Access to Trade Finance in Times of Crisis

Book
Chapter

Chapter 11. Improving the Availability of Trade Financing: The Role of the World Trade Organization

Author(s):
Jian-Ye Wang, and Márcio Valério Ronci
Published Date:
February 2006
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Author(s)

Improving the access of developing countries to more plentiful and secure sources of trade financing, particularly in periods of financial or exchange rate crisis, has been a matter of concern for some time for developing-country members of the World Trade Organization (WTO). The issue was raised during the emerging markets financial crisis in 1997–98, and more recently was been discussed in the WTO General Council and in the WTO Working Group on Trade Debt.

Two areas of the WTO’s work relevant to the issue of trade financing are multilateral negotiations on services—in particular financial service—and trade rules such as the WTO Agreement on Subsidies and Countervailing Measures, which extends to certain trade financing and guarantee activities of specialized public institutions. More generally, the WTO aims also to exercise vigilance that markets are kept open in periods of financial crisis, and that trade measures that might undermine coordinated efforts by the international community to maintain the flows of trade or trade finance be avoided.

WTO Contribution Through Market Access: Trade in the GATS

This chapter looks at market access with a focus on the current negotiations on trade in financial services in the context of the Doha Development Round. It provides a basic overview of the General Agreement on Trade in Services (GATS), discusses the classification of trade financing activities under that Agreement, describes the current status of commitments in this area, and finally, discusses potential initiatives in the current round of services negotiations.

Basic Overview of the GATS

The General Agreement on Trade in Services is the first multilateral framework of rules and principles for the progressive liberalization of trade in services, including financial activities. Without making a comprehensive presentation on the GATS, 57 the discussion here will focus on the most relevant aspects for this chapter, namely, the scope of the GATS, its definition of trade in services, and the schedules of specific commitments.

The GATS sectoral coverage is wide. The agreement covers all services sectors, with the exception of services supplied in the exercise of governmental authority 58 and the bulk of air transport services. 59 In addition, the GATS applies to all measures 60 affecting trade in services.

Going beyond the traditional definition of trade, the GATS defines trade in services in terms of four modes of supply: mode 1, or cross-border supply, whereby the service is supplied from a territory of one country into the territory of the member undertaking the commitment; mode 2, or consumption abroad, whereby the service is supplied in the territory of one member to a consumer of the member undertaking the commitment; mode 3, or commercial presence, whereby the service supplier (e.g., a foreign bank) is legally established in the territory of the member undertaking the commitment and supplies services through that establishment; and mode 4, or movement of natural persons, whereby natural persons supply—on a temporary basis—a financial service in the territory of the member undertaking the commitment.

In the GATS context, services liberalization is pursued mainly through WTO members’ specific commitments guaranteeing the right to supply services (including financial services) under any of these four modes of supply. Sectoral commitments are included in a schedule, one for each WTO member. Sectors to be liberalized are listed “positively” and applicable limitations (if any) are listed “negatively.” Due to the positive listing of sectors, the GATS is usually characterized as having a “positive list approach” to liberalization. For each service on which a commitment is made, the schedule must indicate, under each of the four modes, any limitations on market access or national treatment that the member intends to keep. Once the sector is included, three scenarios are possible:

  • (i) No limitations on access to the market, identified by the entry “none”;

  • (ii) No commitment on access to the market through the mode of supply concerned, identified by the entry “unbound” (i.e., the member remains free to introduce restrictions); and

  • (iii) Subjecting access to the market to specific limitations listed in the schedule (i.e., so-called partial commitments).

Schedules of specific commitments follow a four-column format. The first column defines the sector or subsector on which commitments are being made; the second column indicates any limitation on market access; and the third column indicates any limitations on national treatment. The fourth column is meant to include any additional commitment made under GATS Article XVIII on regulatory measures not subject to scheduling under GATS Articles XVI and XVII. Contrary to commitments on market access and national treatment, additional commitments are undertakings or positive actions promised by the WTO member making the commitment.

Classification of Trade Financing Activities in the GATS

As shown in Box 11.1, the GATS covers all financial services, including all insurance and insurance-related services, and all banking and other financial services (excluding insurance). The list includes activities such as “lending of all types, including consumer credit, mortgage credit, factoring and financial of commercial transaction,” “financial leasing” or even “guarantees and commitments.”

Box 11.1.Classification of Financial Services (GATS Annex on Financial Services)

Insurance and insurance-related services

  • (i) Direct insurance (including co-insurance):

    • (a) life

    • (b) nonlife

  • (ii) Reinsurance and retrocession

  • (iii) Insurance intermediation, such as brokerage and agency

  • (iv) Services auxiliary to insurance, such as consultancy, actuarial, risk assessment, and claim settlement services.

Banking and other financial services (excluding insurance)

  • (v) Acceptance of deposits and other repayable funds from the public

  • (vi) Lending of all types, including consumer credit, mortgage credit, factoring and financing of commercial transactions

  • (vii) Financial leasing

  • (viii) All payment and money transmission services, including credit, charge and debit cards, travelers cheques, and bankers’ drafts

  • (ix) Guarantees and commitments

  • (x) Trading for own account or for account of customers, whether on an exchange, in an over-the-counter market, or otherwise the following:

    • (a) money market instruments (including cheques, bills, certificates of deposits)

    • (b) foreign exchange

    • (c) derivative products including, but not limited to, futures and options

    • (d) exchange rate and interest rate instruments, including products such as swaps and forward rate agreements

    • (e) transferable securities

    • (f) other negotiable instruments and financial assets, including bullion

  • (xi) Participation in issues of all kinds of securities, including underwriting and placement as agent (whether publicly or privately) and provision of services related to such issues

  • (xii) Money broking

  • (xiii) Asset management, such as cash or portfolio management, all forms of collective investment management, pension fund management, and custodial, depository and trust services

  • (xiv) Settlement and clearing services for financial assets, including securities, derivative products, and other negotiable instruments

  • (xv) Provision and transfer of financial information and financial data processing and related software by suppliers of other financial services

  • (xvi) Advisory, intermediation and other auxiliary financial services on all the activities listed in subparagraphs (v) through (xv), including credit reference and analysis, investment and portfolio research and advice, and advice on acquisitions and corporate restructuring and strategy.

Trade finance—which is defined as short-term, mainly less than 180 days, externally provided financing to support exports and imports—is covered by the definition of financial services used for GATS purposes, particularly those of lending of all types, and guarantees and commitments. 61 However, the expression “trade financing,” or the alternative financial instruments used in trade financing (e.g., of credit, guarantees, and acceptances) are not spelled out in any detail. 62

Current Commitments by WTO Members

In most cases, the provision of “trade financing” has not been singled out in WTO members’ commitments. Therefore, this line of business has been kept subject to the same restrictions applicable to other forms of lending, particularly with regard to the supply through a commercial establishment in the host country.

Table 11.1 shows that the number of commitments guaranteeing the free provision of trade financing on a cross-border basis (mode 1) is limited. The table presents the commitments undertaken by WTO members on trade financing before and during the 1997 negotiations, as well as the commitments made by the so-called “acceding members” (i.e., those WTO members that joined the organization through individual accession protocols after the inception of the WTO).

Table 11.1. WTO Members with Full Commitment on Cross-Border Supply of Trade Finance 1

(As of December 2003)

Pre-1997 negotiations 1997 negotiations Through accession protocols
Angola 2 Bahrain 3 Armenia
Benin 4 Ecuador Croatia
Gabon Ghana 5 Estonia
Gambia Indonesia 6 Georgia
Guyana Israel 7 Jordan
Haiti Kenya Kyrgyz Republic
Malawi Malaysia 8 Lithuania
Morocco 9 Malta Moldova 10
Mozambique Mauritius 11 Panama
Sierra Leone Philippines 12 Papua New Guinea
Solomon Islands Romania Qatar
Zimbabwe Slovenia 13 United Arab Emirates
Switzerland
Tunisia 14
Source: WTO Secretariat’s elaboration based on schedules of specific commitments.

“Full commitment” is understood as a market access commitment with no limitations, except as otherwise indicated in the footnotes. Commitments by Cambodia and Nepal have not been considered since they have not officially become WTO members.

Residents may borrow abroad after the National Bank of Angola has authorized them.

Undertaking this activity (including soliciting and advertising) in/from Bahrain requires a licence from the Bahrain Monetary Authority.

Residents may borrow abroad after first obtaining authorization from the Minister of Finance in conformity with the Exchange Control Regulations for loans of over CFAF 50 million.

Commitment on “credit facilities.”

Only on “international factoring services.”

Such activities can only be carried out through banking institutions licensed by the controller of foreign exchange to act as an authorized dealer.

Financial services associated with lending to residents in any currency in excess of an equivalent of RM25 million must be undertaken jointly with commercial banks or merchant banks in Malaysia.

Commitment on lending to finance commercial transactions with Morocco (CPC 8113*).

Commercial presence is required through a branch or subsidiary.

Excluding factoring.

Commercial presence is required.

Unlimited except accepting credits (borrowing of all types), and accepting guarantees and commitments from foreign credit institutions by domestic legal entities and sole proprietors. Consumer credits will be free upon the adoption of the new Foreign

Borrowing by resident companies subject to authorization according to exchange controls regulations.

The current situation can be summarized as follows:

  • Of 90 WTO members that have committed to allow the supply of at least some form of lending, only 38 have made full commitments (“none”) ensuring the free provision of finance for commercial transactions by nonestablished financial entities (i.e., on a cross-border basis).

  • Almost all of those 38 commitments come from developing countries and economies in transition. 63

  • Many of the most advanced developing-country members have not made commitments allowing for the cross-border provision of trade finance into their markets. These include Brazil, China, Chinese Taipei, India, Pakistan, South Africa, and Thailand.

Commitments on the cross-border provision of all types of lending have two dimensions of interest for this discussion. On the one hand, they include the direct supply of trade financing by international banks; and, on the other, they also cover interbank lending (i.e., local banks short- and long-term borrowing from the overseas market). Funding abroad is one of the channels used by local banks (whether private or state-owned) to raise capital to finance exports of domestic companies.

Ninety WTO members made commitments on the supply of lending through a commercial establishment in the host country. Establishing a commercial presence (e.g., subsidiary, branch, representative office) is indeed an important aspect of international banks’ strategies on trade finance. However, there are two main reasons why it is more difficult to present a generalized picture of commitments on the provision of trade finance through a commercial presence. First, unlike commitments on cross-border supply, the practice shows that commitments governing the commercial presence of foreign banks are not an all or nothing affair. In other words, while commitments on the cross-border supply of lending are either “full” (no limitations) or nonexistent (“unbound” in the GATS jargon), most commitments on the supply of lending through subsidiaries, branches, or other forms of establishment are “partial” (i.e., subject to limitations such as foreign equity restrictions or limitations on the number of foreign institutions allowed). Therefore, it is difficult to make generalizations. Second, since trade financing activities usually are a part of the range of services provided by banking institutions, the provision of trade financing through establishment is subject to the same limitations applicable to the establishment of any bank (e.g., limitations on foreign ownership).

It is worth noting, however, that the absence of a commitment does not mean that the supply is not permitted. A member may maintain a very liberal regime on the foreign provision of trade finance while not making any commitment under the GATS. But with no commitments there is no guarantee that the country will stay open.

Potential Initiatives in the Current Round of Services Negotiations

Under the GATS, WTO members may undertake commitments guaranteeing the right to supply financial services, including trade finance, on a cross-border basis (as a service) or through a commercial presence (e.g., subsidiary or branch).

Current negotiations on financial services may contribute to a more secure and predictable environment for trade financing activities. At least five reasons can be adduced for undertaking market access and national treatment commitments on trade financing in the GATS. First, national policies become more predictable and certain, due to the credibility-enhancing effect of a multilateral commitment protected by an efficient dispute settlement mechanism. Second, open markets may help ensure the continued availability of finance for imports and exports under reasonable conditions. Third, further competition in the market is expected to encourage quality improvement, as well as the introduction of new trade finance instruments. Fourth, further competition may lead to an improvement in risk intermediation and increase the market’s liquidity, resulting in lower financing costs and reducing the likelihood of a simultaneous collapse of all financial intermediaries. Finally, a willingness to make commitments in a multilateral negotiation may induce other countries to do likewise, leading to a virtuous cycle of mutual benefits.

The limited number of liberalization commitments, particularly on the cross-border provision of trade finance, leaves ample room for improvement in the current round of negotiations. From a technical point of view, one of the reasons why WTO members may have hesitated to take commitments on short-term lending for trade finance purposes is the highly aggregated nature of the classification of lending activities contained in the GATS, which includes other—more sensitive—types of lending, such as consumer and mortgage credit. However, WTO members are free to make commitments specific to a particular service (trade finance) and mode of supply (e.g., modes 1 and 3). Tailor-made or ad hoc definitions can be used in that regard. The aim would be to circumscribe the sector definition so as to allow the maximum number of commitments possible, and thus provide a truly open environment for such activity. A few WTO members have already used their own definitions to cover foreign trade finance activities. For instance, Chile defined “credit granting” as including “…current loans, loans in letters of credit,…issue and negotiation of letters of credit for imports and exports, issue and confirmation of stand-by letters of credit.” 64 Morocco defined the sectors as “lending to finance commercial transactions with Morocco (CPC 8113*).” Commitments on short-term interbank lending for trade finance purposes may also be envisaged.

It is also worth noting that other financial activities related to trade finance, and which are also covered by the GATS, might also have to be liberalized in order to maximize the benefits of specific commitments in this area. A couple of examples may illustrate this idea. On the one hand, like any other credit granting activity, trade finance would call for a previous check-up of the financial condition of the loan recipient. Commitments on the cross-border provision of other auxiliary financial services, such as advice, intermediation, and credit reference analysis may be necessary in that regard. 65 On the other hand, the success of a letter of credit, which is the most widely used trade finance instrument, depends inter alia on insuring the merchandise being shipped against damage or loss. In fact, the existence of appropriate documentation (e.g., an insurance certificate or policy) is a sine qua non condition of any letter of credit. Commitments on the crossborder provision of insurance of risks relating to the goods being transported may be of importance in that regard. 66

Although the main interest is to ensure the continuous availability of trade finance for developing countries, greater value would be added if commitments were made by both developed and developing countries. Even though ensuring the availability of trade financing for developing countries on a continuous basis would require these countries to make commitments in this area, it is fair to acknowledge that trade financing is not a one-way street. The modalities of trade financing (e.g., back-to-back letters of credit), as well as the need to cater to regional trade flows, call for commitments being undertaken also by developed countries. In that regard, banks from developing countries are also major players in trade financing, particularly in the case of regional trade flows. 67

Apart from ensuring a more open and predictable environment via the expansion of market access commitments, the GATS can also contribute by enhancing transparency. In fact, the GATS already imposes the obligation on WTO members to provide notification, at least once a year, of all the changes introduced to regulations affecting trade in the sectors covered by specific commitments such as lending (Table 11.1).

Specific commitments on trade finance are only one element of a broader initiative toward ensuring the availability of trade finance for developing countries in times of crises. Benefits stemming from those commitments must be put in the right perspective. In normal times, commitments by recipient countries would ensure that trade financing flows are not restricted. However, in times of crises, commitments might not prevent lender countries from pulling back because of a drop in confidence. Other initiatives and policies, both on the part of the international community and the individual countries, would be needed in order to keep those trade finance flows stable. 68

WTO Role in the Area of Rules

The second issue, the implications of the Subsidies and Countervailing Measures (SCM) Agreement disciplines for export credits, guarantees, and insurance—particular to developing countries—is a complex one. The WTO Secretariat does not have any interpretative power in this domain, as the interpretation and implementation of the agreement is left to members, and certain legal issues regarding the scope of the disciplines are unresolved. In addition, the SCM Agreement is being reviewed as part of the Doha Round, and it is too early to say whether the relevant provisions of interest will be affected. This depends only on the members. That said, certain points can be made regarding the current SCM Agreement:

  • The agreement prohibits subsidies that are contingent upon export performance, and export credits, guarantees, and insurance may under certain circumstances fall within the scope of that prohibition. 69

  • Under item (k), second paragraph, of Annex I, export credit practices that are in conformity with the interest rate provisions of the OECD Arrangement on Officially Supported Export Credits are not prohibited. 70 However, given that the OECD Arrangement applies only to medium- and long-term credit (two years or more), and that the main concern on trade finance discussed in this chapter relates to short-term financing, this provision is of limited relevance to the problem under consideration here.

  • Least-developed member countries are exempted from the prohibition on export subsidies, as are certain other developing-country members listed in Annex VII(b) to the agreement until their GNP per capita reaches $1,000 (in 1990 constant dollars) for three consecutive years. 71

Although the SCM Agreement is not clear in all respects, certain observations can be made regarding ways to reduce the risk that measures taken to address the problems identified in this chapter could be deemed inconsistent with the agreement. First, the agreement prohibits only two types of subsidies: those contingent upon exportation, and those contingent upon the use of domestic over imported goods. Thus, schemes that deal only with the financing of essential imported inputs, are available irrespective of whether the imported inputs are for use for the production of goods for export or for domestic consumption, and do not discriminate with respect to the origin of the inputs, are not likely to run afoul of the prohibitions found in the SCM Agreement. Second, some members seem to be of the view that multilateral development assistance is not within the scope of Article 1 of the SCM Agreement. Thus, schemes that are funded entirely by multilateral institutions are less likely to give rise to dispute settlement challenges in the WTO. Finally, as noted above, a significant number of less-advanced developing country members are not currently subject to the WTO prohibition on export subsidies. For these members, there is substantially greater flexibility to address the problems identified in this chapter, even through measures that are oriented toward problems of trade financing faced by exporters.