Current Legal Issues Affecting Central Banks, Volume IV.
Chapter

Chapter 4 The First Three Years of the European Bank for Reconstruction and Development: Legal Issues and Solutions

Author(s):
Robert Effros
Published Date:
April 1997
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Author(s)
ANDRE NEWBURG

Introduction

In a paper summing up the role played by law in the affairs of the International Monetary Fund, its former General Counsel, Sir Joseph Gold, wrote that the IMF is “an economic organization, but one in which great weight is attached to the law of the institution. . . .”1 The task of IMF lawyers, he noted, “has been to find within the law solutions for the many problems that arise” in the institution’s life. In doing so, they have developed a “discrete branch of public international law” that might be called “international monetary law.”2

The important function of law described by Sir Joseph Gold has also characterized the young life of the European Bank for Reconstruction and Development (EBRD or Bank). As in other international financial institutions, the constitutional law of its charter has shaped the development of EBRD policy and practice. This chapter will examine some legal issues that have arisen during the Bank’s initial years. It first refers to those elements of the Bank’s charter that differ from the charters of other international financial institutions, particularly the political and environmental aspects of the Bank’s mandate. The chapter then addresses issues arising from the dramatic changes in the countries constituting the Bank’s membership; the private sector focus of the Bank’s charter; and the Bank’s relationships with other international financial institutions.

The EBRD’s Charter and Unique Mandate

Despite the close affinity with its international financial institution siblings, the law of the EBRD is different. Two key distinctions are its youth and its unique mandate. The Bank began operations in April 1991.3 Therefore, EBRD lawyers, unlike their counterparts in other international financial institutions, do not benefit from a long line of internal precedents for guidance. To some extent, they can rely on the earlier interpretations and practices of other international financial institutions, especially the International Bank for Reconstruction and Development (the World Bank or IBRD) and the IMF, which have developed over the decades a vast body of precedents. The drafters of the Agreement Establishing the European Bank for Reconstruction and Development (the Agreement) quite sensibly sought to draw on the experience of those more mature institutions in formulating the Bank’s structure, and parts of the Agreement closely resemble the Asian Development Bank’s and the World Bank’s charters.4 Those charters have been interpreted and developed in regulations, policy papers, operational guidelines, legal opinions, and decisions by governing bodies. In areas where the Agreement follows the charters of other international financial institutions, the EBRD has looked for guidance to the practices of its sister institutions and has benefited greatly from interpretations developed over the years by them.5 However, as several of the Bank’s more novel features have no parallels in other institutions, many of the issues faced by the Bank have presented new questions of law and policy.

While providing a model for the Bank, the existence of the other international financial institutions also made it necessary to define carefully the functions of the new institution. The drafters attempted to carve out a role for the Bank that would complement and not duplicate that of other institutions. The result is an institution that in various respects differs markedly from its sister institutions.

First, the Bank was formed specifically to support the transformation of the countries of Central and Eastern Europe into market-oriented democratic societies. Article 1 of the Agreement states:

[T]he purpose of the Bank shall be to foster the transition toward open market-oriented economies and to promote private and entrepreneurial initiative in Central and Eastern European countries committed to and applying the principles of multiparty democracy, pluralism and market economics.6

Article 8 of the Agreement strengthens this purpose by providing that the Bank may operate only in countries “proceeding steadily in the transition toward market-oriented economies” and that apply “the principles set forth in Article 1. . . .”7

Second, the Bank has a specific environmental mandate. It is required to promote, in all of its activities, “environmentally sound and sustainable development.”8

Third, the Bank has a specific private sector focus. Article 2 states that the Bank shall promote “private and entrepreneurial initiative.”9 The Bank therefore combines under one roof the functions of a merchant or investment bank with those of a development bank.10 It finances the emerging private sector with equity investments and loans, and it finances public sector infrastructure necessary for private sector development and the proper functioning of a market economy.

Fourth, the Bank is the first international financial institution in which the countries of Eastern Europe the Baltic countries, Russia, and the other countries of the former Soviet Union were not only founding members but were also represented on its Board of Directors.

The political and environmental aspects of the Agreement are unique characteristics of the Bank. The charters of other international financial institutions prohibit them from being influenced by political considerations or by the political character of their members, and these charters do not contain provisions explicitly requiring attention to environmental concerns.11 Although this has not prevented the World Bank from taking human rights and environmental considerations into account in its operations, it may to some extent have constrained its scope for action on these issues.12

Underlying the political objectives reflected in the Agreement is the conviction that economic development is closely linked to political democracy, the rule of law, and respect for human rights. These goals have been added to the international community’s long-standing concerns for development and economic growth as instruments for the alleviation of poverty. As the EBRD’s President, Jacques de Larosière, stated at the Bank’s 1994 Annual Meeting in St. Petersburg:

Success in [the direction of structural reform] requires that the population understand the significance … of reforms which may be painful in their immediate consequences. Hence the importance of the strengthening of and progress toward democracy that the EBRD must take into account in its own activity.13

Procedures to implement the political aspects of the EBRD’s mandate are set out in a 1991 policy paper.14 Political and economic progress is to be assessed annually, in the Bank’s country strategies, rather than on a project-by-project basis. The Bank attaches particular importance to those civil and political rights that are essential elements of multiparty democracy. Ratification of the European Convention on Human Rights and admission to, and good standing with, the Council of Europe are regarded as positive indicators of a country’s commitment to the principles of multiparty democracy.15 In evaluating the progress being made by a country toward the rule of law and democracy, the Bank consults with, and relies substantially on, the views of the Council of Europe, the Conference on Security and Cooperation in Europe, and other international bodies with special expertise.

If a member were to implement policies inconsistent with the Bank’s purpose, the Board of Directors is required to consider whether the country’s access to Bank resources should be suspended or modified.16 However, the Bank not only monitors the political events in the countries in which it conducts operations, but it also may provide assistance in strengthening the rule of law and democratic institutions.17 Economic, as well as political, objectives can be served by such assistance. Without effective legislative and institutional reforms, transparency, accountability, due process, and reliable means of legal redress, there will be no large-scale foreign investment in the countries of Central and Eastern Europe.

In tandem with the Bank’s political mandate and also unique among international financial institutions is the Agreement’s special emphasis on the environment. The Agreement lays out an environmental mandate that requires the Bank to “promote in the full range of its activities environmentally sound and sustainable development. . . .”18 Although other international financial institutions have adopted similar policies because of recent controversies over the environmental aspects of their activities, the Agreement is the first such charter that expressly recognizes the increasing public concern for the environment.

The environmental mandate both indicates a general direction for the Bank’s investment policies and places limits on the Bank’s operations.19 The Bank does not finance projects that do not satisfy its environmental standards. Its environmental policies and procedures require all projects to be screened for potential environmental impact at an early stage. If projects are deemed environmentally sensitive, they are subject to more extensive assessments. In cases that involve the transfer or lease of property, or the modification of existing facilities, an environmental audit is also required. The Bank’s environmental standards are based generally on those of the European Community, although Bank policy recognizes the need, on occasion, for the use of “more stringent environmental standards in areas which suffer from high levels of pollution or are ecologically fragile.”20 The Bank also seeks to promote environmentally sound projects. An outstanding example is the Nuclear Safety Account, established with the Bank in 1993 by 13 countries and the European Community for the purpose of providing grants for urgent safety improvements in nuclear power reactors in countries of the region.21

It is early yet to judge the extent to which the distinctive features of its charter have furthered the Bank’s overall mission. A positive assessment, based on the first three years of operations, was given by the Bank’s President at the 1994 Annual Meeting when he described the Agreement as having created “an ideal vehicle for effective action.”22

Membership Issues

Soon after its inauguration, the Bank had to face in rapid succession a number of issues relating to the admission of new members and the dissolution of countries that had been founding members of the Bank. Although decisions regarding eligibility for, and the terms and conditions of, membership are within the exclusive competence of the Bank’s governing bodies,23 the Bank’s actions in this regard had to be taken against the background of the policies of its members and other international bodies.

Even before the coming into force of the Agreement, the German Democratic Republic, which had signed the Agreement as a “recipient country,” ceased to exist as a result of German reunification on October 3, 1990.24 Germany decided not to take up the 15,500 shares (1.55 percent of the Bank’s capital) allocated to the former German Democratic Republic and did not seek access to the Bank’s resources available to the Lander of that former country. In any event, it would seem difficult to sustain the position that assistance to a region that had become an integral part of Germany would be consistent with the purpose of the Agreement.25 By a decision of the Board of Governors, the shares that had been allocated to the former German Democratic Republic were added to the shares that had been designated as nonallocated in the Agreement and were made available for subscription by new or existing members.26

Although several non-European countries, including Brazil and India, indicated an interest in membership, it soon became evident that there would be a need first to earmark nonallocated shares for subscription by new regional recipient members. In July 1991, Albania became the first new applicant for membership. A few months thereafter, applications were received from each of the three Baltic countries, which had declared their independence from the U.S.S.R. In each case, the country had been recognized by substantially all member countries.27

Dissolution of the U.S.S.R.

The dissolution of the U.S.S.R. at the end of 1991 and the emergence of the countries of the former Soviet Union as independent states raised a number of novel and complex issues that required rapid resolution if the Bank’s ability to operate in the entire territory of the former Soviet Union were not to be disrupted. As the U.S.S.R. had not been a member of the World Bank Group or of any other multilateral financial institution, the Bank had to develop its own doctrine on a basis that would be acceptable to its membership, as well as to the Russian Federation and the other countries of the former Soviet Union that were prospective members of the Bank.

In order to continue preparation for Bank operations in Russia and the other former U.S.S.R. countries, it was important to formulate an approach under which U.S.S.R membership could be regarded as having provisionally devolved upon them pending the resolution of various issues. Accordingly, early in January 1992, a proposal was submitted to the Board of Directors under which the “successor” states of the U.S.S.R. would continue “in principle” to be eligible for Bank operations, provided that they expressed the desire “to continue” membership in the Bank and to adhere to the Agreement. At the same time, consultations were undertaken to ensure consistency with the views of the Bank’s other member countries in respect of the succession to the U.S.S.R.

It soon became apparent that many members wished to treat the Russian Federation as the sole successor to the U.S.S.R. in the Security Council and other UN bodies, and to its rights and obligations under various international treaties. The United States especially wanted to establish the Russian Federation as the successor to the U.S.S.R’s obligations under strategic arms reduction agreements. As a number of the former countries of the Soviet Union are located in Asia, the question also arose of whether all the republics could be considered “European” so as to satisfy the eligibility criteria of the Agreement.28 A related issue was that, as the Asian countries could be eligible for membership in the Asian Development Bank (ADB), membership in the EBRD might be incompatible with the view of some countries that a “recipient” country should not be a member of more than one regional multilateral development institution.

After considerable discussion, the Board of Directors adopted a policy that sought to accommodate these concerns while meeting the Bank’s objective of maintaining continuity of operations pending the completion of membership procedures.29 Under this approach, upon dissolution of a member country, its shareholdings are divided among the states that had been part of its territory and that “the Board of Governors of the Bank determines, for purposes of the Agreement Establishing the Bank, to be the states upon which the membership devolves.”30 In each case, membership is conditioned on confirmation by the country that it wishes to adhere to the Agreement and is “committed to the Bank’s purpose as described in Article 1 of the Agreement.”31 Moreover, if a country had been part of the territory of a dissolved recipient member country, it will for purposes of the Agreement retain its status as a Central or Eastern European recipient country. The Board of Directors also determined that nothing in the Agreement would bar a recipient country from also being a member of another “regionally focused international financial institution,” although it noted that the Board of Directors might wish to take such membership into account in formulating the operational strategy for that country.32

As the Bank’s members wished to ensure that the aggregate shareholding of the 12 countries of the former Soviet Union would not exceed the shareholding of the former U.S.S.R., it was necessary to obtain the agreement of each of the 12 countries of the former U.S.S.R. to a division between them of the 60,000 shares held by the U.S.S.R. A tentative allocation was proposed by the Bank, and, by the end of February 1992, an agreement had been reached by which the Russian Federation retained two-thirds of the shares and the balance was divided among the other countries. Each country was credited with its pro rata share of the initial stock subscription payment that had been made by the U.S.S.R. and undertook to pay the remaining installments. As a result, it was possible to admit the Russian Federation to membership prior to the Bank’s first annual meeting in April 1992. By December 1992, the 11 other countries of the former Soviet Union, having completed the necessary formalities, had also become members.

Limitation on Operations in the U.S.S.R.

As a result of the dissolution of the U.S.S.R, the Bank had to deal, much sooner than had been expected, with the controversial question of the limitation on Bank operations in the U.S.S.R. This limitation reflected a complex compromise that had been reached in the last stages of the negotiation of the Agreement in an effort to dispel the concern of some countries, principally the United States, that the U.S.S.R. could absorb the vast majority of the Bank’s resources. It also reflected skepticism about the extent to which the U.S.S.R. at the time was prepared to move toward multiparty democracy and a market economy.33 In order to avoid singling out the U.S.S.R. and putting it on a different footing than the other recipient countries, an intricate solution was devised. Article 8.4 was added to the Agreement, permitting any recipient country to request the Bank, for a period of three years after the entry into force of the Agreement, to provide access to its resources only for “limited purposes” and in an amount not in excess of the payments made by that country for its shares.34 Such a request was to be “attached as an integral part” of the Agreement.35

Prior to signature of the Agreement, the head of the Soviet delegation, Victor Gerashchenko, addressed a letter to the Chairman of the Conference on the Establishment of the European Bank for Reconstruction and Development, acknowledging the “fears of a number of countries that due to the size of its economy the Soviet Union may become the principal recipient of credits of the Bank” and stating that his Government was prepared to limit its access to the Bank’s resources pursuant to Article 8.4.36 Moreover, although the Gerashchenko letter expressed confidence that continuing economic reforms in the Soviet Union could “inevitably promote the expansion of the Bank’s activities into the territory of the Soviet Union,” it went on to state that the U.S.S.R. “will not choose that at any time in future the Soviet borrowings will exceed an amount consistent with maintaining the necessary diversity in the bank’s operations and prudent limits on its exposure.”37

With the dissolution of the U.S.S.R., it became evident that, while the Bank’s activities in all 12 countries of the former Soviet Union could in principle be limited to technical assistance and the other types of financing permitted by Article 8.4, it was impracticable to apply the quantitative limitation to these prospective new members. In any event, it was clear that these countries would not wish to join the Bank on terms that, even for a limited period, provided them with no net new resources. However, significant differences of opinion remained as to the appropriate manner in which the limitation should be removed. Although the Gerashchenko letter had been a unilateral request, it now was “attached as an integral part of the Agreement.”38 While Article 8.4 envisaged that the limitation could be removed by a supermajority vote of the Governors, it permitted such action only at the end of a period of three years from the coming into effect of the Agreement.39 A few members took the position that, as a legal matter, the Gerashchenko letter could be “detached” only by an amendment of the Agreement. This was likely to be a lengthy process as it required the approval of three-fourths of the member countries representing not less than 85 percent of the total voting power and, in some countries, parliamentary procedures.40

The General Counsel advised the Board of Directors that the particular characteristics of the U.S.S.R, at the time of signature of the Gerashchenko letter had constituted an essential basis for the limitation and that the dissolution of the U.S.S.R., which had not been foreseen or contemplated at the time, radically transformed the basis and framework of the limitation. Although this could under general principles of international law be considered a fundamental change of circumstances justifying its termination,41 it was not necessary to rely solely on this principle. The power of interpretation accorded to the Board of Directors by the Agreement is designed to give the Board adequate latitude to enable the Bank to pursue its objectives in the changing conditions under which it operates.42 In these circumstances, an interpretation by the Board of Directors that the limitation was no longer applicable would be consistent with the Agreement. This approach also appealed to several member countries that were concerned that viewing the dissolution of the Soviet Union as a fundamental change of circumstances could have unacceptable implications for other international treaties concluded by the U.S.S.R. The Board of Directors accordingly exercised its powers of interpretation by deciding that “the limitation on financing and operations that had been requested by the former U.S.S.R. pursuant to Article 8.4 of the Agreement is no longer meaningful and shall not be applicable” to the countries of the former U.S.S.R.43

Some member countries continued to fear that the removal of the limitation could result in the allocation of a disproportionate amount of the Bank’s resources to the countries of the former U.S.S.R. They did not consider as an adequate safeguard the operating principle of the Agreement that the Bank should not allow a disproportionate amount of its resources to be used for the benefit of any member.44 In response to these concerns, the Board of Governors approved a policy pursuant to which at least 60 percent of the Bank’s resources is to be committed to recipient countries other than the countries of the former U.S.S.R. until the end of 1994. Thereafter, any change would be a general policy decision requiring a two-thirds vote of the Board of Directors.45

Dissolution of Yugoslavia

The dissolution of the Socialist Federal Republic of Yugoslavia raised new issues relating to Bank membership. The situation was complicated by the secession of several constituent republics and the region’s collapse into civil war. After extensive deliberation, the Bank’s governing bodies determined that, as Yugoslavia had been dissolved and no longer existed as a state under international law, it had ceased to be a member. None of the countries resulting from the dissolution would be regarded as sole successor, but each of the constituent republics was eligible to be considered for membership.46

The dissolution of Yugoslavia also made it necessary to consider the division of its shareholding in the Bank. Not wanting to prejudge the broader issue of rights to the assets of the dissolved Yugoslavia, the Board of Governors decided that, initially, each country previously forming part of Yugoslavia should, upon accession to membership, be allocated the minimum subscription.47 Following a definitive reallocation of Yugoslavia’s shares, each country would, as a condition of continuing membership, subscribe to such number of additional shares as the Board of Governors might determine. Accordingly, the Bank allocated Slovenia, the first of the former Yugoslav republics admitted to membership, the minimum number of shares upon its admission to membership in October 1992.48 Croatia followed suit, and its membership was approved in January 1993 on the same terms.49 In light of the controversy over its name, the membership application of the former Yugoslav Republic of Macedonia raised the sensitive question of whether the Bank could admit a state that did not have a universally accepted name. The General Counsel advised that, under principles of public international law, a state need not have an internationally recognized name to be considered for membership in the Bank.50 In the end, a compromise was reached, and the new state’s membership was approved in February 1993 under the provisional name “Former Yugoslav Republic of Macedonia.”51

Dissolution of Czechoslovakia

In contrast to the former Yugoslavia, the dissolution of Czechoslovakia at the beginning of 1993 led to a relatively smooth and uncontroversial succession, resulting in speedy membership for both the Czech Republic and the Slovak Republic. By the middle of January 1993, the Board of Governors had approved the admission of the two new members; the terms of admission reflecting an agreement between them as to the division of the assets of the former Czech and Slovak Federal Republic.52

Private Sector Focus

The development of a strong private sector being one of the fundamental goals of the Bank, the Agreement contains a number of provisions bolstering the Bank’s private sector focus. Thus, the intended recipients of Bank financing are defined in terms designed to concentrate the Bank’s efforts on the financing of the private sector and on state-owned enterprises in the process of privatization.53 At the same time, the drafters of the Agreement recognized that, given the small size or even nonexistence of the private sector in the recipient countries, the Bank also should support the public sector in its transition from purely centralized control to demonopolization, decentralization, or privatization and to a competitive business environment. The drafters also recognized that the Bank should assist recipient member countries in implementing structural and economic reforms.54 Loans also may be made for the reconstruction or development of infrastructure if “necessary for private sector development and the transition to a market-oriented economy.”55

In their desire not to leave things to chance, the drafters of the Agreement imposed quantitative constraints on state sector operations by requiring that not more than 40 percent of the Bank’s resources be committed to the state sector of the recipient countries as a whole during the first two years of the Bank’s operations and during each fiscal year there after. The same limitation applies to each recipient country over a five-year period.56 The development of a methodology for the application of these quantitative tests was a drawn-out and sometimes difficult process, resulting in approval by the Board of Directors of the so-called portfolio ratio policy, in which the Board interpreted some key terms not defined in the Agreement.57

State and Private Sectors

The term “state sector” is defined broadly in the Agreement to include national and local governments, as well as enterprises “owned or controlled” by them.58 The term “private sector” is not defined, but the definitions are so structured that any enterprise not falling within the state sector is treated as private sector. Some members considered that an enterprise owned by any state, whether or not the recipient country, should be considered to be a state sector entity. However, as the purpose of these provisions of the Agreement is to limit Bank support for enterprises controlled by the governments of the recipient countries, it was determined that only an enterprise owned or controlled by the government of the recipient country should be deemed to constitute part of the state sector.

There were differences of view as to the import of the terms “owner-ship” and “control.” Some members considered that state ownership of a majority interest in an enterprise necessarily required state sector classification. Others believed that equity ownership should be deemed significant only to the extent that it carried with it the power to control the management and policies of the enterprise. It was ultimately agreed that the portfolio ratio policy should note that, while majority ownership created a presumption of control, there were circumstances in which a minority shareholder could exercise control, as, for example, under contractual arrangements. In practice, in dealing with portfolio ratio classifications, the Board of Directors has accepted private sector classification where effective control is exercised by minority private sector investors, even though majority ownership continues to be retained by the state.

The Agreement also excludes from the state sector a state-owned enterprise that is “implementing a programme to achieve private owner-ship and control.”59 The portfolio ratio policy, while recognizing that such a determination can be made only on a case-by-case basis, states that it would be appropriate to consider that a privatization program is being implemented if the government has “officially declared its intent to privatize the enterprise … within a reasonable time, and is taking appropriate steps to give effect to that intent.”60

Measurement of Portfolio Ratio

The Agreement defines the portfolio ratio in terms of the total of the Bank’s committed loans, guarantees, and equity investments provided to the state sector. Consistent with the Bank’s operational usage, the portfolio ratio policy treats funds as committed when the documentation for the financing has been signed and is legally binding. Measurement of the ratio on a global basis was to be made as of April 15, 1993 and December 15, 1993 (the latter date marking the end of the Bank’s fiscal year). Thereafter, it is to be measured in respect of each fiscal year as of the end thereof. The ratio in individual recipient countries is to be measured at the end of the first five years of operations.61

The Bank did not meet its 60 percent private sector objective at the initial measurement dates. As of April 15, 1993, the private sector ratio was 45 percent, increasing to 56.5 percent at December 31, 1993. Under the conditions in which the Bank operates, it may not achieve a global 60 percent private sector ratio for the 1994 fiscal year. However, it is important to note that, when measured in terms of the number of projects or of the level of disbursements, the scope of the Bank’s private sector activities is considerably greater than the ratio based on the volume of commitments suggests. As of December 31, 1993, 74 percent of the total number of projects had been in the private sector, accounting for 89 percent of total disbursements.

There is increasing awareness by member countries that, in view of the vast changes that have occurred since the Agreement was signed on May 29, 1990, it may not be reasonable to expect the Bank to meet the ratio for each of the recipient countries by 1996, the end of the first five years of operations. When it was signed, the Agreement envisaged eight recipient countries, only four of which (Bulgaria, Hungary, Poland, and Romania) now exist in their original form.62 Of the four other countries, the German Democratic Republic ceased to exist before the Bank began operations, and three (Czechoslovakia, the U.S.S.R., and Yugoslavia) dissolved into a number of smaller countries.63 These 4 countries have now been replaced by 20 recipient countries, including 12 countries of the former Soviet Union that had been subject to a stringent financing limitation. These developments have had a significant impact on the demand profile for Bank financing. In many of the new recipient countries, the private sector is still small, and there is a great need for financing public sector infrastructure projects and supporting the transition to a market-oriented economy.

An effort to meet the target of committing 60 percent of resources to the private sector in each recipient country could imply a reduction or slowing down of support for state sector projects. Such a policy would not, however, further the long-term objective of the Bank in countries in an early stage of transition to a market economy. The drafters of the Agreement recognized the close interdependence of private and public sector activities. As noted in the Chairman’s Report of the conference at which the Agreement was negotiated, the development of the private sector was necessarily seen as a long-term objective.64 It was evident that, in order to achieve this objective, considerable efforts would be needed in the public sector so as to achieve conditions conducive to the development of the private sector.

The Agreement does not specify what action the Board of Directors should take if the state sector ratio is exceeded as of any measurement date. The Board has been advised that this is a matter entirely within its discretion, having due regard for the object and purpose of the Agreement. In the circumstances, it would seem consistent with the Agreement to apply the portfolio ratio in a manner that will permit the Bank to continue its support for the public sector in countries in early stages of transition while maintaining the commitment of the Bank to private sector development, with a view to achieving the 60:40 ratio as soon as reasonably possible in countries in more advanced stages of transition.

Relationship with Other International Financial Institutions: The Negative Pledge

The Agreement calls on the Bank to cooperate with other international financial institutions and organizations.65 This provision reflects the concern of the founders to minimize overlap and duplication of effort between the Bank and those existing institutions that are backed by many of the same countries as the Bank. In the spirit of this provision, the Bank has entered into agreements of cooperation with several international organizations, including the Council of Europe, the Organization for Economic Cooperation and Development, the International Labor Organization, and the United Nations Development Program.66 As several Asian member countries of the Bank have recently become members of the ADB,67 a memorandum of understanding has been concluded as a first step toward a flexible allocation of areas of principal responsibility between the two institutions in each of these countries. The Bank also regularly participates in cofinancings with the IBRD and with the International Finance Corporation.68

An interesting example of cooperation between the EBRD and the IBRD, in which the legal departments of the two institutions played a significant role, was the resolution of a potential conflict of a legal nature relating to the IBRD’s negative pledge clause.69 This clause is of particular importance for the World Bank, which is permitted by its charter to make loans only to, or with the guarantee of, a member state and which does not normally seek security for its loans. Instead, it relies on a broad negative pledge covenant of the member state intended “to ensure that no other external debt shall have priority over its loans in the allocation, realization or distribution of foreign exchange held under the control or for the benefit” of the borrower.70 This covenant applies to the creation of any lien, as security for any external debt, on the “public assets” of the member country. In the current version of the clause, “public assets” are defined to include assets of any “entity owned or controlled by, or operating for the account or benefit of, such member. . . .”71

The EBRD, on the other hand, given its private sector focus and its objective of supporting privatization and the transition of state-owned enterprises to a competitive business environment, tries to avoid reliance on state guarantees whenever it can do so, consistent with sound banking principles.72 The EBRD has therefore sought to develop nonrecourse financing techniques based on various types of security interests. Such credit structures also make it possible for the EBRD to fulfill its catalytic role of attracting cofinancing from commercial banks and export credit agencies, which generally have been reluctant to extend unsecured sovereign credits to many of the countries in which the EBRD operates. In the case of projects of state-owned enterprises and public infrastructure projects, such security arrangements frequently involve the creation of liens on properties or revenues that fall within the definition of “public assets” in the World Bank’s negative pledge clause.

This issue was brought into focus when both the World Bank and the EBRD began to prepare for operations in the Russian Federation after it had joined the World Bank in 1992. In addition to cofinancing a World Bank oil sector loan to the Russian Federation, the EBRD wished to complement such sovereign lending with nonrecourse project financings of the oil sector, which remained substantially in the hands of state-owned enterprises. Such project financings typically are secured by a pledge of oil export revenues in an “offshore” debt-service account. In order to permit the EBRD—and the export credit agencies with which it wished to arrange cofinancings—to proceed with such projects, it was necessary to find ways in which conflict with the World Bank’s negative pledge could be avoided. Although in the past the World Bank granted waivers in special circumstances, this procedure is cumbersome, as it normally requires case-by-case approval by its Board of Directors.

The modern trend in international financial practice has been to relax the application of negative pledge restrictions, so as to permit the incurrence of secured debt to finance productive projects. The formulation of a general waiver policy for project financings consistent with that practice appeared to be a desirable course of action for the World Bank, as well as for the EBRD in respect of its public sector loan and guarantee agreements.73 The elaboration of such a general waiver policy occurred over a period of about 18 months, involving not only consultation between the IBRD, the EBRD, and some of their shareholders, but also with representatives of the Berne Union and the Russian Federation, the country that initially had the greatest interest in reaching an understanding regarding security arrangements for project financings.74

There was general agreement on the concept that the waiver should be granted in respect of projects producing incremental foreign exchange earnings. However, the World Bank and the EBRD initially took different approaches to establishing the conditions to be met by the project, and by the country, in order to be eligible for the waiver. The World Bank policy that had been adopted in March 1993 had required, among other things, that the assets subject to the lien be held by a special purpose entity. It had also imposed a number of other specific conditions. Meanwhile, the EBRD in considering its waiver policy had to take into account the EBRD’s purpose of assisting its recipient countries to mobilize capital for state-owned enterprises in transition and to maximize the use of project-financing techniques, rather than relying on state guarantees. The EBRD also wished to adopt a waiver policy that would encourage financing, including cofinancing of its projects by export credit agencies and commercial banks, which typically prefer security arrangements to state guarantees.

Accordingly, in November 1993, the EBRD adopted a policy under which the waiver applies generally to liens securing external debt incurred in project financings, provided that there is a reasonable expectation that the debt can be serviced from the revenues generated by the project. If project revenues are paid into an escrow account, the lien may not cover more than 12 months’ projected external debt service. Waivers may be granted by the Bank for an initial period of three years, on recommendation of the EBRD President, to a country that is implementing policies furthering the transition to an open, market-oriented economy.75

As differences in the negative pledge waiver policies of the World Bank and the EBRD could have led to practical difficulties in countries that are borrowers from both banks, there were continued consultations, following which the World Bank submitted to its Executive Board a proposal more closely aligning the policies of the two institutions. This revised waiver policy was approved by the Board of Directors of the World Bank in December 1993.

Conclusion

In addition to the distinctive features previously mentioned, the EBRD Agreement differs from the charters of other international financial institutions in its level of operational detail. Rules that in other international financial institutions are developed by governing bodies in documents such as regulations, policy papers, and operational guidelines are etched in the founding document of the EBRD. Additional interpretative guidance is provided by the Chairman’s Report.76 Providing explanatory notes to the individual provisions of the Agreement, the Chairman’s Report was intended to be read with the Agreement itself. It states that

certain formulations in the text represented general understandings which needed to be recorded, but which were not suitable for the Articles. It was therefore agreed that … [this] report would form part of EBRD’s basic documents, for future reference in interpreting the Articles.77

There is an obvious conflict between the interests of contracting parties, which wish to influence an organization by regulating extensively its future activities, and those of its governing bodies, which seek optimal freedom of action in managing the course of the institution. In the case of the Bank, one commentator has remarked that a “strong desire not to leave things to chance seems to have taken precedence … over considerations of appropriate drafting.”78 Others have predicted that “the detailed provisions of the Agreement, which were inevitably influenced by the exigencies of the time of drafting, may cause difficulties in implementation over time.”79 It is too soon to tell whether the proper balance has been struck. As Sir Joseph Gold stated in his paper on the International Monetary Fund:

[t]he effectiveness of the legal norms of the Fund depends on the extent to which they are respected by members, and respect for them depends on the extent to which members are convinced that the norms promote their interests. The conviction may emerge that norms are unsatisfactory because they are out of date.”80

The EBRD’s experience with some of the issues that have been touched upon here suggests that, in order to serve its object and purpose, the legal norms of the EBRD must continue to be adapted to the rapidly changing environment in which it operates.

COMMENT

RUSSELL L. MUNK

Introduction

Using the European Bank for Reconstruction and Development (EBRD) by way of example, this comment briefly summarizes how the United States participates in the several development banks. Each country that is a member of a development bank has a Governor. The U.S. Governor for all of the development banks is the Secretary of the Treasury; that is why the U.S. Department of the Treasury is the agency within the U.S. Government that has responsibility for U.S. participation in the development banks.

Each bank has a Board of Executive Directors with responsibility for supervising the day-to-day operations. The EBRD has 23 Executive Directors, 1 of whom is a representative of the United States. Under U.S. law, the U.S. Executive Director is appointed by the President and confirmed by the U.S. Senate.1 This can create problems because there is often a delay in getting an Executive Director appointed. For example, there was a question of what would happen during the interim between the end of the prior Administration and the appointment of an Executive Director by the current Administration. The Treasury temporarily appointed the Assistant Secretary of the Treasury to be the U.S. Executive Director of the EBRD. In turn, the Executive Director appointed an Alternate Executive Director, who actually functioned in London. Finally, in the spring of 1994, the Senate confirmed an individual as the Executive Director.

Role of the U.S. Treasury Department

Within the Treasury Department, a 16-person Office of Multilateral Development Banks is responsible for following the issues in the development banks on a day-to-day basis. Three persons work on environmental issues, three persons review loan documents, and a couple of people review procurement issues.

Interagency groups within the U.S. Government also monitor the development banks. There is one group for expropriation issues and another for the environment. In these groups, representatives from the State Department, the Environmental Protection Agency, and the Commerce Department, as well as the Treasury Department, meet and discuss various issues relating to U.S. participation in development banks.

A relatively new phenomenon is the increasing role of the nongovernmental organizations (NGOs), which concern themselves with environmental, resettlement, and population issues. The Treasury Department is careful to consider their views in formulating its policies.

Funding

One of the reasons that the development banks are interested in the United States is their need for financial support. However, the United States has a large budget deficit. The upshot is that the United States is in arrears on its obligations to a number of the development banks. For those involved with U.S. participation in the development banks, this is a source of concern. Every year, the Treasury Department seeks contributions from Congress for the development banks. For several years, however, the Treasury Department has not been able to get congressional authorization for financial support of the EBRD.

One problem with the EBRD is that it is a new institution. Usually, new institutions require more money in their start-up stage. Typically, in a more established institution such as the World Bank or the Inter-American Development Bank, if a country buys stock, most of the stock is callable capital. If the bank is otherwise unable to service its debt, the callable capital acts as sort of a guarantee, and the subscribing country does not have to put cash in the bank up front. However, that is not the case with the EBRD. As a new institution, it did not have loans outstanding. The only way that it could make money was to take cash from the members and invest it, and then operate off the investment. Thus, 30 percent of the EBRD capital is represented by paid-in capital.2 As a consequence, the Treasury Department has had difficulty mobilizing the amount of funds that the United States owes to the EBRD.

Setting the Agenda

The Treasury Department maintains a continuous dialogue with the EBRD. The United States would always like the development banks to address items on their agendas that they are not currently addressing. At the same time, the United States recognizes that it is not the only member of the development banks. With respect to the Fund for Special Operations at the Inter-American Development Bank, if the United States opposes a loan, it will fail. However, in the other development banks, even if the United States votes no, the loan will still go ahead.

In the EBRD, environmental considerations are built into the charter. In 1989, the U.S. Congress passed a law that is referred to as the “Pelosi Amendment.”3 It requires, among other things, that the U.S Executive Director may not vote in favor of a loan with significant environmental effects unless an assessment has been prepared, and such assessment has been circulated 120 days before the loan goes to that bank’s Board of Executive Directors. The EBRD has been unable or unwilling to meet this 120-day requirement. As a result, the United States has voted against a number of EBRD loans. It is noteworthy that, according to the Pelosi Amendment, any loan with a significant effect on the human environment—negative or positive—must be studied. In a number of cases, difficulties arose because, although the loan had a significant positive effect, the EBRD did not prepare the documents 120 days in advance.

Another area where the United States is pressing the EBRD is disclosure of information. The NGOs and members of Congress feel that the development banks have not been open enough and have not consulted affected peoples sufficiently in their operations. This concern has given rise to an effort to make the documents of the development banks more available to the public and to NGOs. The World Bank set up a public information center, and it made arrangements in 1993 for disseminating its documents more widely. The United States believes that this precedent should be followed by the EBRD, as well.

Arising out of its concern for greater protection of the interests of people affected by bank projects, the United States has also been encouraging the EBRD to establish an inspection panel. A few years ago, a project of the World Bank provoked a controversy about resettlement plans.4 At that time, the World Bank established a commission of experts, headed by Bradford Morse, to look into the matter.5 The Morse Commission prepared a report that in general concluded that the World Bank had not adequately insisted that the provisions of the loan documents be implemented.6 The Executive Board of the World Bank took up the issue and determined not to authorize further disbursements for this particular project unless certain reforms were initiated by India. India did not carry out these reforms and decided not to continue to receive funding for the project. Some members of Congress and individuals within the U.S. Executive Branch were impressed by the work of the Morse Commission; they suggested the establishment of a permanent body in the World Bank that would function like the Morse Commission. In September 1992, the World Bank set up an inspection panel consisting of a permanent group of three outside experts to look into complaints regarding the World Bank’s implementation of policies and its enforcement of loan covenants. Members of that panel were appointed in the spring of 1994. The EBRD has not yet taken steps to set up such a panel, even though the United States is pointing to the EBRD’s sister institutions, the Inter-American Development Bank and the Asian Development Bank, as examples; these latter institutions seem well along in establishing such panels for themselves.

Concerned about the possibility of waste, fraud, and abuse, the U.S. Congress has encouraged the Treasury Department to exhort the development banks to tighten up their internal auditing and inspection procedures. In turn, the Treasury Department has sought to encourage the EBRD to strengthen the role of its internal auditor.

Finally, there are issues regarding expropriation. A new law mandates that the United States vote against loans to countries in which there are outstanding claims against expropriation by U.S. citizens.7 However, the law excludes, among other things, expropriations that took place before January 1, 1956. Moreover, the United States does not have to vote against a loan to a country with outstanding expropriation claims if the loan supports basic human needs.8 The Treasury Department will have to explain this law—and how it will be implemented—to the various development banks.

Conclusion

The United States is very supportive of the important role that is played by the development banks. At the same time, the U.S Congress and the public have expressed an active interest in this role. Laws have introduced new requirements concerning U.S. participation in the development banks. The Treasury Department will continue to explain and interpret these requirements, and otherwise oversee U.S. participation in the banks.

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