Prudential exceptions in international trade and investment agreements. Problems of interpretation and enforcement

Gatina Dilyara Rustemovna Postgraduate student, Department of International Law, Russian Foreign Trade Academy of the Ministry of Economic Development of the Russian Federation 117546, Russia, Moskva, g. Moscow, ul. Khar'kovskii Proezd, 11, k.3, kv. 28 diley94@mail.ru Other publications by this author

The events of the last few years have increased the importance of studying the rules-exceptions contained in international trade and investment agreements, which fix the conditions under which States, in certain circumstances, may legitimately fail to comply with their obligations in the field of liberalization of trade in goods and services, as well as protection of foreign investment. A special place among such norms is occupied by exceptions for prudential reasons – that is, norms that allow states to take measures to prevent the occurrence of a financial crisis ^[1]. Unfortunately, these norms have not been widely studied in international law. At the same time, States, including Russia, have recently introduced measures that theoretically may require the application of this rule in the framework of a dispute. For example, the Decree of the President of the Russian Federation "On additional temporary economic measures to ensure the financial stability of the Russian Federation" established a less favorable regime for the implementation of activities in the financial services market by persons who are residents of unfriendly countries. Also, the Central Bank of the Russian Federation, in connection with the sanctions imposed on the Russian Federation by the United States, European countries and a number of other states, regularly introduces measures to stabilize the situation on the financial market in the context of the implementation of sanctions risks. For example, transfers abroad from bank accounts (money transfers without opening bank accounts, including electronic money transfers) of legal entities – residents of "unfriendly" foreign countries, with the exception of banks from "unfriendly" countries and a number of other measures have been suspended.

Of course, at present there is no need to talk about the real risk of international disputes on these issues. It seems that the need to introduce appropriate measures is obvious in the current circumstances for the entire world community. At the same time, we now consider it important to shed some light on the cases in which the actions of States aimed at maintaining financial stability, in cases where they have led to a violation of international obligations, can be recognized as legitimate.

Exceptions for prudential reasons are contained in the following international agreements to which the Russian Federation is a party:

· General Agreement on Trade in Services (hereinafter - GATS);

· The Treaty on the Eurasian Economic Union (hereinafter referred to as the Treaty on the EAEU);

· A Partnership and cooperation agreement establishing a partnership between the Russian Federation, on the one hand, and the European Communities and their member States, on the other hand.

For the convenience of interpretation of this rule, we suggest quoting the exception for prudential reasons contained in Part 2 (a) of the Financial Services Annex to the GATS: "Regardless of any other provisions of this Agreement, a Member State is not prevented from taking measures based on prudential considerations, including the protection of investors, depositors, policyholders or persons in respect of whom financial service providers have a fiduciary duty, or ensuring the integrity and stability of the financial system. If such measures do not comply with the provisions of the Agreement, they should not be used as a means of evading the obligations assumed by the Member State in accordance with the Agreement."

The difference between the concepts of "measures taken for prudential reasons" and "prudential measures"

One of the main problems of interpretation of this rule is the lack of an official definition of the concept of "measures taken for prudential reasons", as well as the term "prudential measures".

Par. 2 (a) of the Financial Services Annex to the GATS contains only examples of groups of measures that can be considered as "measures taken for prudential reasons", namely: 1) measures aimed at protecting consumers of financial services; 2) measures aimed at ensuring financial stability, 3) measures that aimed at ensuring financial integrity.

In foreign dictionaries, the term "prudence" is translated as "caution" or "prudence" in relation to danger or risk. The main "danger" associated with activities in the financial services market is the bankruptcy of financial organizations, which can lead to a financial crisis ^{[2, p. 12]}. Accordingly, measures taken for prudential reasons should be aimed at preventing situations of insolvency of banks, insurance companies, as well as securities market participants that could pose a threat to financial stability. Taking into account the above, we believe that the term "measures taken for prudential reasons" can be understood as any government measures introduced in the national financial services markets in order to prevent the occurrence of a financial crisis or eliminate its consequences, which may include 1) prudential measures; 2) non-prudential measures, 3) anti-crisis measures.

Despite the similarity of the names, prudential measures are one of the types of measures that can be considered as "measures taken for prudential reasons" within the framework of the interpretation of the norms under study. In the absence of a regulatory definition, prudential measures are proposed to be understood as a set of government measures requiring financial service providers to control their risks by complying with the established regulatory requirements (standards) for capital adequacy and liquidity, as well as limits on risk concentration, and involving reporting by such organizations to the national financial regulator in order for it to assess compliance by such organizations with regulatory requirements and taking measures aimed at preventing the occurrence of a financial crisis at an early stage ^[3]. Unlike prudential, non-prudential measures are understood as measures that do not require monitoring of the financial condition of organizations providing financial services, which includes, inter alia, measures aimed at protecting consumers of financial services, combating crimes in the financial services market, and regulating competition.  Anti-crisis measures differ from prudential and non-prudential measures in that these measures are temporary, as they are introduced in response to the occurrence of crisis situations.

The norms in question contain a non-exhaustive list of measures that can be recognized as "measures taken for prudential reasons". These may include, for example, measures aimed at combating the financing of terrorism and money laundering; measures to prevent the imposition of financial services, concealment of essential information from customers; measures aimed at protecting personal data, preventing and identifying conflicts of interest; measures to protect depositors' financial resources in the event of bank bankruptcy, etc.

It is important to note that the interpretation of the material grounds for applying exceptions for prudential reasons should be carried out evolutionarily, that is, in the light of today's conditions ^{[4, pp. 11-12]}. At the same time, the analysis showed that not a single exception under prudential agreements contains "self-jurisdiction" elements that would allow States to independently determine which measures they take correspond to the goals specified in them.

The absence of judicial elements in these norms suggests that international dispute resolution bodies, in the framework of assessing the legality of the use of exceptions for prudential reasons, will need to rely on objective criteria to answer the question whether the relevant measure was actually taken for prudential reasons. That is, the prudential goals listed in the exceptions under study will need to be considered in accordance with the usual meaning of these terms, which is given to them in the context, as well as in the light of the object and objectives of the contract in which such a rule will be contained.

The problem associated with the confusion of the concepts of "prudential measures" and "measures taken for prudential reasons" has found its continuation in the way in which the "exception for prudential reasons" is formulated in paragraph 19 of the Protocol on Financial Services to the said agreement.  This norm cannot be called a norm similar to par. 2 (a) of the Financial Services Annex to the GATS, mainly due to the fact that the GATS specifies "measures taken for prudential reasons" as grounds for non–compliance with international obligations in the field of liberalization of trade in services, and the EAEU Treaty specifies "prudential measures". Taking into account the above interpretation of these terms, the difference in wording may lead to the fact that within the framework of the EEA, the right of a state to determine its internal prudential policy may be limited in comparison with the rights granted to states under the WTO ^[5]. Thus, it seems correct to bring the wording of the exception for prudential reasons contained in the EAEU Treaty into line with the GATS and state this rule as follows:  "Nothing in this Protocol, the Protocol on Trade in Services, Establishment, Activity and Investment, as well as in sections XV and XVI of the EAEU Treaty, prevents a member State from taking measures based on prudential considerations, such as: 1) protection of the interests of investors, depositors, policyholders, beneficiaries and persons to whom the service provider bears fiduciary responsibility, 2) ensuring the integrity and stability of the financial system. If such measures do not comply with the provisions of this Protocol, they should not be used by a Member State as a means of evading the obligations assumed by that Member State in accordance with this Treaty."

Grounds for applying exceptions for prudential reasons

In cases where measures taken for prudential reasons lead to a violation of the rights of financial service providers from foreign countries, it is important to understand the criteria to establish their legality.

Interpretation of exceptions for prudential reasons makes it possible to identify material and procedural conditions, compliance with which will indicate that measures imposed by the State may fall under the scope of exceptions for prudential reasons and, accordingly, serve as a basis for avoiding international liability in the dispute.

The material condition is the compliance of the measure with prudential goals (the goal of preventing the risk of a financial crisis or eliminating its consequences), which, depending on the wording of the exceptions studied, may include: 1) protection of consumers of financial services, 2) ensuring the financial stability of financial service providers, 3) ensuring financial stability 2) ensuring financial integrity.

The procedural conditions include, firstly, the need for the measure to meet the criterion of "risk orientation", which implies its focus on preventing the risk of a financial crisis. This follows from the very nature of "measures taken for prudential reasons" and implies that in the event of a dispute, an international justice body/investment arbitration should assess whether the appropriate measure is capable of eliminating the risk of adverse consequences for the normal functioning of the financial services market. In our opinion, both measures introduced in response to the immediate threat of a financial crisis and measures designed to prevent the occurrence of these consequences in the long term can correspond to the criterion of "risk orientation".

The second procedural condition is the presence of a causal relationship between the introduced measure and the goal pursued during its introduction to prevent the occurrence of adverse consequences in the financial services market. As it was noted in the case of Argentina – Financial Services, this condition is met if "the introduced measure contributes to achieving the desired effect" ^{[6, par. 7.9.38]}.

The last procedural condition is the good faith of the actions of States when introducing measures that have caused violations of the rights of third States. Bona fide actions imply that the creation of discriminatory conditions for foreign financial service providers is not the very purpose of the introduced prudential or other measures aimed at preventing the risk of a financial crisis.

The indication that States should act in good faith is contained in the final sentence of paragraph 2 (a) of the Financial Services Annex to the GATS: "If such measures [measures taken for prudential reasons] do not comply with the provisions of the [GATS] Agreement, they should not be used as a means of evading specific obligations assumed by a Member State in accordance with the Agreement."

At the first reading of this rule, it may seem that the above proposal blocks the application of the exception, since if a measure introduced for prudential reasons leads to a violation of the rights of States in the field of liberalization of trade in financial services/ investment protection, then it cannot but be considered as a means of evasion by a Member State from themselves in accordance with the international agreement of obligations ^{[7, p. 759]}.

At the same time, the history of the development of paragraph 2 (a) of the Financial Services Annex indicates that this phrase was included in order to prevent the use of the rights granted to the norm in question for malicious purposes. Therefore, it cannot be considered as a norm prohibiting the use of prudential measures if they lead to violations of obligations under the GATS. This proposal should be interpreted as a requirement to act in good faith when applying prudential measures and to avoid abuse of the rights granted by the exception in question.

Ways to consolidate the principle of good faith

An analysis of the formulations of prudential exceptions contained in various international trade and investment agreements has shown that the relevant norms may provide for different standards for assessing the actions of States when applying prudential measures for compliance with the principle of good faith: low and high ^[8]. A low standard of assessment implies the need to prove that the relevant measure was "reasonable".

The group of exceptions with a higher standard of assessment will include those exceptions for which States need to prove that the measures they are taking are no more burdensome than is required to achieve prudential goals, and that the principle of national treatment is observed with respect to such measures (see Table 1).

 It seems that the requirement to apply a high standard of assessment leads to the fact that the State has obstacles in order to take measures that they consider necessary to maintain the stability of their financial system. Thus, in agreements with the participation of the Russian Federation, it is proposed to include exceptions for prudential reasons, providing for a low standard for assessing the actions of the state for its integrity. This will protect national economic interests when providing access to foreign suppliers to the financial services market.

Procedure for the consideration of disputes arising from the application of exceptions for prudential reasons

Within the framework of this article, it is important to say a few words about the procedure for considering international disputes if one of the parties refers to an exception for prudential reasons as a justification for the legality of its actions. Since each exception norm, by its nature, is designed to protect the rights of States in the most sensitive areas for them ^{[9, p. 235]}, an incorrect conclusion made by an international justice body when considering disputes about the legality of the application of these norms can potentially undermine the state's confidence in the current system of resolving international disputes and subsequently lead to the withdrawal of the state from the relevant international agreement.  

In accordance with the Financial Services Annex to the GATS, the inclusion of arbitrators with competence corresponding to the specifics of the financial service on which the dispute is being conducted is intended to ensure the correct and fair consideration of disputes arising from the application of exceptions for prudential reasons. It is important in this regard to mention the mechanism of consideration of investment disputes, the subject of which is the application of exceptions for prudential reasons. For example, the provisions of the Trade Agreement between the United States, Mexico and Canada (USMCA), as well as the Comprehensive Economic and Trade Agreement (CETA) between Canada and the European Union, provide for the need to transfer the consideration of such disputes to a specially created commission, whose members are representatives of bodies authorized to introduce measures for prudential reasons as from the State from which there is an investor, and from the state in which the investments are made. This composition is explained by the purpose of conducting a professional assessment of the possibility of applying the exception for prudential reasons in specific circumstances ^[10].

In our opinion, this approach is perhaps the main mechanism capable of ensuring a balance between the rights of an investor and the national interests of the state in the framework of investment disputes, the subject of which is the application of exceptions for prudential reasons. In conditions when an investor, due to his status, cannot get access to the entire volume of information necessary to assess the legality of state actions when introducing measures based on prudential considerations, it is this mechanism that "equalizes" the rights of the investor and the state, and allows for a fair consideration of an investment dispute. It seems that this approach should become universal in cases where the investor is the party to the dispute, which implies the need to include in each investment agreement containing the norms under study, also provisions regulating a special procedure for the consideration of such disputes.

The problems of interpretation and enforcement of exceptions for prudential reasons are certainly related to the lack of a broad practice of applying the rules in question. At the same time, in those few disputes in which the parties referred to exceptions for prudential reasons, the courts, as well as investment arbitrations, did not see grounds for applying these rules. Despite the fact that the norms under consideration provide broad powers to States in terms of introducing measures aimed at preventing the occurrence of a financial crisis, these measures can be subjected to a comprehensive assessment by international justice bodies in order to clarify the true intentions of States when introducing appropriate regulation. The norm, which at first glance represents a loophole for unfair actions on the part of States, nevertheless contains restrictions that do not allow for unfair actions of States. This applies, among other things, to exceptions providing for a low standard of evaluation of actions for their integrity. The limitations on the application of exceptions for prudential reasons highlighted in this article, which include "risk orientation", "the presence of a causal relationship", follow directly from the interpretation of only one term - "measures taken for prudential reasons", in which the whole secret of the application of such exceptions is hidden. This makes this rule unique to some extent, and allows it to allocate a special place among the exception rules in force in international law.