bowl'). Most progress in financial relative (and asymmetric) bargaining powers services rule-making and market opening between the negotiating counterparts. In has been achieved via FTAs; by contrast, fact, only two LCR countries have tended to LCR countries that have relied on the include financial services chapters in South- multilateral framework and on sub-regional South agreements ­ Mexico (primarily in the customs unions have not made much immediate post-NAFTA periodiii) and progress to-date. Panama (which is an offshore financial center and a net exporter of financial Figure 1: `Map' of Financial Services- services). Related Trade Commitments in LCR (mid-2006) Figure 2: Foreign Bank Penetration in Selected LCR Countries CHILE TAIWAN COSTA RICA (CHINA) SINGAPORE DR-CAFTA USA DOM. REP. CARICOM 100% countries Costa Rica Nicaragua Honduras EL SALVADOR PANAMA 90% El Salvador NAFTA GUATEMALA PERU COLOMBIA Assets 80% CACM nk ANDEAN Mexico ­ HONDURAS ECUADOR COMMUNITY Northern Ba 70% Triangle CANADA (CAN) BOLIVIA VENEZUELA NICARAGUA igneroFfo 60% (prior to 2006) G3 BRAZIL %sas 50% Bolivia nk 40% URUGUAY MEXICO ARGENTINA Bad Dom. Rep. Jamaica 30% ne Panama MERCOSUR ow Uruguay Paraguay h- 20% EC VENEZUELA ut Ecuador PARAGUAY EFTA JAPAN (2006) So Barbados 10% Colombia Argentina Mexico Peru Antigua Trinidad Chile Brazil Venezuela 0% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Source: Own analysis, SICE database. Foreign Bank Assets as % of Total Bank Assets Note: Lines indicate the existence of a financial Source: Own analysis based on Van Horen N. (2006). services chapter/Annex in a PTA between the relevant Note: A foreign bank is defined to have at least 50 countries (dashed lines indicate that the agreement percent foreign ownership. Figures reported represent has not yet been ratified or implemented), while the averages over 2000-2004 in each country. South- ovals indicate the presence of a trade agreement for owned banks are foreign banks headquartered in a the creation of a common market or customs union. developing country. The inclusion of financial services in LCR Templates, rules and disciplines for PTAs depends greatly on whether it is a financial services in PTAs North-South or South-South agreement. Unsurprisingly, developed countries in PTAs that have developed disciplines on North-South agreements have been the main services in general (including financial proponents of including financial services. services) have traditionally followed two `architectural' models or templates: one 2 Trade Note April 11, 2007 based on the GATS and the other based on Figure 3: Market Access Commitments ­ the NAFTA. While the liberalization of Proportion of Financial Services financial services under the GATS is based Committed by Chile, Colombia and Costa on a hybrid list approach, NAFTA-type Rica in the GATS and Subsequent FTAs PTAs use a negative-list or top-down 100% approach. The latter approach obliges 90% countries to list all non-conforming 80% s or measures, otherwise they are deemed to be ect 70% b-S Su 60% fully and automatically liberalized (the so- cesiv 50% called "list it or lose it"). The choice of Serla nci 40% modality used to negotiate and schedule naiF 30% of liberalization commitments can be an % 20% important contributor to the actual level and 10% quality of liberalization attained (see below). 0% Mode 1 Mode 2 Mode 3 NAFTA- and GATS- type agreements also GATS - Chile US-Chile EC-Chile GATS - Colombia US-Colombia GATS - Costa Rica DR-CAFTA have important differences in terms of scope Source: Authors' interpretation based on WTO and USTR information, Contreras P. and Yi S. (December and coverage ­ for example, in their 2003), Contreras P. (2005), Saez R. (2006), Arbeláez treatment of cross-border trade and of non- M. A., Flórez A. and Salazar N. (August 2006) and regulated financial institutions While the Echandi R. (2006). vast majority of PTAs that were negotiated Note: Three levels of market access commitments are by LCR countries have followed the applied in the above analysis by financial services sub-sector and mode: none (value of zero), partial NAFTA model, the financial services (value of 0.5) and full commitment (value of 1). Mode chapters of recent agreements (e.g. US-Chile 4 commitments, as well as all national treatment FTA) have tended to mix elements of the commitments and horizontal restrictions, are two architectural templates. excluded. All pre-commitments to liberalize additional sub-sectors and/or modes in future years are included. The rules and disciplines contained in PTAs Have recent PTAs led to increased with regards to financial services have two financial services liberalization objectives: (1) to liberalize trade in financial commitments for relevant LCR countries services through the removal of compared to those made under GATS? discriminatory and market access-impeding measures affecting foreign financial services An analysis of market access and national suppliers; (2) to promote better regulatory treatment commitments scheduled in the practices (e.g. on transparency), while also financial services chapters has been allowing countries to regulate their financial undertaken for a sample of LCR countries services markets on prudential grounds. In that have recently participated in PTAs addition to market access, national (Chile-US and Chile-EU FTAs, Colombia- treatment and most favored nation US FTA and Costa Rica in the DR- obligations, important financial services- CAFTA). Results provide evidence of related provisions cover prudential significant additional liberalization safeguards, dispute settlement and commitments when compared to the GATS. transparency, as well as standstill This is not unusual given the time elapsed (`freezing' of existing regulatory regime and the (unilateral) market opening thus preventing backsliding), ratcheting (i.e. undertaken by these countries since the mid- automatic lock-in of new liberalization 1990s. Additional commitments tend to span measures) and denial of benefits (rules of all financial sub-sectors, including those that origin). were not well covered in the first GATS round, such as insurance, securities-related and other financial services. The same is 3 Trade Note April 11, 2007 true in modal terms, with significant new regulatory reform. The fact that the LCR commitments particularly in mode 2 countries under review appear to have (consumption abroad). Commitments are in already largely liberalized their domestic general more extensive across all modes for financial systems on a unilateral basis prior FTAs involving the US, particularly for to their engagement in PTA negotiations has mode 2. By contrast, mode 1 commitments also contributed to this outcome. (cross-border trade), while better than what has been harvested to date under the GATS, Of course, consolidation of the regulatory remain relatively more timid (see Figure 3). status quo and the application of certain disciplines in trade agreements remain Have recent PTAs led to actual important because they can limit the liberalization of financial services as arbitrary use (and abuse) of `policy space' opposed to merely binding the status by the authorities. New disciplines such as quo? those on regulatory transparency, as well as the lock-in of the current policy regime via An analysis of individual LCR country commitments, standstill and ratcheting experiences is much more difficult to clauses, enhance predictability, prevent undertake because of insufficient potentially costly policy reversals, and can information on the regulatory status quo thus benefit both domestic and foreign prior to, during and after the implementation financial services providers and local of such trade agreements. A review of the consumers. It is therefore conceivable that a existing literature for the aforementioned PTA could exert significantly positive countries indicates that de novo impact on the business environment liberalization ­ which has chiefly taken the (including for financial services) even if real form of pre-commitments to future market liberalization commitments remain limited opening ­ is relatively modest. Apart from to the status quo. However, the issue of Costa Rica's insurance sector that would policy space is a double-edged sword, and have to open for the first time, real policymakers need to decide on the level of liberalization appears to have mostly taken policy flexibility and regulatory discretion place in the cross-border provision of some (which might not be the current one) that insurance services, as well as in asset properly balances policy considerations that management and auxiliary financial go beyond trade liberalization objectives per services. Although there is limited available se. Linked to this issue is the need for data on the actual market size of these sub- policymakers negotiating the financial sectors and modes, anecdotal evidence services provisions of PTAs to be cognizant suggests that they are relatively less of the important nuances in disciplines and important than `core' banking services. commitments that might create unintended However, the abolition of numerical quotas consequences or limit policy space beyond (e.g. economic needs test) and certain what was envisaged. The short time span juridical restrictions on forms of entry (e.g. since the entry into force of most PTAs insurance branchingiv) might also contribute means that their contribution ­ whether to further liberalization in other sub-sectors anticipated or unanticipated ­ still cannot be under mode 3. fully assessed. The above finding is a strong indication that, Many de novo liberalization commitments with a few exceptions, PTAs seem to be are actually not preferential in nature primarily used to consolidate and `lock in' existing unilateral liberalization rather than An interesting additional finding of the as means to actively promote further market analysis is that many de novo liberalization opening and the process of domestic commitments are actually not preferential in 4 Trade Note April 11, 2007 nature. While some commitments (e.g., the opening and domestic regulatory reforms. It abolition of an economic needs test for also shows that many de novo liberalization Chile) are country-specific and benefit the commitments are actually not preferential in financial services providers of the FTA nature, while there is no architectural model counterpart, others (e.g., permitting preferable for the liberalization of financial branching or opening up the insurance services. More work needs to be done in industry to private providers for Costa Rica) order to permit the ex post evaluation of require new `horizontal' regulations or laws recent PTAs and support the ex ante that would presumably apply to the entire decision-making process for financial sector industry and could actually benefit financial policymakers in these countries. service providers from third countries. This would seem to suggest that there might not be important first-mover advantages or serious economic distortions created by using PTAs to promote market opening in i Areas relevant to the domestic financial system financial services, although much depends that are not captured by the financial services on the specific nature of liberalization chapter include foreign investments in domestic commitments per se. non-financial securities, activities of non- regulated financial institutions (only in NAFTA- Is a GATS- or NAFTA-type type agreements), provisions on payments and `architectural' model preferable for capital movements, as well as accounting, data processing, telecoms, legal and taxation services. liberalization purposes? ii Some of these FTAs include an obligation to negotiate a financial services chapter some time The answer is unclear ­ while a simple after the entry into force of the agreement. review of the analyzed FTAs would seem to iiiThe NAFTA was the first FTA by a LCR favor NAFTA-type agreements, this can be country that included trade in financial services largely attributed to the involvement of the within its scope and devoted a specific self- US in many of them. In addition, the contained chapter to such trade. Subsequently, direction of causality between scheduling Mexico has been a key player in incorporating approaches and the level of liberalization financial services in its preferential trade commitments can run both ways. Finally, as agreements; of the twelve PTAs (all are FTAs) entered into by Mexico, seven contain a financial previously mentioned, both models have services chapter. introduced new features in recent years that iv However, it should be noted that domestic borrow from each other, revealing authorities retain the right to regulate such convergence around a hybrid-type approach. branches as they deem necessary for prudential purposes, including via the establishment of Conclusion local capital requirements. The proliferation of PTAs in LCR, many of which nowadays cover financial services, has potentially important implications for the structure of domestic financial systems and for their contribution to the overall financing of the economy. The aforementioned analysis has yielded some preliminary insights. It shows particularly that LCR countries have used PTAs primarily to consolidate and `lock in' existing unilateral liberalization rather than as means to actively promote further market 5 Trade Note April 11, 2007 This Trade Note was written by Constantinos References Stephanou (cstephanou@worldbank.org), Financial Economist in the Financial and Arbeláez, M. A., Flórez A. and Salazar N., Private Sector Development (FPD) unit of 2006, "Financial Services in the the Latin America and the Caribbean Region Colombia-U.S. Free Trade Agreement", (LCR). It is mainly based on a background World Bank mimeo. paper co-authored with Marilyne Goncalves Contreras P. and Yi S., 2003, (mgoncalves2@worldbank.org), consultant "Internationalization of Financial in FPDVP's Financial Market Integrity Services in Asia-Pacific and the Western department, which was commissioned as part of a broader project on trade in financial Hemisphere" Pacific Economic services in LCR (see Cooperation Council working paper. http://econ.worldbank.org/WBSITE/EXTER Contreras P., 2005, "Liberalization of Trade NAL/EXTDEC/EXTRESEARCH/EXTPRO in Financial Services: New Trends in GRAMS/EXTTRADERESEARCH/0,,conte the Western Hemisphere", mimeo. ntMDK:21184363~pagePK:64168182~piPK Echandi R., 2006, "The DR-CAFTA-US FTA :64168060~theSitePK:544849,00.html for Negotiations in Financial Services: The the background papers). The contribution of Experience of Costa Rica", World Bank Pierre Sauvé, as well as of the reviewers for mimeo. this paper, is gratefully acknowledged Saez R., 2006, "Trade in Financial Services: The Case of Chile", World Bank mimeo. Goncalves M.P. and Stephanou C., 2007, "Financial Services and Trade Agreements in Latin America and the Caribbean: An Overview", World Bank Policy Research Working Paper 4181. Van Horen N., 2006, "Foreign Banking in Developing Countries: Origin Matters", World Bank mimeo. 6