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The Regulation of Capital Flows

Though deployed successfully in restoring markets after the 2008 Financial Crisis, recent unconventional monetary measures have generated spillovers. The prospect of their retraction (i.e receding liquidity) engenders further adverse spillovers. It is in containing such spillovers that capital flow measures (CFMs) may prove to be vital. This guide addresses the issue of incongruent regimes applicable to capital flow measures, with a focus on the International Monetary Fund’s (IMF) Articles, international investment agreements (IIAs) and the World Trade Organization (WTO) regime.

Clinic: Graduate Institute, 2016

What are Capital Flows?

The term “Capital flows” refers to the movement of money across borders for the purpose of investment, trade, business production or allocation of revenues across different affiliates of an international corporation to reduce its tax liabilities. As such, capital flows take different forms. Because of their increasing size, capital flows became a matter of concern for regulators, both domestic and international. Consequently, they also became subject to different legal regimes which remain to be coordinated.

What is a Capital Flow Measure (CFM)?

CFMs refer to measures that are designed to limit capital flows and encompass both the measures that discriminate on the basis of residency and those that do not.

What is the IMF’s stand on CFMs?

The IMF Articles allow member states to enact restrictive capital flow measures in limited circumstances, though in practice, the regulation of the capital account under the IMF Articles is generally left to the discretion of member states.

Under the IMF Articles, the regulation of the CFMs should be restricted to current account transaction (with the objective of their liberalization); while capital account flow regulations are left to the discretion of member states. However, the IMF Articles may regulate the capital account either through indirect regulation of capital flows when approving restrictions on the current account; or when financing a member state in the midst of a financial crisis. Furthermore, the IMF may discuss capital account policies on certain occasions within the framework of bilateral consultations.

What is the WTO’s stand on CFMs?

Under the WTO, both the General Agreement on Tariffs and Trade (GATT) and the General Agreement on Trade in Services (GATS) Agreements complement and defer to the design of the IMF, permitting regulatory flexibility over exchange rates and capital flows, while ensuring that their abuse does not negate the objectives of the WTO framework.

The GATT is concerned with trade and monetary restrictions affecting the current account only. In deference to the IMF it allows member states to address balance of payments crises using exchange and trade restrictions (equivalent to restrictions on current transfers). Even so, it has been observed that the term “exchange restrictions” used under Art. XV.9 (a) of the GATT may well be used to enforce capital controls in restricting access to foreign exchange.

For its part, the GATS regulates both current and capital flows to the extent that they affect specific service commitments undertaken by member states. However, certain GATS provisions, such as the “prudential carve-out” are specifically applicable to trade in financial services and may allow for CFMs in this area. However, the extent of such a prudential carve-out and the degree to which it would draw from or be influenced by IMF prescriptions remains unclear.

What is the 2012 US Model BIT’s stand on CFMs?

Within the 2012 US Model Bilateral Investment Treaty (BIT) (substantially similar to its previous 2004 version) there exists enough regulatory flexibility for host state governments to mitigate risks that can accompany large swings in capital flows. Furthermore, some observe that general exceptions (the customary international law defense of “necessity” and the treaty “essential security interest” exception) would allow for policy space to enact CFMs in the event of a national balance of payments’ crisis, despite the lack of a specific safeguard dealing with such a case.

However, the above flexibilities may not operate ideally owing to interpretive uncertainties in currently prevailing jurisprudence, further compounded by the conspicuous lack of precision on the need and timing for CFMs in a given economy. Even so, the 2012 BIT is not as restrictive qua CFMs as certain other IIAs. Indeed, the only evident restriction on CFMs under the 2012 BIT is with respect to prudential/preventive CFMs impacting sectors other than financial services (which restriction is arguably similar in scope to that under the WTO regime).

How to manage the conflict of norms over CFMs

IMF prescriptions are not considered to amount to a “norm” under international law as they would not take on the functional character of a norm. This is significant for it implies that: a) conflicts with possible IMF prescriptions (such as on capital flows) may not be subject to rules governing conflict of norms under public international law; and, b) IMF prescriptions may not be overarching justifications or defenses before arbitral tribunals in the absence of a specific reference to them or greater clarity on the legal relationship they create.

However, the potential for the conflict of norms dealing with CFMs may arise in an economic crisis where CFMs may be endorsed by the IMF while being prohibited by an IIA. The WTO regime, in such circumstances and depending on the provision attracted, provides for deference to the assessment of the IMF. Otherwise, a conflict may also exist in normal circumstances where CFMs, recognized by the IMF as an important prudential policy tool, may not be employed by a host-state due to IIA restrictions. A pre-requisite to such conflict would be the exhaustion of interpretative rules in aid of reconciling such conflict.

In attempting to prevent such conflict, Art. 31(3)(c) of the Vienna Convention on the Law of Treaties (VCLT), posits that treaty interpretation must take into account “relevant rules of international law applicable in relations between the parties.” As a codification of customary international law, this provision may well require an arbitral tribunal to take into account IMF prescriptions as a “relevant rule” when interpreting IIA flexibilities, thus providing for systemic integration. However, in the event that the above principles would fail to reconcile opposing norms, the principle of lex posterior posits that the treaty later in time over the same subject matter would prevail, as codified under Art. 30 of the VCLT. Furthermore, the principle of lex specialis, though not embodied under the VCLT, posits that the more specific treaty supersedes the more general treaty.

In the event of a conflict therefore, IIA obligations would prevail over IMF prescriptions as being later in time and more specific. Arguing to the contrary would be difficult as it would require: a) IMF prescriptions, notwithstanding their sui generis “soft” character, to be capable of conflicting with and superseding IIA norms; and, b) IMF prescriptions to create fresh rights/obligations between its members (to qualify as lex-specialis/lex-posterior), notwithstanding that IMF prescriptions create only vertical rights between the IMF and the member and not horizontal rights between members.


Ramon della Torre - Dottore in Economia e Commercio, Dip. IFRS - Association Chartered Certified Accountants, L.L.B. & Laurea Magistralis in Financial Law, Master in International Law.

#IMF #Information #GraduateInstitute #Investment #BilateralInvestmentTreaty #WTO #GATT #GATS #ViennaConvention

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