Tuesday, September 9, 2014

Europe Trade Pact Could Weaken Canada Power to Regulate Banks

The Bank of Canada marker is pictured in Ottawa on September 6, 2011.
Canada’s ability to head off a financial crisis by tightening banking regulations may be curtailed under the still secret Canada-European Union trade agreement.

The pact, awaiting final approval in Canada and Europe, is part of a new breed of free trade deals that goes far beyond reducing tariffs to covering commercial interactions, services and the flow of money between companies in the signatory nations.

With multi-billion-dollar investments and the health of the banking sector at stake, the rules governing the ability of foreign investors to sue Ottawa over its handling of financial services — and vice-versa for Canadian companies in Europe — emerged as one of the most contentious aspects of the five-year negotiations between Canada and the EU. Financial services was the last section of the treaty settled by the two sides’ negotiators in talks that dragged on until August.

The final outcome in the Comprehensive Economic and Trade Agreement (CETA) could have important implications for Canada, its economically vital banking system and Canadian depositors.

Ottawa’s relatively strict banking regulations prevented the kind of financial sector meltdown here that crushed economies in Europe and the United States in 2008. So Ottawa’s aim in the Canada-EU horse-trading was to hold off European demands to liberalize our banking rules and to preserve as much power as possible to prevent risky lending and reckless securities practices by Canadian and foreign banks operating in this country.

The deal hammered out by negotiators has yet to be released by Prime Minister Stephen Harper’s government. But leaked CETA texts show Canada made significant concessions on financial services in its effort to finally complete the negotiations.

Under CETA, a European financial services corporation operating in Canada would have the right to launch a legal challenge against Ottawa over regulations the company considers unfair or detrimental to its profit-making ability (and vice-versa for Canadians operating in the EU). These challenges bypass regular courts and are decided by special tribunals. Corporations can be awarded millions of dollars if a challenge succeeds.

Under CETA, the scope for foreign banks to launch such investor-state challenges is much broader than in Canada’s other major pact of this type: the North American Free Trade Agreement (NAFTA).
With NAFTA, legal challenges regarding financial services are limited and can only be undertaken when a foreign investor believes it has been disadvantaged by expropriation of its assets without compensation or by a foreign government’s interference in the transfer of funds between the foreign bank branch and its home office.

But under CETA, legal challenges regarding banking rules can be brought against governments on a significantly wider range of investor protections. Besides claims over transfer of funds or expropriation issues, foreign banks can also try to sue Ottawa if a bank believes that, as a result of Canadian regulations, it is being discriminated against compared to the treatment of other Canadian or foreign investors.

And, in an important difference from NAFTA, under CETA foreign banks can sue on the grounds that they are not being afforded “fair and equitable treatment,” a broadly defined standard of global investor rights.

This has raised questions about Ottawa’s ability, in the rush of a pending financial emergency, to clamp down on banking practices the government considers unsound. With potential suits looming, some observers ask whether federal banking regulators be leery of acting swiftly and decisively.
“It will have an impact if there is a crisis,” said Gus Van Harten, who specializes in international investment law at Osgoode Hall Law School.

Van Harten said “fair and equitable treatment” clauses give arbitrators of investor-state dispute cases a very wide scope to award damages to corporations.

“Anyone who says that, in a major financial crisis, this agreement is not going to loom large is basically a fool,” he said. “With billions of dollars at stake, you’re going to think very carefully about what an unknown trio of arbitrators is going to do with the fair and equitable treatment clause as applied to the financial sector. So I can’t believe that our government officials wouldn’t be very attentive to that.”

Scott Sinclair, a trade expert with the Canadian Centre for Policy Alternatives, said it appears Ottawa gave in on the financial services issues “in its zeal” to conclude CETA.

“Paradoxically, given our experience during the financial crisis and the fact that Canada weathered that fairly well, we should have been in a strong position to withstand European pressure for further restrictions on our regulatory authority over financial services,” Sinclair said.

But the opposite seems to have happened, he said.

Canada did negotiate what is called “a carve-out” to protect its ability to put in place prudent financial services measures. But if a suit is launched by a foreign investor against Ottawa, it will be referred to a financial services committee made up of experts from Canada and Europe. To block the investors’ legal challenge at that stage, the committee much reach a consensus that the government’s use of prudent measures was legitimate and therefore not a breach of the foreign investors’ rights.

But, unless there is a consensus, the legal case will move ahead to a tribunal.

Among the types of regulation that might be subject to challenge are Ottawa’s moves in recent years to head off a real estate bubble. Since 2008, the federal government has tightened mortgage rules on four occasions.

As part of CETA, the Harper government is also widening the opportunity for European companies — in financial services and other sectors — to buy Canadian companies without being subject to a review under the Investment Canada Act (ICA). The Europeans wanted takeovers of Canadian companies by EU-based investors to be completely exempt from pre-merger reviews under the ICA, which investigates large buyouts to see if they are of “net benefit” to Canada.

The federal government was already moving gradually to raise the threshold for a mandatory review of takeovers by a foreign company to $1 billion from the previous $344 million. But, in a concession to the EU, Ottawa agreed that under CETA the threshold for requiring a review of a takeover of a Canadian company by EU investors will rise to $1.5 billion.

And, as a result of Ottawa’s trade obligations, the threshold will also rise to $1.5 billion for buyouts of Canadian corporations by U.S. and Mexican companies.

But CETA protects Canadian banks from takeover by EU-based banks by preserving Canada’s “widely held” ownership rule, which by limiting any single shareholder’s control effectively blocks a foreign buyout of a Canadian bank.

Ottawa says investor protections will help boost investment by Canadian companies abroad and encourage EU-based companies to put money into this country.

“Foreign direct investment, such as an EU company opening a plant in Canada, creates new jobs and introduces the receiving country to new technologies, different management techniques and broader international markets,” the federal government said in a background paper on CETA.

But, with Ottawa and the EU facing a two-year ratification process for CETA, it is unclear whether investor protection measures allowing corporations to challenge government regulations will remain in the agreement in their current form when the pact goes into force.

There are growing objections to these measures in Europe, where many people say they give corporations too much power to interfere in government efforts to regulate the environment, health and public safety.


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