Investment tribunal finds against prudential measures defense

What is this defense?

The clause is aimed at helping shield states from liability under trade and investment treaties when they enact a policy to promote financial stability. Since the 1990s, new commercial pacts began placing limits on how states could regulate financial services flows. As a result, regulators have worried that popular or necessary domestic policies like Dodd-Frank, Glass-Steagall, and myriad others might run afoul of treaty obligations. The compromise was the prudential measures defense.

The Rusoro case was heard under the Canada-Venezuela bilateral investment treaty (BIT), the prudential measures defense of which reads:

ARTICLE X
Investment in Financial Services

Nothing in this Agreement shall be construed to prevent a Contracting Party from adopting or maintaining reasonable measures for prudential reasons, such as: (a) the protection of investors, depositors, financial market participants, policy-holders, policy-claimants, or persons to whom a fiduciary duty is owed by a financial institution; (b) the maintenance of the safety, soundness, integrity or financial responsibility of financial institutions; and c) ensuring the integrity and stability of a Contracting Party’s financial system.

What did the tribunal decide?

In their award, a tribunal of Juan Fernandez-Armesto of Spain, Francisco Orrego Vicuna of Chile, and Bruno Simma of Germany found for Rusuro Mining against Venezuela.

The core of the company’s case was a claim of expropriation of gold mines — a straightforward issue as these things go. On this, and on another minor question, the company prevailed — winning nearly $1 billion in damages.

But the company also alleged that Venezuela’s system of capital controls violated other rights under the treaty. In 2003, the Chavez administration began officially requiring that foreign exchange trades go through the government. Unofficially, a gray market existed where traders could buy and sell currency at a higher exchange rate. In 2009–10, the government cracked down on the swap market and began requiring gold sales to also go through the government (supposedly and in part to combat illegal gold sales).

Venezuela argued these policies were prudentially motivated; the tribunal deemed otherwise (emphases added):

505. Venezuela argues that Art. X of the BIT affords governments regulatory space to enact policies for prudential reasons, and that, when it issued the 2009 and 2010 Measures regulating the gold market and tightened the exchange control regime by closing the Swap Market, such measures were part of its monetary and financial policy and prevented threats to the “integrity and stability” of its “financial system”.

506. The Bolivarian Republic’s allegation is incompatible with the plain text of Art. X of the BIT.

507. Art. X permits Canada and Venezuela to “[adopt] or [maintain] reasonable measures for prudential reasons” and then provides an open list of examples, including the solvency of financial institutions, the protection of financial clients and the integrity of the financial system.

508. The very language of the rule shows that its scope is limited to prudential measures adopted in order to protect the financial sector and its institutions, i.e. banking, insurance and securities. The regulation of the gold mining sector and the general exchange control regime fall outside the carve outpermitted by Art. X. This conclusion, which derives from a literal interpretation of the rule, is confirmed by its title (“Investment in Financial Services”), which reinforces the conclusion that the provision is directed exclusively at investments in the financial sector.

509. Rusoro was a gold mining company, that owned and exploited its Mining Rights in Venezuela, produced gold and sold it to industrial clients (and — when forced by the regulation — to the BCV). Rusoro has never been a bank, an insurance company, a broker or any other type of financial institution. And Venezuela has failed to establish that the offending measures were necessary to reinforce Rusoro’s solvency, to protect the purchasers of gold or to safeguard Venezuela’s financial system. There is no indication that the purpose of the 2009 or 2010 Measures and of the closure of the Swap Market was in any way related to the adoption of “reasonable measures for prudential reasons” in the Venezuelan financial system, as required by Art. X of the BIT.

It will come as a surprise to regulators that gold and foreign exchange are not matters of finance. Some of history’s most consequential financial regulations have indeed been about both.

Under the tribunal’s interpretation, very few policies would seem to qualify for the defense. Given the emphasized language above, the only example I can think of off hand would be equity limits by foreign investors in Venezuelan banks or insurers. But such policies would either have a security motivation (and thus not qualify for the defense) or would be about controlling capital floods or flights (in which case they would be part and parcel of an official exchange system the tribunal ruled isn’t covered by the defense.)

In the end, the defense was not needed anyway. The tribunal found that the exchange controls did not violate Venezuela’s obligations in the first instance. But the arbitrators’ extensive dicta makes clear that the defense would not have helped had a violation been established.

Part of a growing body of legal decisions

What’s noteworthy about the decision of the Rusoro tribunal is that it was dealing with a particularly robust version of the prudential measures defense. The U.S. formulation is similar to the Canada-Venezuela iteration, but has the following additional hurdle added: “Where such [prudential] measures do not conform with the provisions of the Agreement, they shall not be used as a means of avoiding the Member’s commitments or obligations under the Agreement.” I and others have argued that this could be interpreted as making the defense self-cancelling, in essence requiring that the policy a state is conceding violated trade rules (for a good reason) not violate those rules.

The only previous test of the defense we’ve seen (at least that I’m aware of) was at the World Trade Organization (WTO). In a case brought by Panama against Argentina’s anti-tax haven policies, a panel took a relatively more forgiving interpretation. They ruled that a respondent country could invoke the defense when a challenged policy “affected” trade in financial services (which was interpreted broadly) and was prudential in nature (which could evolve over time in response to new threats). These two were easy tests to meet, but Argentina failed on the third hurdle: for prudential reasons means the policy has to be totally effective in its goals. (Argentina won on an appeal, but the Appellate Body did not discuss or reverse this conceptualization of the defense.)

The WTO panel and Rusuro tribunal show that it’s not even necessary to reach the issue of self-cancellation to foreclose access to the prudential defense.