The COVID-19 pandemic has triggered an “impending global recession” as governments have been forced to suspend much economic activity in an effort to slow the spread of the virus.1 Economic and political uncertainty, coupled with an oil price war between Russia and Saudi Arabia, has put financial markets into turmoil and the banking and financial services sector of the economy under serious strain. Governments have started to introduce measures to salvage their economies and to stabilize the banking and financial sectors in their countries.
While the precise form and effect of some of the sovereign measures in the banking and financial services sectors may not become fully evident for some months, past experience with the international disputes arising out economic and financial crises provides some guidance. Although some responsive measures may be fully legitimate, others may cause unwarranted harm to investors in the banking and financial services sectors.
When the actions of a government—even if nominally well-intentioned—cause injury to a foreign investor or its investment, international investment law provides protection as well as effective means of recourse against the State. This body of law, when applicable, regulates and limits the ways in which governmental actions are allowed to impact foreign investors (and certain domestic investors). When these protections are violated, the investor potentially may bring an international arbitration against the State to vindicate its rights, and may enforce the resulting award against the State’s assets, including assets that are held outside of the country where the investment is located.
This OnPoint addresses the types of measures arising out of past crises that have been so severe as to result in international arbitration, and identifies immediate action items that investors in the banking and finance sectors could take to protect their investments.
Past Crises and Adverse Responsive Measures
As seen from past investment disputes, economic and financial crises are the most common cause of governmental actions adverse to investors in the banking and finance sector. This was of particular note during the 2008 Global Financial Crisis. After Lehman Brothers collapsed, sovereign states around the world scrambled to introduce a plethora of regulatory measures to save their economies, ranging from forced debt restructuring to outright nationalization, with the inadvertent and unavoidable effect of eradicating value from many investments. This crisis serves as a vivid reminder of the profound effects that governmental responses can have on investments in the finance sector.
Although the 2008 Global Financial Crisis provoked extreme measures, it was not alone in having this consequence. The 2008 Crisis itself had a reverberating impact on economies around the world and triggered numerous other crises, such as the later Greek financial and sovereign debt crisis, which started in 2009 and only ended in 2019, as well as the consequent Cypriot financial crisis of 2012-2013. In the decade before that, the 2000-2002 Argentine Financial Crisis saw that government implement measures that caused massive losses to foreign investors in finance and other sectors. Around the same time, the Czech banking crisis, triggered by the privatization of the banking sector following the end of communism, also sparked controversy over such government measures.
Specific Measures Implicated In Past Investment Disputes
While economic and financial crises have far reaching effects on banking and finance sector investments, their precise form varies depending on the particular nature of the investment and the specific measure taken by a State to mitigate the damages. The following are some of the main categories of measures undertaken in response to past crises that have been sufficiently harmful to financial sector investors so as to give rise to investment disputes:
- Sovereign debt default or forced restructuring: Governments may attempt to reduce sovereign debt by defaulting on their debt, or by altering the contractual terms of their sovereign bonds. Greece, for example, retrospectively introduced collective action clauses into its bonds as part of its attempt to solve its sovereign debt crisis, with the consequent restructuring resulting in a loss of up to 70% of the value of the bonds.2 Iceland froze its own government bonds in 2016 as it attempted to recover from its liquidity crisis, leaving funds with frozen assets.
- Restrictive financial regulations: Governments have often implemented general regulatory measures in the midst of crises aimed at stabilizing the financial sector or reducing the impact on consumers. These financial regulations include prohibitions on transferring funds abroad, term deposit rescheduling,3 reductions to interest rates, and suspensions on creditor protections.
- Discriminatory bailouts: Governments may offer assistance only to certain categories of financial institutions (typically favouring domestic over foreign investors) while disadvantaging others by denying them the same aid. For example, the emergency liquidity assistance provided by Greece was not available to Greek branches of foreign banks, such as the Cyprus Popular Bank (Laiki Bank), which filed an investment treaty claim against Greece alleging a lack of equal treatment.
- Obligatory bail-ins: Governments may introduce bail-ins, which provide relief to financial institutions by forcing the annulment of bank deposits and other debts owed to creditors (in effect, confiscating the savings of depositors). For example, during the 2012-2013 Cypriot Financial Crisis, Cyprus recapitalised the Bank of Cyprus and Cyprus Popular Bank (Laiki Bank) through the bail-in of depositors by converting bonds and deposits in excess of €100,000 into shares in the two banks.4
- Forced capital restructuring or nationalization: Governments will often implement capital restructuring plans or forcibly purchase shares or issue new shares in order to inject new capital into financial institutions. Although such measures may salvage a financial institution from economic demise, investments made in the ownership of banks, for example, will be significantly diluted in value or eradicated completely. For example, Belgium, the Netherlands, and Luxembourg purchased EUR 29.2 billion of new shares to save Fortis Bank when the 2008 Financial Crisis hit, eradicating much of the value of Ping An Insurance’s EUR 2 billion investment in Fortis.
- Restrictions on bank withdrawals: Governments may restrict customers’ ability to withdraw funds from banks in order to ensure that the banks retain liquidity. For example, the 2000-2002 Argentine Crisis saw consumers withdrawing their money from banks to offset the effects of the devaluation of the peso, which in turn led to a decrease in confidence in the Argentine economy by investors. Argentina introduced measures in response to limit withdrawals from domestic banks, which had the effect of restricting the flow of funds by investors.5
- Exchange rates and currency controls: Governments may implement changes to exchange rates or controls on currency transactions as a way to stabilize markets in the face of deepening financial crises. When Argentina was in midst of the 2000-2002 crisis,6 the government converted many obligations from dollars to pesos before devaluing the peso. This forced conversion and devaluation significantly changed and disrupted its pre-crisis financial services regime.7
What Can Banking and Finance Sector Investors Do to Protect Themselves?
Domestic recourse against emergency measures that cause harm will be highly restricted, with courts unwilling to second guess the political branches of governments and the regulatory decisions of central banks and financial regulators.
But investors do have options to obtain adequate international protection for their investments, and should immediately take stock of the currently available protections, including by taking the following actions:
- Assess available international protections: Banking and finance sector investors should assess whether their investments—both in financial instruments and in financial institutions—are currently subject to international investment protection. The international investment system may be the only source of relief if a government implements a responsive measure during the present crisis that adversely impacts such an investment. If an investment is not currently protected by that system, it may be possible to implement investment holding structures in order to ensure that such protection is available.
- Assess alternative sources of protections: Banking and finance sector investors should assess whether their investments might be subject to protection based on domestic investment laws or contractual arrangements, and specifically whether these allow recourse to a decision-maker beyond the national courts of a given government (such as through international arbitration). The availability of such avenues is less common than purely international investment protection, but may also be option for relief from adverse responsive measures.
- Assess current insurance coverage: Banking and finance sector investors should review their insurance policies to determine if they might protect against any restrictions placed upon the financial markets. For example, the Multilateral Investment Guarantee Agency (“MIGA”) provides insurance against currency inconvertibility and restrictions on the transfer of currencies. Investors should identify any exclusions for measures related to pandemics or matters of public health.
- Assess responsive measures that are implemented: As governments begin to implement specific measures in response to the current crisis, banking and finance sector investors should assess whether they have an adverse effect on their investments and whether they breach any applicable protections for those investments. This will allow the investor to negotiate with the government regarding its impact or seek recourse against the measure through international arbitration, as well as to avoid any loss of their rights through their actions (such as by consenting to a measure).
How Dechert Can Help
Dechert’s International Arbitration Group assists clients in assessing their applicable international investment protections, as well as other potential sources of protections. When clients are adversely affected by governmental measures, we assist them in evaluating what forms of recourse might be available and, where appropriate, pursuing recourse through international arbitration or other means.
2) See Poštová banka, a.s. and ISTROKAPITAL SE v. Hellenic Republic, ICSID Case No. ARB/13/8, Award (9 Apr. 2015), ¶¶ 67-72.
3) Continental Casualty Company v. Argentine Republic, ICSID Case No. ARB/03/9, Award (5 Sep. 2008), ¶ 137.
5) Daimler Financial Services AG v. Argentine Republic, ICSID Case No. ARB/05/1, Award (22 Aug. 2012), ¶ 41.
6) “Argentina’s collapse: A decline without parallel,” The Economist (28 Feb. 2002), available at https://www.economist.com/special-report/2002/02/28/a-decline-without-parallel.
7) Daimler Financial Services AG v. Argentine Republic, ICSID Case No. ARB/05/1, Award (22 Aug. 2012), ¶ 41.