JOURNAL OF INTERNATIONAL LEGAL STUDIES JOURNAL OF

JOURNAL OF
INTERNATIONAL
LEGAL STUDIES
ISSUE
04
2011
Journal of International Legal Studies
@ International Programs in Law, Faculty of Law of Kyushu University
CONTENTS
Articles
ADMINISTRATIVE TOOLS AND IMPROVING THE REGULATION
OF INTERNATIONAL FINANCIAL TRANSACTIONS
Matthew Perry Canini
p.1
SHAREHOLDERS’ GENERAL MEETINGS AND THE ROLE OF
PROXY ADVISORS IN FRANCE AND JAPAN
Edouard Dubois
p. 56
CREATIVITY, COPYRIGHT, AND COMMUNITY: AN EXPLORATION OF THE ISSUES SURROUNDING FAN-CREATED WORKS
UNDER U.S. AND JAPANESE COPYRIGHT LAW
Adrienne Lipoma
p. 107
INVESTOR-STATE DISPUTE SETTLEMENT UNDER THE ICSID
CONVENTION – A COMFORTABLE ROOM FOR VIETNAM?
Dang Tran Anh Tuan
p. 146
Journal of International Legal Studies
@ International Programs in Law, Faculty of Law of Kyushu University
FOREWORD
Toshiyuki KONO
Professor & Director of International Programs
Graduate School of Law, Kyushu University
Kyushu University ’s LL.M. program in International Economic and Business Law (IEBL)
was established in 1994 and, at the time, was the first such Master ’ s program in law to be
taught entirely in English within Japan. By offering such a program, we were able to remove
one of the major obstacles confronting students who wished to pursue graduate legal studies
in Japan, namely the Japanese language. More than 15 years later, the program is firmly
established as Japan’s leading English language LL.M. with over one hundred alumni from
more than 30 countries.
The success of the IEBL program was recognized in July 2006 when the Japan Society for the
Promotion of Science (JSPS) in cooperation with the Ministry of Education, Sport, Science
and Culture, (MEXT) awarded a substantial educational support grant to the Graduate
School of Law in order to develop the program. This JSPS grant has facilitated the creation of
an expanded infrastructure that will ensure the future growth and success of our program.
A particular feature of our implementation of this project has been the creation of a more
edge topics from diverse legal fields. Our faculty is now uniquely qualified to offer students
both a Japanese and international perspective on the complex legal issues confronting
practitioners, government administrators and policymakers. The aim of such activities has
been to equip our students with the necessary skill set to produce international caliber
research work.
As one part of this project, I am proud to launch the Kyushu University Journal of
International Legal Studies. This on-line journal is designed to provide graduate students
with a platform for the dissemination of their research work and to encourage interest in all
that modern information technology facilitates this kind of project and sincerely hope that
our students activities are exposed to as large an audience as possible.
As Director of the International Programs in Law, I am confident that Kyushu University
offers internationally competitive educational opportunities. As graduate level qualifications
become increasingly important for young legal professionals, and as law faculties around the
world respond to this new demand by expanding their activities at a graduate level, the
global market in legal education has become increasingly competitive. By providing the kind
of educational and research opportunities afforded by the IEBL program, the Faculty of Law
has strategically positioned itself as a market leader both within Japan and internationally.
We are confident that our past efforts will ensure the continuing success of our program and
look forward to welcoming many new generations of international students to our
university.
KYUSHU UNIVERSITY JOURNAL OF INTERNATIONAL LEGAL STUDIES
EDITOR-IN-CHIEF
STATEMENT OF AIMS
Toshiyuki KONO
The Kyushu University Journal of International Legal Studies is
published on behalf of the International Programs in Law, the Graduate
School of Law, Kyushu University. It is designed to provide graduate
law students of Kyushu University with a platform for the
Professor & Director of
International Programs of
Law, Kyushu University
EDITORS
Branislav HAZUCHA
Assistant Professor of Law at
Hokkaido University
relating to international economic and business law, broadly defined.
Areas of particular int erest include: global governance and
corporations; economic and business law in Asia; innovation and the
law & fundamental perspectives on law.
Narufumi KADOMATSU
Professor of Law at Kobe
University
Xiaojie LU
Lectutrer of Law at Tsinghua
University Law School
Hiroya NAKAKUBO
Professor of Law at
Hitotsubashi University
Graduate School of
International Corporate
Strategy
Dan W. PUCHNIAK
Assistant Professor of Law at
National University of
Singapore
Hiroo SONO
Professor of Law at Hokkaido
University
COPY EDITOR
Antonio FORMACION
Assistant Professor at Kyushu University
Fukue Island ( 福江島 , Fukuejima), Nagasaki, Japan
ADVISORY BOARD
Herbert KRONKE
Professor of Law at
University of Heidelberg
Yoshiyuki TAMURA
Professor of Law at Hokkaido
University
Mark RAMSEYER
Mitsubishi Professor of
Japanese Legal Studies at
Harvard University
M SORNARAJAH
CJ Koh Professor of Law at
National University of
Singapore
Sadakazu OSAKI
Head of Research at the
Center for Strategic
Management and Innovation,
Nomura Research Institute
Copyright @ 2011 by the International Programs in Law, Faculty of Law of Kyushu University. All
rights reserved. No portion of the contents may be reproduced in any form without permission from
IPL - Kyushu University. Please forward all rights and permission requests to the IPL - Kyushu
University at 6-19-1, Hakozaki, Higashi-ku, Fukuoka-shi, 812-8581, Japan.
ADMINISTRATIVE TOOLS AND IMPROVING THE REGULATION OF INTERNATIONAL
FINANCIAL TRANSACTIONS
Matthew Perry Canini
1. Introduction: A Non-Institutional Starting Point for International Financial
Regulatory Reform
Debate about international financial regulation tends to focus on two areas: crisis
avoidance, and the normative interactions of players in the international financial
architecture. Financial crisis has been recurrent over the last century and following each
crisis there is a similar scholastic and regulatory undertaking to restructuring the
international financial architecture. 1 In this way, academics have noted that the existing
architecture is reactionary, and consequently ineffective in dealing with new forms of
crisis. 2 Concurrently, some scholars argue that a new multilateral treaty is superior to the
current ad-hoc system. 3 The second area of this debate, focusing on the normative
interactions of players in international financial regulation, is as valuable an area of study
as crisis avoidance, especially since domestic bureaucrats negotiate many important
domestic regulations at the international-level through standards setting organizations. 4
These more normative elements of international finance thus have a large effect on
domestic financial policies, which in turn has strong implications for consumers and
financial intermediaries in domestic markets.
1
See HOWARD DAVIES & DAVID GREEN, GLOBAL FINANCIAL REGULATION THE ESSENTIAL GUIDE 13
(2008). See also generally David Zaring, International Institutional Performance in Crisis, 10 CHI. J. INT’L
L. 475 (2010) (arguing the crisis response of institutions that were designed to be forums for international
financial regulatory cooperation did not function as so during the 2008 global financial crisis); Eric J. Pan,
Challenge of International Cooperation and Institutional Design in Financial Supervision: Beyond
Transgovernmental Networks, 11 CHI. J. INT’L L. 243 (2010) (arguing that the current financial
architecture is insufficient and further arguing that stronger prudential reform is needed as well as
oversight of “cross boarder financial institutions”); KERN ALEXANDER, RAHUL DHUMALE & JOHN
EATWELL, GLOBAL GOVERNANCE OF FINANCIAL SYSTEMS THE INTERNATIONAL REGULATION OF
SYSTEMATIC RISK 155-73 (2006) (arguing current international financial architecture is insufficient and
supporting new treaty structure for governance).
2
See e.g DOUGLAS W. ARNER, FINANCIAL STABILITY ECONOMIC GROWTH AND THE ROLE OF LAW 87
(2007) (concluding that current financial architecture has emerged due to financial crisis response and
manifested as sets of “international financial standards”). Arner argues that crisis pushed the focus of
financial regulation in two directions based on the crisis experiences developed countries and developing
countries. See id., at 36. These are the focus on cooperation and the focus on stability, respectively. See id.
See also Alexander, supra note 1, at 3.
3
See Alexander, Dhumale & Eatwell, supra note 1, at 162 (discussing multilateral treaty for international
financial governance). See also ROSS P. BUCKLEY, INTERNATIONAL FINANCIAL SYSTEM POLICY AND
REGULATION 135 (2009) (acknowledging Bretton Woods level institution with enforcement powers would
be superior to current soft law system but cognizant of the political challenges faced in achieving such
regulator).
4
See David Zaring, Hard and Soft in International Administration, 5 CHI. J. INT’L L. 547, 548-9 (2005)
(identifying three areas of international rulemaking by administrative cooperation citing them as informal
international rulemaking through cooperation). See also Kal Raustiala, The Architecture of International
Cooperation: Transgovernmental Networks and the Future of International Law, 43 VA. J. INT’L L. 1, 31
(2003) (discussing the International Organization of Securities Commissions (IOSOC) as “[non]traditional international organization” where “no members are state”). The IOSOC is an informal
organization that engages in policy discussion amongst administrators and propagates standards. See id.
Against this background, numerous studies explore other elements of the international
finance, such as transparency5, legitimacy 6, regulatory organizations 7, and soft law. 8 In
total, there is a robust normative literature in this area. Still, some argue positively for
new styles of organization, departing from traditional public international law structures,
by conceptualizing the international financial architecture as a domestic regulator on the
supra-national scale. 9 In this area, scholars cite administrative law as providing an
institutional structure to manage international finance. 10 This is logical, especially when
considering that technocratic administrative agencies take responsibility for domestic
financial regulation in the United States (hereinafter US), European Union (hereinafter
EU) and Japan, which are the jurisdictions that contain twenty-five of the thirty
systematically important financial intermediaries. 11
This general administrative approach is appealing, but politically it is not very different
from a new multilateral treaty institution, and consequently does not mitigate the
political problem to which international financial regulation is subject. Specifically, that
divergent goals and policies - both competitive and stability policies - between leading
banking and capital market jurisdictions undermines new treaty instruments. 12 Thus, the
5
See generally Christine Kaufmann & Rolf H. Weber, The Role of Transparency in Financial Regulation,
13 J. OF INT’L ECON. L. 779 (2010).
6
See generally Louis W. Pauly, Global Finance, Political Authority, and ｔhe Problem of Legitimation, in
Rodney Bruce Hall & Thomas J. Biersteker (eds.), THE EMERGENCE OF PRIVATE AUTHORITY IN GLOBAL
GOVERNANCE 76, 85 (2002); Daniel C. Esty, Good Governance at the Supranational Scale: Globalizing
Administrative Law, 115 YALE L. J. 1490 (2006); Thomas M. Frank, Legitimacy in the International
System, 82 AM. J. INT’L L 705 (1988) (discussing legitimacy role in fostering compliance with international
rules).
7
See generally David Zaring, International Law by Other Means: The Twilight Existence of International
Financial Regulatory Organizations, 33 TEX. INT’L L. J. 281 (1998). See also Pierre-Hugues Verdier,
Transnational Regulatory Networks and Their Limits, 34 YALE J. INT’L L. 113, 143 (2009) (noting
International Organization of Securities Commissions (IOSOC) significant achievement of establishing a
network of Memorandum of Understandings (MOUs) geared towards enforcement of regulations).
8
See generally Zaring, supra note 4; Robert S. Karmel & Claire R. Kelly, The Hardening of Soft Law in
Securities Regulation, 34 BROOK J. INT’L L. 883 (2009).
9
Pan, supra note 1, at 273-80 (arguing for a global administrator based on similar principles as European
Union (EU) supra-national governance).
10
See id., at 247 (stating administrative law model can work for international financial regulation as well
as other areas of global administration).
11
See Patrick Jenkins & Paul J. Davies, Thirty Financial Groups on Systematic Risk List, FINANCIAL
TIMES (November 29, 2009), available at http://www.ft.com/intl/cms/s/0/df7c3f24-dd19-11de-ad6000144feabdc0.html#axzz1RleePXDc (visied November 15,2011) (listing the thirty intermediaries the FSB
identified as being systematically risky). Of the five intermediaries not in the US, EU, or Japan, four are
located in Switzerland, and one is located in Canada. See id. Six of the intermediaries are insurance
companies and the other twenty-four are banks, albeit banks that do more than take deposits. See id. Five
intermediaries are US banks. See id. Four intermediaries are Japanese banks. See id. The other sixteen
intermediaries are located in the EU see id.
12
See e.g. Buckley, supra note 3, at 135; Raustiala, supra note 4, at 17-9, 49-50 (discussing benefits or
regulatory cooperation in lieu of treaty formation); Stravos Gadinis, The politics of competition in
International Financial Regulation, 49 HARV. INT’L L. J. 447, 449 (2008) (discussing incentives for
international coordination in finance); See also Tom Braithwaite, Brooke Masters & Jeremy Grant,
Financial Regulation: A Shield Asunder, FINANCIAL TIMES (May 19, 2011), available at
http://www.ft.com/intl/cms/s/0/9456a6ca-8249-11e0-961e-00144feabdc0.html#axzz1OvspkOlv
(visited
November 15, 2011) (discussing how US and EU debate over financial regulation could lead to regulatory
arbitrage partly responsible for 2008 financial crisis). “‘Some recent discussion in the various
intergovernmental bodies have, unfortunately, lost sight of our shared regulatory mission and seem to have
2
international financial architecture and in turn international financial regulation in a
sense must habitually exist in some incarnation of its current construction. A
construction comprised of various soft law and standard creating groups, as well as both
legal and non-legal international organizations and forums, responsible for a globalized,
international, and supremely complex international financial system. 13 A system
dominated by a few massive international financial intermediaries operating globally,
originating products that are regulated in multiple jurisdictions, but with no one
jurisdiction possessing full competence to ensure either normative stability or crisis
avoidance. 14 In essence, there is a mismatch between what needs regulation and the
regulatory structure. 15
This mismatch creates numerous governance problems that lawmakers attempt to solve
depending the type of risk that the financial intermediary or financial transaction creates.
For example, standards negotiated in the Basel Committee on Banking Supervision
(BCBS) set capital and other soundness criteria for certain financial intermediaries,
historically banks, by requiring they keep some assets on their balance sheets to buffer
against financial shocks. 16 Another example is Memorandum of Understanding (MOUs),
intergovernmental cooperation agreements that try to address the risk of opaqueness; the
risk that regulators do not know the risks, the extent of the risks, or of violations to the
rules. 17 This latter undertaking and to a certain extent the former 18 try to address this
mismatch by increasing the competence of domestic regulators to govern intermediaries
been too much focused on a search for national competitive advantage.’” See id. (citing Daniel Turullo
“the Federal Reserve governor charged with overhauling regulation for the US central bank…”).
13
See generally Arner, supra note 2.
14
See e.g. Gadinis, supra note 12, at 448-9 (2008) (describing international geographical scope of finance
and financial intermediaries and noting that regulations is still domestic); Chiristian Tietje & Matthais
Lehmann, The Role and Prospects of International Law in Financial Regulation and Supervision, 13 J. OF
INT’L ECON. L. 663, 668-9 (2010) (describing how products are unique in that they arise out of particular
jurisdiction but due to lack of barriers can move instantly across borders). See also generally Charles A. E.
Goodhart & Rosa M. Lastra, Border Problems, 13 J. INT’L ECON. L. 705, 714 -15 (2010).
15
See e.g. Alexander, Dhumale & Eatwell, supra note 1, at 15; Tietje & Lehmann, supra note 14, at 678
(describing how financial regulation is characterized by domestic regulators that have not harmonized);
Gadinis, supra note 12, at 448-9.
16
See HAL S. SCOTT, INTERNATIONAL FINANCE TRANSACTIONS, POLICY, AND REGULATION 361 (16th ed.
2009) (discussing Basel I and capital adequacy). The EU applied the Basel II rules through two directives.
See id., at 386. The US, however, implemented this through regulators under their own power. See Federal
Reserve Board Joint Press Release , Banking Agencies Announce Revised Plan for Implementation of Basel
II
Framework
(September
30,
2005),
available
at
http://www.federalreserve.gov/boarddocs/press/bcreg/2005/20050930/default.htm (visited, July 13, 2011).
These are the Federal Reserve Board (Fed), Office of the Comptroller of Currency (OCC), the Federal
Deposit Insurance Company (FDIC), and the Office of Thrift Supervision (OTS). The OTS has been
abolished and its power transferred to the OCC by the Dodd-Frank Wall Street Reform and Consumer
Protection Act., Pub. L. 113-203, §§ 313, 314(a) (2010) [hereinafter Dodd-Frank].
17
See Verdier, supra note 7, at 144-7 (describing information system created by nation securities regulators
to deal with cross-border “fraud and market manipulation”). MOUs originally in the form of a bilateral
network which was later replaced by a multilateral version. See id., at 144-5. David Zaring calls this kind
of international cooperation a version “proselytization” where developed countries forced minimum
standards on developing countries. See Zaring, supra note 4, at 582.
18
International prudential rules have taken the form of minimum standards some of which attempt to
mandate supervision of cross-border intermediaries. See Scott, supra note 16, at 184. This arose out of the
BCCI Crisis where British bank BCCI manipulated regulatory gaps arising out of the cross-border nature
of its corporate structure to “disguise bad loans.” See id., at 181. The minimum standards coming out of
the BCCI crisis opted for a consolidated regulator approach meaning that only one country should have
primary regulatory power of the principle bank and all its international branches. See id., at 184.
3
within their borders. Essentially, domestic regulators extend their regulatory reach by
soliciting cooperation or harmonization from other jurisdictions.
The effectiveness of this regulatory competence, which tries to ensure domestic markets
function efficiently, with a socially beneficially level of information disclosure 19 –
depends on knowing what underlying international market activities need regulation. 20
Moreover, what the contours of those activities are. Thus by acknowledging information
as a prerequisite for domestic competence, it becomes apparent that an information
asymmetry exists between the international space where financial intermediaries
undertake financial transactions and the domestic space where regulators and markets
have the power to govern. 21 This asymmetry is problematic to the extent it prevents
regulators or markets from performing their governance roles efficiently.
This article will focus on the information asymmetry problem that exists between the
international space and domestic markets and regulators. Moreover, to narrow the focus
further, the article looks specifically at mechanism that can close or at least narrow this
information asymmetry. The article focuses on this area, as opposed to a more
comprehensive or conceptual examination of international financial regulation, for two
reasons. First, as mentioned, there is considerable scholarly discussion regarding
international financial governance and administration. In turn, the article can rely on the
conceptual propositions of other scholars in order to make this a more practical
investigation. Second, the article asserts that this particular asymmetry is especially
opaque, and curing it, or making steps in that direction, will help other areas of financial
regulation. 22 For instance, one the causes 2008 Financial Crisis was counterparty risk in
the swaps market; “the risk that insurance would…not be paid out in the event of
19
Cf. Merrit B. Fox, Retailing Mandatory Securities Disclosure: Why Issuer Choice is not Investor
Empowerment, 85, VA. L. REV. 1335, 1344-5 (1999) (arguing that the “socially optimal level of
disclosure” is higher than managers “private optimal” equilibrium and i.e. managers will choose a level
closer “to the level at which the marginal increase in cost to the managers… equals the marginal increase
in benefit to them…”). But see Roberta Romano, Empowering Investors: A Market Approach to Securities
Regulation, 107 YALE. L. J. 2359, 2361-2 (1998) (arguing similar to US corporate law that in securities
law regulatory competition amongst states will maximize shareholder value and provide a tailored
regulatory regime).
20
See Kaufmann & Weber, supra note 5, at 788 (discussing how unified accounting can benefit market and
regulators). The principal that the regulation follows the market conditions is evidenced by the general
regulatory approach, which holds different policy goals for different kinds of financial activity. Cf.
Financial Stability Board, Key Standards for Sound Financial Systems, available at
http://www.financialstabilityboard.org/cos/key_standards.htm (visited July 13, 2011) (outlining different
policy goals for different areas of finance). Some policies deal with specific financial activity and others
deal with general goals such as information dissemination. See id. Some note that this does not leave
sufficient room for “Policy Space” and that this situation is more complex because of the international
nature of finance. See Tietje & Lehmann, supra note 14, at 668. Lack of consensus in turn makes
coordination difficult and so jurisdictions use competition to ferret out international norms because of the
ability to get evidence through empirical research. See id., at 669.
21
See Financial Stability Board, The Financial Crisis and Information Gaps Progress Report,
5-9 (May 2010), available at http://www.financialstabilityboard.org/publications/r_100510.pdf ( visited
July, 13 2011) [hereinafter FSB Information Gaps] (noting 20 recommendations for improving information
between countries); Arner, supra note 2, at 168-9 (discussing importance and difficulty of disseminating
information in the international context).
22
See FSB Information Gaps, supra note 21, at 11, 13-14 (describing four main areas that
recommendations for closing information gaps address some of which address regulator to regulator
interactions others address market to regulator interactions).
4
default.” 23 Because swap counterparties to financial intermediaries did not know to what
extent the intermediary exposed itself to risks based on the same triggering event they
could not accurately gauge credit risk. 24 Part of this was due to general non-regulation of
swap contracts, but the fact the counterparties could be located in any jurisdiction made
identifying the level of exposure more difficult even if the transaction itself was
regulated in a single jurisdiction. 25 This is the simple version of the opaqueness problem.
It is simpler because the intermediary is the focus of potential regulation and the
intermediary is easily identifiable. The more difficult situations occur when regulators
focus a dispersed set of counterparties to the intermediary as opposed to the intermediary
itself. An example is securitization transactions, where knowing the extent of risk to the
underlying assets is as important as knowing credit risk to the originator. 26 To the degree
that investors do not know the risk the asset poses to the originator, 27 due to off balance
sheet accounting, 28 they do not fully know the value of the security they have purchased
or the value of any risk guarantees the originator may provide against the security. 29 If
the company purchases the asset as a hedge this opaqueness negatively implicates the
23
See e.g. Patricia A. McCoy, Andrey D. Pavlov & Susan M. Wachter, Systematic Risk Through
Securitization: The Result of Deregulation and Regulatory Failure, 41 CONN. L. REV. 493, 529, 536
(2009) (discussing counterparty risk). See also infra notes 171- 174, 201 and accompanying text.
24
See e.g. McCoy, Pavlov & Wachter, supra note 23, at 529. See also Scott, supra note 16, at 772 (noting
there are some contractual means to limit this risk).
25
See Financial Stability Board, OTC Derivative Market Reforms Progress Report on Implementation 1619 (April 15, 2011), available at http://www.financialstabilityboard.org/publications/r_110415b.pdf
(visited July 13, 2011) [hereinafter FSB Derivatives Progress Report] (discussing how failure to establish
trade repositories that can aggregate OTC positions may cause regulator problems on a “global basis”).
One of the solutions suggested to cure opacity problems associated with OTC derivatives is the
establishment of trade repositories that would collect information on these transactions that regulator
would be able to access. See Bank for International Settlements, Consideration for Trade Repositories in
OTC Derivatives Markets Consultative Report
1 (May 2010), available at http://www.bis.org/publ/cpss90.htm ( visited July 13, 2011).
26
See e.g. FINANCIAL CRISIS INQUIRY COMMISSION, THE FINANCIAL CRISIS INQUIRY REPORT 27 (2011)
[hereinafter FCIC REPORT] (discussing how contagion originating from a rapid depreciation of subprime
mortgages spread to other investments which were secured against these mortgages). See also IMF Global
Financial Stability Report
, Sovereigns Funding, and Systematic Liquidity 13 (October 2010) , available at
http://www.imf.org/external/pubs/ft/gfsr/2010/02/index.htm (visited March 25, 2011) [hereinafter IMF
Stability Report Oct. 2010] (estimating losses in the global banking sector as of October 2010 to be $2.2
trillion).
27
VIRAL V. ACHARYA, THOMAS F. COOLEY, MATTHEW P. RICHARDSON & INGO WALTER, REGULATING
WALL STREET THE DODD-FRANK ACT AND THE NEW ARCHITECTURE OF GLOBAL FINANCE 481-2 (2010).
28
See Viral V. Acharya, Philipp Schnabl, & Gustavo Suarez, Securitization Without Risk Transfer 16-21
(Nat’l Bureau of Econ. Research, Working Paper No. 15730 (2010)), available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1364525 (visited July 13, 2011) (discussing how
ABCP was off-balance sheet and because it was guaranteed it was not subject to capital charges although
the instrument would have been charged if they were simply issued as loans).
29
See e.g. IMF Stability Report Oct. 2010, supra note 26, at 59 (describing Asset Backed Commercial
Paper (ABCP) markets created contagion through opaqueness and lack of objective valuation methods).
The uncertainly concerning valuation made it difficult for ABCP to be sold in secondary markets. See id.
This essentially destroyed the market necessitating banks look elsewhere for liquidity. See id.
Simultaneously the valuation problem raised concerns over potential losses of intermediaries making it
difficult for banks to value each other. See id., at 59-60. Liquidity consequently became scarce and
combined with uncertainty caused the overnight LIBOR to increase significantly further making it difficult
for banks to cover short-term obligations. See id., at 61. See also McCoy, Pavlov & Wachter, supra note
23, at 498 (“[T]he fundamental and inevitable failure of market derived from the lack of proper pricing of
risk.”).
5
companies desired level of risk, which then creates systematic concerns. 30 Part of the
solution is better accounting standards but another aspect is the ability to assess the
financial product accurately and independently. 31 In both these cases, both regulators and
markets would benefit from better information. Better information helps regulators
because it will allow them to assess violation of rules, and markets because it will allow
parties to assess the riskiness of any particular transaction. 32
Understandably, the benefits to markets will depend on not only available information
but also the extent that market participants understand the relevance of the information
and the degree that those participants, especially financial intermediaries, internalize the
risk of negative market reaction. 33 This is the problem of do markets care and if they do,
will management respond. Although this article discusses some of the implications of
this problem in Part 4, it does not deal with it directly. The article avoids this because it
is something domestic regulators can handle domestically, and probably better, because
it is partly a question of legitimacy of the information disseminator. 34 US markets will
react more strongly to what the US Securities and Exchange Commission (hereinafter
SEC), the Commodities Futures Trading Commission (hereinafter CFTC), or Federal
Reserve (hereinafter Fed) says about risk than the Bank of International Settlement
(hereinafter BIS) or another similar international institution. Moreover, it will be
different, based on which domestic regulators and markets we consider. The US capital
markets generally have dispersed shareholding while in Japan shareholdings are more
concentrated. 35 This implies managers may be hurt more by discounted share prices, due
to holding too many risky investments in the market for corporate takeovers in the US
than in Japan. 36 Hence, the method of risk internalization may be different depending on
30
See e.g. Scott, supra note 16, at 597-600, 657-8 (discussing effects on investment vehicles and conduits
arising from the subprime crisis and noting high losses in value).
31
See Steve Charnovitz, Addressing Government Failure Through International Financial Law, 13 J.
INT’L ECON. L. 743, 749 (2010) (“The new US model of risk management by wise guardians is misguided.
The best way to avoid risks to US financial stability is to use market to identify the risk and put prices and
value on it.”); McCoy, Pavlov & Wachter, supra note 23, at 498-9 (noting that because of deregulation
markets could not price risk for securitized product).
32
Cf. e.g. generally FSB Information Gaps, supra note 21.
33
See e.g. Christian Leuz & Peter Wysocki, Economic Consequences of Financial Reporting and
Disclosure Regulation: A Review and Suggestions for Future Research 9 (2008) (working paper),
available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1105398 (visited July 13, 2011) (citing
evidence that increased disclosure may “increase firm value by improving manager’s decisions”).
34
See Raustiala, supra note 4, at 82 (discussing how compliance tracks positively with level of legitimacy
of an international rule so long as it was propagated under the “right process.”); ABRAM CHAYES &
ANTONIA HANDLER CHAYES, THE NEW SOVEREIGNTY 127 (1995) (arguing legitimacy will cause
compliance even when cost benefit analysis is unfavorable); Karmel & Kelly, supra note 8, at 897 (arguing
compliance of hard or soft law depends on “self-interest and legitimacy”). See also Esty, supra note 6, at
1513 (arguing that where issues are politically divisive greater legitimacy of international institutions is
necessary). Although the benefits to cooperating in international finance are high so are the costs. Cf. id., at
1512. In turn, financial institutions require “developed procedures to establish the legitimacy of policy
making.” Id., at 1513. See also Frank, supra note 6. However, the distinction of will governments follow a
rule in terms of international legitimacy and will markets respond is another question. To incentivize
markets to respond the rule or information would also have to affect shareholder value. See infra Part 4.
35
See e.g. generally Asli Demirgüç-Kunt & Ross Leving, Bank-Based and Market Based Financial
Systems: Cross-Country Comparisons (W. Bank Pol’y Working Paper No. 2143 (1999)), available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=569255 (visited July 24, 2011) (describing the US and
UK centered around markets while Japan and Germany are centered around banks).
36
See e.g. Ross Levine, Bank-Based or Market-Based Systems: Which is Better? 3 (Nat’l Bureau of Econ.
Research,
Working
Paper
No.
9138,
(2002)),
available
at
6
the characteristics of a domestic market. Unfortunately this article is unable to obtain
empirical literature dealing with this issue directly. 37 Consequently, the economic
consequences regarding international reforms to close information asymmetries can only
be estimated through anecdotal evidence and analogy.
Now that the characteristics of the information asymmetry this article will study are clear,
it is important to understand how this article will address the problem. The starting point
of this article is to look for what can be done to cure this information asymmetry in light
of the political problems involved with institutional restructuring of the current
regulatory apparatuses. 38 To this end, the article looks at the mechanisms that domestic
economies use to cure these kinds of information asymmetries, specifically
administrative tools.39 Then it attempts to evaluate which administrative tools will most
benefit the international financial system to assist the efforts of lawmakers to regulate
international finance for both crisis avoidance and normative stability.
These apparatuses have many forms, some passive, such as data repositories, to more
active ones such as swaps trade repositories, to types that imply the powers of a domestic
regulator such as a data repository with active oversight. On the international-level,
regulators already use administrative institutional structures in international financial
regulation, but they are relegated largely to standards setting, a quasi-legislative function,
with only a few exceptions. 40 Most of these tools are set up to monitor the
implementation of various soft law standards. 41 Few tools directly aid or attempt to cure
information asymmetries between the international space and domestic markets. The few
mechanisms that do exist rely heavily on state-to-state interaction, 42 which can have
significant beneficial effects, but against the background of a globalized market for
international finance, does not sufficiently address the regulatory mismatch. 43 Moreover,
the fact that domestic regulators have various incentives for opaqueness exacerbates this
problem. 44
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=307096 (visited July 13. 2011) (citing research that
market based systems like the US have more influence on managers through the possibility of takeovers).
37
See infra Part 4.
38
Cf. Donald C. Langevoort, Global Securities Regulation After the Financial Crisis, 13 J. Int’l Econ. L.
799, 801 (2010) (advocating a similar approach in terms of regulatory convergence of capital markets
where political resistance might be less severe).
39
See UK Financial Services Authority Handbook
, SUP 1.4, Tools of Supervisions, available at http://fsahandbook.info/FSA/html/handbook/SUP/1/4
(visited July 14, 2011) (listing various regulatory methods available to the FSA). See also SEC Homepage,
Important Information about EDGAR, available at http://www.sec.gov/edgar/aboutedgar.htm (visited
November 16, 2011) (describing EDGAR system, a centralized public system that houses all SEC filing by
company).
40
For a discussion of the non-legal nature of the international financial architecture see infra note 276 and
accompanying text. For a detailed discussion of intergovernmental standards settings and the concept of
“transgovernmentalism” and its implications for the international financial architecture see generally
Zaring, supra notes 1, 4, & 7, Raustiala, supra note 4, and Verdier, supra note 7.
41
See infra notes 283 -289 and Part 3.3 discussing oversight mechanisms in the international financial
architecture.
42
See infra note 339.
43
See supra notes 13-15 and accompanying text.
44
See Scott, supra note 16, at 185-6 (describing disincentives that hosts countries have to convey relevant
information to home countries about financial institution branches located in their jurisdiction). Some of
these incentives for opaqueness include: fears over damage to the banks global operations thus affecting
the host country and reluctance to admit domestic regulatory failures. See id. On the other hand, “home
7
It is necessary to recognize a theoretical distinction here. This article will not be looking
directly at the concept of “global administrative space.” 45 It will presume its existence,
but like the recent article by Professor Pan, arguing for a new international
administrative agency, 46 the concern here is the functional aspect of administrative law
and institutions and how they can be applied more effectively on the international-level.
Specifically, how they can cure the information asymmetry between the international
space and domestic markets and regulators. Moreover, this study does not gear toward
any particular level of institutional restructuring. 47 Rather, it looks at the potential
effectiveness of specific administrative tools; asserting that regulators only need to
restructure to the point of making the tool effective.
At first glance, it is easy to argue that a look at administrative tools is inherently an
examination of institutional restructuring. Naturally, at the international-level, new tools
will imply institutional restructuring or additional powers to the existing international
financial architecture. Where institutions are informal and inherently non-legal this
invites criticism and predictability questions. Likewise, authors have expressed concern
that the G20 coordinated efforts to dealing with the 2008 Financial Crisis in lieu of the
existing international financial architecture. 48 The G20 did this while simultaneously
bypassing existing structures creating predictability concerns for the international system,
which undermines the architecture’s legitimacy. 49 The policy apparatus of the G20 at
some point will have to legalize if it wishes to remedy this while continuing its role as
financial crisis-response-director. 50 However, given the contentiousness and uncertainty
in international financial markets regulators attempting legalization in this context should
be highly cognizant of their objectives. 51 Financial restructuring should have as its end
country, out of concern that the host country might take measures to preserve bank assets in the host
country for the benefit of host country creditors…” Id., at 186.
45
See Benedict Kingbury, Nico Krisch & Richard B. Stewart, The Emergence of Global Administrative
Law, 68 L. & CONTEMP. PROBS. 15, 18 (Summer/Autumn 2005) ( “The conceptualization of global
administrative law presumes the existence of global or transnational administration…enough global or
transnational administration exists that it is now possible to identify a multifaceted ‘global administrative
space’…”).
46
See Pan, supra note 1, at 273-80 (arguing that administrative power over international finance is better
vested in an international administrative agency and comparing this possibility to supra-national
governance in the EU).
47
See Pan supra note 1, at 273-5 (arguing for a system that resembles a “college of supervisors approach”).
48
See Zaring, supra note 1, at 478 (“The failure of Basel, [International Organization of Securities
Commissioners] IOSCO, and their ilk to do anything to respond to the crisis, and their leaving response
coordination to the G20, a political organization, is sobering.”). The exception is the International
Monetary Fund (IMF), which has played a role in bailing out sovereigns. See id., at 479.
49
See Mario Giovanoli, The Reform of the International Financial Architecture After the Global Crisis, 49
INT’L L. & POL. 81, 105 (2009) (describing concerns such as unclear relationships between G20 and other
institutions, as well as a lack of a formal infrastructure and hap hazard meeting schedule); Chayes &
Chayes, supra note 34 at 127 (“Legitimacy…depends on the extent to which the norm (1) emanates from a
fair and accepted procedure, (2) is applied equally and without invidious discrimination, and (3) does not
offend minimum substantive standards of fairness and equality.”).
50
Giovanoli, supra note 49, at 105 (noting benefits associated with formalizing G20’s role in financial
governance).
51
Cf. Robert Cookson, Kevin Brown & Jeremy Grant, Geithner Triggers Backlash on Regulation,
FINANCIAL TIMES (June 7, 2011), available at http://www.ft.com/intl/cms/s/0/38e6dd84-911f-11e0-966800144feab49a.html#axzz1OvspkOlv (visited November 16, 2011) (discussing warning of US treasury
secretary Timothy Geithner about failure of Asian economies to adopt derivatives regulation as being
potential cause of future financial crisis).
8
goal the accomplishment of certain defined criteria. Ergo the first step in this
examination is to ascertain the potential desirable effects of the tool. Once this is done,
the level of institutional restructuring for effective implementation is a subsequent
problem. Admittedly, divorcing this from political concerns is impossible; hopefully if
lawmakers realize the relative importance of a specific international administrative tool
the path to implementation through international restructuring will be clearer.
Part 2 of this article starts by examining financial transactions in terms of the risks they
create. I assume that domestic regulators have the means at their disposal to regulate the
domestic aspects of finance. Consequently, the article focuses on those risks that occur
cross-border i.e. in the international space. The article does this by examining frequent
international financial transactions against some of the domestic and international
regulatory reforms that lawmakers implemented subsequent to the 2008 Financial Crisis.
Second, it summarizes and analyzes the International Monetary Fund (hereinafter IMF)
and Financial Stability Board (hereinafter FSB) recommendations for closing
“Information Gaps” in order to identify state-to-state and other international recognized
regulatory problems involving information asymmetries. 52 Finally, this Part will go into
a brief account of the international financial architecture to give a macro view of the
legal framework of international financial regulation. Through this juxtaposition, the
article tries to highlight some of the information weak-points that exist between domestic
jurisdictions (mostly the US) and the international space. The proposition is that
domestic markets are at least partially ignorant of international space in which finance
occurs. This ignorance causes the information asymmetry and in turn the regulatory gap.
The article derives these risks by looking at transactions for three reasons. First, similar
to the decline in lending standards that fueled the US housing bubble this base level can
spin out into a global crisis. 53 Next intermediaries and domestic markets by knowing the
risks can take on part of the risk-management responsibility. 54 Finally, closing this
information asymmetry and providing transparency can increase confidence in financial
markets. 55 Moreover, at least US regulatory reforms, even when promoting transparency
seem to revolve around financial intermediary transparency, with the exception of
swaps. 56 This is not necessarily wrong, but overly focusing on intermediaries is an
52
See generally FSB Information Gaps, supra note 21; IMF Staff and the FSB Secretariat, The Financial
Crisis and Information Gaps Report to the G-20 Finance Ministers and Central Bank Governors (October
29, 2009), available at http://www.financialstabilityboard.org/publications/r_091107e.pdf ( visited July 18,
2011) [hereinafter FSB Info Oct 29, 2009].
53
See e.g. Angela Maddaloni & Jose-Luis Peydro, Bank Risk-Taking, Securitization, Supervision and Low
Interest Rates: Evidence from Lending Standards 28 (Am Fin. Ass’n 2011 Denver Meeting Paper),
available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1571697## (visited July 14, 2011)
(discussing how low interest rates and poor regulation lead to a decline in mortgage lending standards).
54
See Acharya, Cooley, Richardson & Walter, supra note 27, at 98-9 (discussing the need for transparency
between financial intermediaries to show the exposure to counterparty risk that “allow[s] market
participants to price more accurately risk in contracts with each other and to employ suitable risk
controls.”).
55
See Kaufmann & Weber, supra note 5, at 783 (discussing transparency and confidence in financial
markets).
56
See Langevoort, supra note 38, at 806-8 (discussing how prior to the 2008 Financial Crisis US securities
regulations has been trending to institutional investor regulation). This is not to suggest disclosure
requirements are being left out. There are new disclosure requirements for Over-the-Counter (OTC)
derivatives and international information cooperation commitments. See Dodd-Frank §§ 727-8 (requiring
public reporting for swaps and swap data repositories). However, many of these reforms are also structural.
9
incomplete approach 57, especially considering that large financial intermediaries are both
sophisticated and incentivized to avoiding regulatory burdens. 58 For example, the US is
implementing a categorical approach to determine if a financial intermediary will be
subject to new systematic risk regulations. 59 In an extreme case, the intermediary may try
to alter its business practices and structures to remove itself from a regulated category. 60
An overly intermediary focused approach may allow for regulatory arbitrage out of the
category by changing only cosmetic factors that leave the underlying risk of the company
intact. 61
The focus on intermediaries is not surprising considering that the fall of Lehman
Brothers is strongly associated with the 2008 Financial Crisis. 62 A potential bankruptcy,
which implies another round of taxpayer bailouts, fiscally warrants a concern for the
healthy operation of these intermediaries. 63 Nonetheless, as the article will highlight in
Part 2, a danger arises when intermediaries and regulators create a closed system where
market participants are left ignorant and forced to rely on non-market measures of risk
(such as ratings agencies), which have been sanctioned by governments. 64
Part 3 of this article examines various tools that domestic and international
administrative regulators use to cure information asymmetries, and tries to assess their
value in curing the information asymmetry between the international space and domestic
financial markets and jurisdictions. The article will then compare the value of the tool to
the level of legal restructuring that implementing it will necessitate.
For example, reforms to trade swaps and other derivatives on execution facilities or requirements for
central clearing institute new financial structures. See Dodd-Frank §§723(a)(3)(h), 733 (describing
requirement swap clearing, and execution facility registration); Acharya, Cooley, Richardson & Walter,
supra note 27, at 48 (discussing how Dodd-Frank “does a fair amount to improve transparency” but fall
short in regulating the “information role” of rating agencies.”). This paper tries to focus on information
asymmetry concerns that in turn could be used to aid these new structures. Admittedly, exchanges add
transparency to the system and help to cure information asymmetries. This paper simply deals with those
information asymmetry questions directly as opposed to through an intuitional structuring.
57
See Acharya, Cooley, Richardson & Walter, supra note 27, at 94 (discussing the need to supplement
systematic risk regulation that focuses on intermediaries with “market-based measures.”).
58
See David Jones, Emerging Problems with the Basel Accord: Regulatory Arbitrage and Related Issues,
24 J. BANKING & FIN. 35, 36, 38 (2000) (discussing how “regulatory capital arbitrage” can hide
“deteriorations in true financial conditions of banks” and explaining many banks believe regulatory
arbitrage could “enhance shareholder value.”).
59
Acharya, Cooley, Richardson & Walter, supra note 27, at 94-5 (comparing categorical measures of
systematic risk to mathematical measures).
60
Id.
61
Id.
62
See William A. Allen & Richhild Moessner, The International Propagation of the Financial Crisis of
2008 and a Comparison with 1931 5-6 (Bank For Int’l Settlements Working Paper No. 348, 2011),
available at http://www.bis.org/publ/work348.htm (visited October 5, 2011) (arguing Lehman collapse
triggered a destabilizing flow of funds between countries).
63
See Acharya, Cooley, Richardson & Walter, supra note 27, at 87 (discussing bailouts in relations to
systematic risk and moral hazard). See also John C. Coffee, Jr., Systematic Risk After Dodd-Frank:
Contingent Capital and the Need for Regulatory Strategies, 111 COLUM. L. REV. 795, 799 (2011)
(criticizing Dodd-Frank for not incorporating bailouts into the regulatory scheme and instead simply
outlawing them); Scott, supra note 16, at 615-23 (discussing costs and problems and polices surround the
Bear Stearns and AIG bailouts as well as the Lehman Brothers Bankruptcy).
64
See infra notes 163-178 and accompanying text. For a brief discussion of the general role of ratings
agencies see infra notes 350- 358 and accompanying text.
10
Finally, Part 4 will try to surmise the possible market effects that may by associated with
better information from the international space. The degree that the domestic market
reacts to information from the international space feeds back into the value of
implementing any individual tool. Tools are only worthwhile to the extent that markets
care about what the tool is doing. 65 Moreover, the value of the tool will depend on the
degree that markets care about institutional quality in addition to information quality.66
Finally, results from empirical research can hint as to types of benefits tools need to
provide to create market value.
In sum, the article is an examination of the tools of administration in light of the existing
international financial architecture and not a general examination of the architecture
itself or its authority. While a new treaty institution may arguably be beneficial for
international finance, 67 such an organization will not come about any time soon, 68
especially as the immediacy of crisis abates and nations refocus on their own national
interests. 69 The key point is to consider what is practicable in terms of international
administration in light of the risks created by the underlying international financial
transactions that occupy this space.
2. International Financial Transactions and the Risk of International Finance
Today
Individual transactions are the base concern of financial regulators. 70 The next level is to
look at the market structures (companies) executing those transactions. 71 Finally, a look
at the systematic concerns, which can to invade all types of transactions, is necessary. 72
For this article, the relevant part is the first and second levels but on the international,
transnational, or global tier. 73 The following part will attempt to analyze the relevant
65
See infra Part 4.
See infra notes 414 - 423 and accompanying text.
67
See supra note 3 and accompanying text.
68
See Giovanoli, supra note 49, at 122-3 (stating that the political situation prevents a global regulator
from emerging “and may not even be desirable”). See also Karmel, supra note 8, at 890-8 (explain that soft
law is used in international securities regulation because of the slow pace of public international law);
Raustiala, supra note 4, at 72-6 (arguing “regulatory power is asymmetric” treaties become unlikely in
favor of informal cooperation).
69
See supra note 12 and accompanying text.
70
Cf. RAVI C. TENNEKOON, THE LAW & REGULATION OF INTERNATIONAL FINANCE, at vii, 1,17 (1991)
(describing regulatory underpinnings of international finance from transactional perspective based on laws
of England and New York).
71
See Acharya, Cooley, Richardson & Walter, supra note 27, at 37 (“The institutional structure that should
be created to implement the regulatory changes that have…been passed into law…depends critically on
certain macro decisions about the goals of the regulation.”). Depending on the structure of financial
intermediaries, regulation will be different. See id. The authors example is if large financial intermediaries
are broken up the regulator concern will be different than if they remain intact. See id.
72
See Alexander, Dhumale & Eatwell, supra note 1, at 4-5 (discussing how “Successful financial
regulation particularly in the attempted management of ‘systematic risk’ must be based on a coherent
understanding of the relationship between microeconomic risk, macroeconomic contagion, and
macroeconomic consequences.”).
73
The paper cabins the terms international, global, and transnational into the term international space or
cross-border. Although there are different aspects of financial regulation that can fall into these categories
for the purposes of this paper international space means those aspects of finance outside of domestic
control. For a discussion of the different international natures of various cross-border financial transactions
66
11
risks surrounding common international financial transactions and intermediary behavior,
with the hope of highlighting the information asymmetry that exists between the
international-space and domestic markets. It then tries to assess which of those risks
lawmakers and regulators adequately address through domestic mechanisms and
informal international cooperation, and finally tries to ascertain where information
shortfalls occur between the international space and domestic markets and regulators.
The modus behind this prospective is to address the rapidity that contagion spread across
boarders during the 2008 Financial Crisis. Traditionally, although crisis is far from
uniform, 74 contagion happens when a domestic financial downturn is so potent that an
economy cannot contain or absorb it solely within its borders. 75 The 2008 Financial
Crisis, however, was not limited to the repercussions of the players in the US real estate
market being unable to absorb the rapid collapse of home values. 76 In fact, sentiment
during the early stages of the downturn suggested the devaluation would not spread to
other parts of the economy. 77 The unexpected dimension, and the interesting aspect in
terms of this article, is that parties across the globe held financial instruments tied
directly to these assets as if they seized their portfolios in New York the way a domestic
company would. 78 In this sense, the current crisis goes beyond the historical notion of
contagion. Moreover, the financial intermediaries that constructed these products, and
held them for their proprietary account, operated transnationally with little regard for the
fact counterparties were cross-border. 79 Certain aspects of the crisis thus looked domestic
in nature and because of this, it is necessary to assess risks associated with the
transactions that facilitated this contagion.
see Scott, supra note 16, at 1-2. In this way, the international financial intermediary is simply a
multinational enterprise and can thus be studied with those concerns in mind. For a discussion of the
regulation of multinational enterprises see generally PETER T. MUNCHLINSKI, MULTINATIONAL
ENTERPRISES & THE LAW (2d ed. 2007). The nature of the business, however, distinguishes financial
intermediaries from companies doing other forms of foreign direct investment or international trade. See
supra notes 13-15; infra note 102 and accompanying text. In turn, it is that aspect the paper seeks to
address.
74
See e.g. Luc Laevan & Fabian Valencia, Systematic Banking Crisis: A New Database 5-7 (IMF Working
Paper No. 08-224 (2008)) (describing different financial crisis arising from banking, currency, and
sovereign debt).
75
See e.g. Arner supra note 2, at 32 (describing contagion effect which followed various crises of 1990s).
The increased role of contagion in the 1990s can be attributed financial globalization, which mostly took
place due to increased cross-border portfolio investment during that period. See id., at 34.
76
See FCIC REPORT, supra note 26, at 27 (“Federal Reserve Chairman Ben Bernanke now acknowledges
that he missed the systemic risks. ‘Prospective subprime losses were clearly not large enough on their own
to account for the magnitude of the crisis,’ …‘Rather, the system’s vulnerabilities, together with gaps in
the government’s crisis-response toolkit, were the principal explanations of why the crisis was so severe
and had such devastating effects on the broader economy.’”)
77
See id., at 159 (discussing how Federal Open Market Committee thought that spillover from the
mortgage was unlikely for various reasons).
78
See e.g. Langevoort, supra note 38, at 799-800 (discussing origins of the 2008 Financial Crisis in terms
of interconnected nature of finance); Viral Acharya & Philipp Schnabl, Do Banks Spread Global
Imabalances? The Case of Asset-Backed Commercial Paper During the Financial Crisis of 2007-09, 58
ECON.
REV.
37,
41
(2010),
available
at
http://www.palgraveIMF
journals.com/imfer/journal/vaop/ncurrent/full/imfer20104a.html#note1 (visited July 30, 2011).
79
See Acharya & Schnabl, supra note 78, at 43-4, 44 Table 1. (giving example of German ABCP conduit
holding asserts from fifteen countries most of which were located in US and UK).
12
The article examines these transactions based on a few assumptions. The first is that
markets are the best arbiters of what is an acceptable risk in finance. 80 Finance is
inherently about buying and selling of risk and principally players should be able to
choose the levels in which they engage. Obviously, the last crisis proved that this should
not be ubiquitous. Overly risky actions by banks eschewed prudent investing for perverse
inventive schemes and the competitive demands of financial intermediaries. 81 However,
it is sufficient to say that individual transactions may not have taken place if the buyer or
the seller knew the full extent of the exposure. Nor does this article disregard the obvious
problems of systematic risk, where otherwise prudent actions by banks may compile into
systematically risky behavior 82, or the role of fraud. 83 However, the intention is not to
cover all the bases of financial regulation but assess this one particularly poignant
information asymmetry, which curing can benefit other aspects of the regulatory scheme.
Naturally, any particular transaction will generate a number of different types of risks. 84
Likewise, when regulating these risks many transactions and financial intermediaries are
subject to different kinds of regulations at different levels of the global governance
scheme. 85 In light of this the goal of an information tool is to cross these lines and
communicate directly to markets.
2.1 Goals and General Concerns of International Financial Regulation
First, to understand how administrative mechanisms can cure information asymmetries it
is necessary to understand what international finance and financial regulation tries to
regulate. Financial regulations seek to control the kinds of risk that buyers and sellers in
financial markets are allowed to trade and which institutions (historically banks) are
allowed to bear. 86 Regulations generally fall into two areas. The first is prudential
regulation 87 , most notably deposit insurance and capital adequacy of individual
80
See Steve Charnovitz, Addressing Government Failure Through International Financial Law, 13 J.
INT’L ECON. L. 743, 749 (2010) (arguing crisis can be avoided by using markets to price risk).
81
See e.g FCIC REPORT, supra note 26, at 63. See also Carlos Arteta, Mark Carey, Ricardo Correa & Jason
Kotter, Revenge of the Steamroller: ABCP as a Window on Risk Choices 22-5 (Federal Reserve Board)
(July 27, 2010), available at http://webuser.bus.umich.edu/jkotter/papers/revengesteamroller.pdf (visited
July 17, 2011) (citing empirical evidence that bad executive pay scheme are linked to sponsoring Asset
Backed Commercial Paper (ABCP) conduits).
82
See Avinash Persaud, Macro Prudential Regulation Fixing Fundamental Market (and Regulatory)
Failures, Crisis Response, compiled in Crisis Response Note, no. 6 at 2, World Bank doc. 50347 (July 1,
2009),
available
at
http://wwwwds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&the
SitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=00033303
8_20090915020940 (visited November 18, 2011) (“In trying to make themselves safer, banks and other
highly leveraged financial intermediaries can behave in ways that collectively undermines the system.”).
83
See e.g. FCIC REPORT, supra note 26, at 78 (discussing various causes of imprudent subprime lending).
84
Cf. e.g. Alexander, Dhumale & Eatwell, supra note 1, at 188-9 (discussing risks associated with
settlement systems).
85
See e.g. Rolf H. Weber, Multilayered Governance in International Financial Regulation and
Supervision, 13 J. INT’L ECON. L 683, 684-5 (2010) (discussing various kinds of regulation in
“international financial regulation.”).
86
See e.g. Tietje & Lehmann, supra note 14, at 666.
87
See e.g. Davies & Green, supra note, 1 at 15-16 (discussing how prudential regulation is primary method
to control systematic risk); HEIDI MANDANIS SCHOONER & MICHAEL W. TAYLOR, GLOBAL BANK
13
companies. 88 The second is investor protection, which provides for public disclosures. 89
These are not the only two areas of regulation. Private companies that facilitate market
interactions such as clearing houses or exchanges also set various specific requirements
to mitigate risk. 90 Corporate governance is also important to varying degrees, depending
on the jurisdiction, normally complementing the extent of the securities and banking
laws. 91 The aforementioned conceptual areas, however, are traditionally what regulators
use to secure the soundness of markets. 92
The policies address the two goals of financial regulation respectively. Prudential
regulations gear toward stability and investor protection regulations gear toward making
the normative interactions of finance fair. 93 These policies may principally have different
goals, but there are effects for both transparency and soundness that come from each. For
example, the SEC promotes stability through market transparency and plays an active
role in insuring that information disclosures are accurate. 94 Information about listed
companies is then not only used by the capital markets but also other financial
intermediaries seeking to interact with each other. This transparency thus helps inform
them about the extent of the risk inherent in each intermediary. As for prudential
regulation, capital requirements that the Office of the Comptroller of Currency (OCC)
and SEC place on bank and non-bank intermediaries, 95 in addition to promoting actual
soundness, can be set up to send market signals about the soundness of those
intermediaries. 96
The onus of who the decision maker is will likely depend on what function in society the
rule is designed to fulfill. Regulators leave decisions about unacceptable risks, like the
risk that banks cannot meet their current liabilities to depositors, only minimally to
market participants i.e. only to amount investors deposit money in excess of deposit
insurance. 97 Regulators leave other risk decisions almost entirely to market participants,
REGULATION AND POLICIES, at xii (2010) (discussing types of regulations for banks); Scott, supra note 16,
at 164 (discussing prudential regulations being primary regulatory tool for institutions such as banks).
88
See Scott, supra note 16 at 167.
89
See e.g. Davies & Green, supra note 1, at 22 (discussing how this regulation is designed to prevent
information asymmetries between investors).
90
See e.g. Tietje & Lehmann, supra note 14, at 666 (2010) (discussing technical infrastructure regulations
as being geared toward private actors or based on “private initiatives” by those actors).
91
See MATHIAS M. SIEMS, CONVERGENCE IN SHAREHOLDER LAW 126-7 (2007) (comparing jurisdictions
that regulate transparency through company law versus through securities law).
92
See e.g. Scott, supra note 16, at 25.
93
See e.g. Tietje & Lehmann, supra note 14, at 665-6 (2010) (discussing how certain intermediaries are
governed with “defined conditions” while other try to provide “a fair amount of information” to cure
information asymmetries). See also Scott, supra note 16 at 25 (discussing how investor protection is aimed
at capital markets while prudential regulations are aimed more at banking).
94
See Shelley Thompson, The Globalization of Securities Markets: Effects on Investor Protection, 41
INT’L LAW., 1121, 1128 (2007) (discussing US securities regulation in providing for quality of
information).
95
See Securities Exchange Act of 1934 Over the Counter Rule 15c3-1, 17 C.F.R. §240.15c3-1 [hereinafter
34 Act] (describing “”Net capital requirements for brokers or dealers”); Office of Comptroller of Currency
Regulations, 17 C.F.R. §3.6 (describing “minimum capital ratios” for banks). See also Acharya, Cooley,
Richardson & Walter, supra note 27, at 154.
96
See Hal S. Scott, Reducing Systematic Risk Through the Reform of Capital Regulation, 13 J. INT’L ECON.
L., 763, 775-6 (2010) (discussing market signaling through holding subordinated debt as capital).
97
See Tietje & Lehmann, supra note 14, at 665-6 (discussing role of deposit insurance as to create trust
between the private sector and the banking institutions such that money deposited will be accessible). See
14
such as the risk that a security may decline in value. In financial regulation, only certain
risks need to be controlled. 98 Striking the balance is a matter of discretion for the
jurisdiction.
Regulator interest in certain causes and types of risk to the financial system stems partly
from the fact that the financial system performs a public good in addition to being an
economic activity. 99 Although it is more common to conceptualize regulation as avoiding
the ills of finance, in reality regulators try to balance the system to provide security and
liquid access to capital simultaneously. 100 Weber and Arner have also discuss the key
role that financial liberalization plays in the developing world and show how improper
liberalization can lead to crisis, like the Asian Financial Crisis and Latin American Debt
Crises. 101
Described so far, is currently within the competence of domestic regulators to control.
Financial products and intermediaries are all ‘“domestic[ally] embedded’” in
jurisdictions, but at the same time able to move cross-border shortly after constitution. 102
Concurrently, the international financial architecture has historically been concerned
with these cross-border movements. 103 In this respect, cooperation supposedly fills the
gaps between those domestic regulators and market participants. 104 The most notable is
capital adequacy for banks, which since the BCCI scandal 105 has come about in two
iterations and a third, Basel III, will take effect in 2013. 106 Basel III will reflect a greater
concern for prudential regulation after the 2008 Financial Crisis. 107 However, Basel
Accords like other non-legal international standards depend on domestic implementation,
also Acharya, Cooley, Richardson & Walter, supra note 27, at 2 (discussing historical rational behind
deposit insurance in the US).
98
See Tietje & Lehmann, supra note 14, at 666 (“Financial regulation of market behavior sets the basic
rules on what is and what is not allowed in the market place.”).
99
See Joel P.Trachtman, The International Law of Financial Crisis: Spillover, Subsidiarity, Fragmentation
and Cooperation, 13 J. INT’L ECON. L. 719, 721 (2010) (arguing that financial stability is a “global public
good”).
100
See Tietje, supra note 14, at 664 (explaining that financial “regulation and supervision” is with
“freedom of financial markets.”).
101
See Rolf H. Weber & Douglas W. Arner, Towards A New Design for International Financial
Regulation, 29 PA. J. INT’L L. 391, 430-2 (2008) (discussing role financial liberalization plays in financial
stability of emerging markets and crisis). See also generally Arner, supra note 2.
102
See e.g. Tietje & Lehmann, supra note 14, at 668-9 (discussing the domestic origin of financial
products that are then traded in multiple jurisdictions).
103
See e.g. id., at 669. See also generally Goodhart, supra note 14 (discussing problems of financial
regulation moving cross-border and between “regulated and non-regulated” intermediaries).
104
See e.g. Tietje & Lehmann, supra note 14, at 669. See also Raustiala, supra note 4, at 49 (summarizing
network cooperation in international administration).
105
For a discussion of BCCI see supra note 18.
106
See generally Bank for International Settlements Basel Committee on Banking Supervision
, Compilation of Documents that Form the Global Regulatory Framework for Capital and Liquidity,
available at http://www.bis.org/bcbs/basel3/compilation.htm (visited July18, 2011) (listing documents
related to Basel agreements). See also Nout Wellink, Basel III and Beyond 3 (High Level Meeting on
Better Supervision and Better Banking in a Post-Crisis Era FSI and EMEAP Working Group on Banking
Supervision,
Speech
Kuala
Lumpur,
Malaysia,
January
17
2011),
available
at
http://www.bis.org/speeches/sp110118.pdf (visited March 30, 2011).
107
See Financial Stability Board, Progress in the Implementation of the G20 Recommendations for
Strengthening
Financial
Stability
6
(January
15,
2011),
available
at
http://www.financialstabilityboard.org/publications/r_110219.pdf (visited March 30, 2011). (noting the
importance of “macroprudential” policies for global financial stability).
15
which can vary considerably. 108 According to Tietje & Lehmann this and other
competitive tendencies raise certain issues about the nature of cooperation and
competition between jurisdiction and to what level harmonization should superseded
regulatory competition. 109 Essentially, the authors apply arguments about the value of
regulator competition in choosing the right regulations versus a system of pure
harmonization. 110 Tietje & Lehmann conclude that because international financial
regulation is characterized by this “multilayered or multilevel governance” different
governance mechanism will inhabit different areas, some parts will benefit from
competition and others from harmonization. 111
This article agrees that international financial regulation exists in the arena of “multilayer
or multilevel governance.” 112 Regulator competition, however, creates numerous
principal-agent problems and regulators should keep in mind that social benefit does not
necessarily coincide with the optimal benefit of those parties, be it management or
otherwise, who can choose the regulations. 113 In this way, competition’s efficiency in
choosing regulations can be deceptive, and in the case of finance, where there are
considerable public externalities originating from the bulk of financial transactions,
competitions ability to choose the right regulation is highly doubtful. 114 Nevertheless, the
project here is to show how certain administrative mechanisms can be used to close
information asymmetries that inhabit the “multilayer[-]” “multilevel[-]” model of
international financial governance and smooth the system to make for regulations that
are more effective.
To that end, the following parts will try to isolate those information asymmetries that
inhabit the international space. The first step is to consider the subject matter of those
risks, specifically frequent international transactions. 115 Then to look at recognized
information problems between states as outlined by the IMF 116 Finally, to sketch the
recently reformed international financial architecture in order to show where mechanism
may fit and to understand what level of institutional restructuring may be required. 117
108
See Verdier, supra note 7, at 137 -9 (discussing how Basel I was implemented different in US, UK and
Japan due to different domestic bank concerns). Basel II incorporates this kind of discretion into the
intermediaries themselves by allowing them to determine their own riskiness. See id., at 140, 142 (citing
criticism of Basel II). See also Langevoort, supra note 38, at 813. See also generally Gadinis, supra note
12 (generally discussing relationship between intermediary incentives and national and foreign
jurisdictions over different international market structures, both dispersed and centralized markets, the
desire to lobby for less or greater regulation will depend on these structures and competition).
109
See Tietje & Lehmann, supra note 14, at 679. See also Trachtman, supra note 99, at 723-4 (discussing
regulatory competition and cooperation between states regarding international financial regulation).
110
See Tietje & Lehmann, supra note 14 at 679-81.
111
See id., at 682.
112
See id. See also generally Weber, supra note 85.
113
See David Andrew Singer, Capital Rules: The Domestic Politics of International Regulatory
Harmonization, 58 INT’L ORG. 531, 535-8 (2004) (“Legislators and financial regulators are engaged in a
principal-agent relationship.”). See also Fox, supra note 19, at 1343-6 (discussing how manager choices
for securities rules would be different than investors choices which would also be different from what
would be good for society); Coffee, supra note 63, at 799 (arguing that “privately optimal” level of risk for
“shareholder of a financial institution may not be socially optimal”).
114
See Trachtman, supra note 99, at 723-5 (discussing issues of regulatory competition and problems
arising due to externalities).
115
See infra Part 2.1.
116
See infra Part 2.2.
117
See infra Part 2.3.
16
2.2 Understanding Frequent International Financial Transactions and Their Risk
This part discusses popular international financial transactions many of which
exacerbated the 2008 Financial Crisis. Where they did not exacerbate the crisis, as with
the case of public securities markets, they represent a significant share of international
portfolio movement 118 and consequently should be considered in terms of the
information asymmetry problems they create. Many risks are characteristic of
intermediary behavior and consequently regulatory policy is now focusing on
intermediary regulation. 119 For example, some of problems that manifested during the
crisis were due to regulatory integration with financial intermediaries; this is the case of
ratings agencies. 120 While other problems tied to excessive profit seeking, 121 and so some
US rules will limit the activities intermediaries can engage in. 122 Admittedly, these are
large problems and the international financial architecture is taking numerous steps
towards addressing problems associated with large financial intermediaries. 123 However,
understanding that regulation is dependent on the structure of intermediaries 124 and
structure is easier to change than regulation 125 – transactions offer a way to examine risks
that exist irrespective of varying structures and regulations. In this way, risks inherent in
transactions are less transitory than risks which financial players construct for their own
account. The parttries to isolate these risks because legal commitments at the
118
From March 2011 the aggregate amount of international debt securities outstanding for all issuers was
29,045.6 billon US dollars. See BIS Ouarterly Review., June 2011, at A 113 (Statistical Annex), available
at http://www.bis.org/publ/qtrpdf/r_qa1106.pdf#page=114 (visited July 23, 2011). The total amount of
equity securities outstanding in Q1 2011 was 156.1 billion US dollars for year 2010 it was 707.6 billion
US dollars. See id., at A128.
119
See supra note 56.
120
See e.g. Acharya, Cooley, Richardson & Walter, supra note 27, at 443 (“[B]eginning in the 1930s
financial regulation has mandated that rating agencies be the central source of information about the
creditworthiness of bonds in US financial markets.”). Other manifestations of regulator integration
followed both in other US regulatory agencies and other countries alike. See id. These problems are
exacerbated by the fact that the intermediary purchases the rating directly from the agency creating a
“severe conflict[] of interest.” See id., at 449. For a discussion of the how ratings agencies lead to
regulatory short falls in the securitization market see infra notes 163-178, 350- 358 and accompanying
text.
121
See Viral Acharya & Matthew Richardson, Obama’s Bank Plan is a Start, FINANCIAL TIMES(January
22,
2010),
available
at
http://www.ft.com/intl/cms/s/0/1705ff00-0774-11df-915f00144feabdc0.html#axzz1TekCGzQe (visited October 2, 2011) (discussing proprietary trading and 2008
Financial Crisis).
122
See e.g. Acharya, Cooley, Richardson & Walter, supra note 27, at 199 (discussing the Volcker Rule that
will limit certain proprietary activities by banks under the US Dodd-Frank Act).
123
See generally Bank for International Settlements Basel Committee on Banking Supervision, Global
Sytemically Important Banks: Assessment Methodology and the Additional Loss Absorbency Requirement
(July 2011), available at http://www.bis.org/publ/bcbs201.htm (visited October 2, 2011); Financial
Stability Board, Effective Resolution of Systemically Important Financial Institutions Recommendations
and
Timelines
(July
19,
2011),
available
at
http://www.financialstabilityboard.org/publications/r_110719.pdf (visited October 2, 2011); Financial
Stability Board, Reducing the Moral Hazard Posed by Systemically Important Financial Institutions,
(October 20, 2010), available at http://www.financialstabilityboard.org/publications/r_101111a.pdf
(visited October 2, 2011).
124
See supra note 71.
125
This is not to suggest that large financial intermediaries will fundamentally change their business in
response to regulation. Rather they will attempt regulatory arbitrage. See supra note 59-63 and
accompanying text.
17
international-level will be hard fought. Consequently, such commitments should be able
to address underlying and somewhat lasting information asymmetries.
2.2.1
Public Securities Market Risks
Securities markets require “transparency and public disclosure of information for the
markets to functions well.” 126 A corporation or financial intermediary is capable of
issuing different kinds of securities: debt (bonds) and equity securities, as well as more
complicated securitized assets such as Mortgage Backed Securities (MBS) or Asset
Backed Securities (ABS). Securitization transactions, even when seemingly transparent
or traded on public markets present unique risks. Consequently, the article discusses
risks associated with securitization in the part below.
A quick overview of the regulatory underpinnings seen in US securities transactions will
help highlight where information asymmetries appear. 127 Securities are regulated in two
different phases. 128 The first is between the corporation and the market, as in an Initial
Public Offering (IPO), when the corporation wants to reach the public markets, or a
private placement when they want to reach the private markets. 129 The difference is the
regulatory burden. Reaching the public markets will require periodic disclosures to
public markets and regulators so that investors can assess the relative worth of the
security. 130 In private market transactions, however, the same level of information is not
necessary, because theoretically, in private transactions, parties can close information
asymmetries themselves through bargaining power, or the scope of the offering is small
enough to warrant non-regulation. 131 So long as private issues meet certain requirements,
they do not trigger public disclosures. 132 The next phase is buyer-to-buyer
transactions. 133 In public markets, these take place on exchanges and in private markets
they take place person-to-person, with certain limitations that if broken may trigger
registration. 134
126
Arner, supra note 2, at 228.
For an introductory discussion of the basic elements of securities regulation, see STEPHEN J. CHOI &
A.C. PRITCHARD, ESSENTIALS SECURITIES REGULATION (2008).
128
See e.g. id., at 13 (discussing primary and secondary markets). See also generally Securities Act of
1933, 15 U.S.C.A. §§77a – 77aa (2010) [hereinafter 33 Act] (proscribing laws regarding offer and sale of
securities); 34 Act, 15 U.S.C.A. §§78a- 78pp (2010) (proscribing law governing trading of securities in
secondary markets)
129
See e.g. Choi, supra note 127 at 13-18.
130
See 34 Act Regulation, 17 C.F.R. § 240.12a-11 (describing Form 8K for “current reports”); 17 C.F.R. §
240.15d-13 (describing Form 10q for “quarterly reports”); 17 C.F.R § 249.310 (describing “annual and
transition reports” Form 10-K).
131
See 33 Act Regulation D, 17 C.F.R. §§ 230.501-508 (2010) (providing safe harbors for a non-public
offering). Items 504, 505, 506 provide three versions of the safe harbor based on offering size and who the
investors targeted by the offering. See id., §230.504-506 One of the facts is that open solicitations cannot
be made for the sale of securities. See id. However, where there is an “accredited investor” i.e. an investor
that has either sophistication or high net worth these provisions are relaxed. See id., §504(b)(iii)
(referencing “accredited investor” in 17 C.F.R. § 230.501)).
132
See generally 17 C.F.R. §§230.501-508.
133
See e.g. Choi, supra note 127, at 13-18.
134
See Regulation D, 17 C.F.R. § 230.501 (regulation D safe harbors have resale restrictions breaking such
restrictions will require registration.) There are safe harbors to resale that will prevent violation of the
registration requirement. See 33 Act Rule 144, 17 C.F.R.§ 230.144 (describing resale safe harbors for non127
18
Public securities markets themselves represent a significant albeit somewhat basic
information asymmetry. It is basic because public securities are normally standardized,
regulators require disclosure, and price information is readily available. Thus, so long as
these elements are upheld markets are can price risk effectively. 135 Moreover, regulators
do not need to provide for these factors perfectly across all securities. Investors are wary
of certain risks in their portfolios and in turn diversify their holdings. 136 What this means
is that the risk of a single bad security is not important to most investors. 137 Rather the
aggregate degree that this can be expected across the entire market is relevant to the
prudent investor. 138 For example, the Enron scandal saw large shareholders suffer losses
from the fraud but the market itself was relatively stable. The devaluations associated
with Enron were company specific instances of malfeasance but not regulatory failings
that had implications for the whole market. Information regulation is thus focused on
assuring the market soundness as opposed to policing every company.
There are no international securities exchanges, and for that matter securities law, albeit
some laws have extraterritorial reach. 139 Multiple jurisdictions do not simultaneously
govern the trading of securities transactions or any single exchange institution. Some
exchanges, however, appear transnational like Euronext. Euronext is an integrated
European trading system that spans various exchanges, 140 that allows trading to happen
through a number of access points, functionally making it cross-border. 141 However, in
reality domestic authorities or EU level directives govern the individual exchanges
Euronext controls. 142 Meaning both functionally and from a regulatory standpoint it is
not an international exchange. European regulators harmonized regulations to make the
burden of any single Euronext exchange equivalent to any other, and a “working group”
coordinates between the multiple jurisdictions under the authority of MOUs. 143 Where
particular laws are not harmonized or are outside the scope of EU level governance the
listing corporation must meet varying domestic regulations. 144 Enforcement is also done
at the domestic-level even where regulations are harmonized or there is EU level law; 145
underwriters); 33 Act Rule 144A, 17 C.F.R. § 230.144A (describing resale safe harbors for qualified
institutions i.e. “not engaged in distribution”).
135
Cf. e.g. McCoy, Pavlov & Wachter, supra note 23, at 497 (comparing private label securitized
mortgages to institutional backed securitized mortgages and claiming that illiquidity and nonstandardization made it necessary for rating agencies to evaluate risk and not markets); Langevoort, supra
note 38, at 812 (discussing how standardization of OTC products can be linked to “marketplace
discipline”).
136
See Fox, supra note 19, at 1409
137
See id.
138
See id.
139
See Dodd-Frank § 929(P)(b) (describing extraterritorial jurisdiction for the “antifraud” provisions of the
33 & 34 Acts).
140
NYSE Euronext Website, Regulation, available at http://www.euronext.com/landing/regulation-12602EN.html#Regulatory_structure (visited July 23, 2011).
141
See id.
142
See id. See also generally Council Directive 2004/39/EC, Investment Services Directive – Markets in
Financial Instruments Directive.
143
See NYSE EURONEXT WEBSITE, supra note 140.
144
NYSE
Euronext
Website,
Non
Harmonized,
available
at
http://www.euronext.com/tools/documentation/wide/documents-2397-EN.html (visited July 23, 2011)
(listing non-harmonized regulations affecting the Euronext platform).
145
See e.g. Scott, supra note 16 at 220, 226 (discussing how EU securities regulation is based on mutual
recognition and areas of discrete harmonization with domestic enforcement); Luca Enriques & Matteo
19
however, after the 2008 Financial Crisis EU level regulatory authority has been
expanded. 146 Euronext is thus transnational in the sense of being a multinational
enterprise but is not the subject of transnational or international financial regulations
(other than EU regulations), making it similar to other multinational enterprises.
The character of securities exchanges does not create many information asymmetries
between the international space and the market. Markets close information asymmetries
through disclosure and through price information. Domestic lawmakers determine these
polices and make information readily available to all parties. Concerns do arise through
cross-border trading and international issuing but these are mostly enforcement issues.147
Issues surrounding the level of disclosure can be internalized by investors into the price
of the security. 148 Naturally, the availability of international listing and cross boarder
investing creates concerns about regulatory competition; however, because there is
almost no mutual recognition legislation outside of the EU, which has supra-national
directives to ensure standards, 149 a securities issuer must comply with host country
regulations when issuing publicly in a foreign country. Moreover, there are other
inhibitions on cross-border activity. The US has various restrictions such as the
prohibition on direct selling to US investors from outside the US, or even to US persons
situated outside of the US that abate some of these concerns. 150 This normally does not
apply to secondary market trading (re-sale), but there are lockout periods. 151
Lower disclosure is, however, not necessarily preferable to a company in all
circumstance. Lower cost of capital generally characterizes “better” disclosure, and
Gatti, Is there a Uniform EU Securities Law After the Financial Services Action Plan?, 14 STAN. J. L. BUS.
& FIN. 43, 48-51 (discussing harmonization strategies in EU cross-border securities transactions).
146
See Niamh Moloney, The European Securities and Markets Authority and Institutional Design for the
EU Financial Market –A Tale of Two Competences: Part (2) Rules in Action, 12 EUR. BUS. ORG, L. REV.
177, 192 (arguing new European Securities Market Authority [hereinafter ESMA] “supervisory powers”
are too broad and obstructing “local authorities.”). The ESMA also works a forum to aid domestic
supervisors in the uniform application of supervisions. See European Securities Market Authority Website,
About ESMA, available at http://www.esma.europa.eu/index.php?page=cesrinshort&mac=0&id= (visited
July 23, 2011). See also generally Niamh Moloney, The European Securities and Market Authority and
Institutional Design for the EU Financial Market – A Tale of Two Competences Part (1) Rule Making 12,
EUR. BUS. ORG. L. REV. 41 (2011) (discussing expanded EU institutional rulemaking through the new
European Securities Market Authority).
147
See Verdier, supra note 7, at 143 (discussing IOSOC successful MOU initiative). But see Jamil
Anderlini, Made in China Undone in America, FINANCIAL TIMES (July 26, 2011), available at
http://www.ft.com/intl/cms/s/0/a629b230-b2ae-11e0-bc28-00144feabdc0.html#axzz1TCBpmyJy ( visited
July 26, 2011) (discussing how Chinese companies are using “reverse takeovers” to get around many
securities reporting requirements to list in US capital markets).
148
See e.g. Romano, supra note 19, at 2421 (discussing how if investors do no prefer the disclosure level
of a particular jurisdiction they can discount the market). But see Trachtman, supra note 99, at 723 -4
(questioning market mechanism).
149
The EU functions on a system of harmonization and mutual recognition. See supra note 146. Directive
implementation is also important as substantial deviation could undermine the uniformity required to
replicate a unified capital market. See The Implementation of the EU Prospectus Directive –A Country-by
Country Analysis, 1 CAPITAL MARKETS L. J. 89 (Lachlan Burn ed. 2006). The US does not have mutual
recognition with the exception of the Canada. See Scott, supra note 16, at 150-6 (discussing multijurisdiction disclosure system (MJDS)). The US home country recognition system MJDS currently only
applies to Canada. See id. at 152. This is not a total recognition system only particular rules are recognized.
See id.
150
See 33 Act Regulation S, 17 C.F.R § 230.901-902 (2010).
151
See id., §§ 230.903-904.
20
markets with more disclosure tend to have lower cost of capital. 152 Likewise, the US
markets, which have strict disclosure rules, are thought to facilitate lower cost of capital
compared to other markets. 153 Cross-listing studies, which show higher price for foreign
equities listed on US and foreign exchanges simultaneously, support this proposition.
Part of this effect arises because analysts tend to give increased scrutiny to cross-listed
securities, suggesting positive results are partially because more information is coming
into the foreign market. 154 Cross-listing consequently offers evidence of information
asymmetries between the international space and domestic markets, as well as a cure for
those asymmetries by compelling foreign listed companies to meet higher US disclosure
standards. 155
Operational risk, the risk of nonpayment or non-transfer of the securities, is another
concern; however, clearing and settlement mechanism, most of which are large or
monopoly institutions, handle this risk for public securities markets. 156 These institutions
have significant connections to international financial intermediaries and foreign markets,
which helps facilitates cross-border trading, but also creates concerns the
interconnectedness and centrality of these institutions. 157 There are international
standards that address these solvency concern, but risk still lies in the general
effectiveness of standards and the quality of implementation. 158
Hence, in terms of public securities markets, the transaction of securities itself does not
create significant risks between the international space and domestic markets. The risks
here are in noncompliance with good governance standards or failure to enforce the rules.
There are market risks arising from inadequate disclosure, but quantity of information
relative to another jurisdiction is ascertainable by the investor, and markets that offer
poor disclosure can be discounted. 159 Private transactions create different risks, but the
problematic transactions are normally private derivatives trading and issuing. Risks that
are attendant to the private nature of certain securitization and derivative transactions
will be discussed in those parts below.
2.2.2
Securitization
Securitized products can be highly differentiated from one to another. As such, risks
associated with securitization manifested in various ways during the 2008 Financial
152
See Chiristian Leuz & Peter Wysocki, Economic Consequences of Financial Reporting and Disclosure
Regulation : A Review and Suggestions for Future Research 8-10 (Working Paper) (March 2008),
available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1105398 (visited July 24, 2011)
(discussing the economic consequences of disclosure).
153
See Peter Roosenboom & Mathijs A. Van Dijk, The Market reaction to Cross-listings: Does the
Destination Market Matter?, 33 J. BANKING AND FIN. 1898, 1903-4 (2009) (discussing market benefits for
companies to cross-list on major US exchanges).
154
See id., at 1904 (showing evidence that lower number of analysts following the listing before crosslisting in London will lead to higher return after cross-listing due to increased interest).
155
See id., at 1907.
156
See Scott, supra note 16, at 497-99 (discussing clearing and settlement systems).
157
See id., 513-19 (discussing international aspects of clearing and settlement systems). Cross-border
linkages are maintained by financial intermediaries to facilitate cross-border trading. See id., at 514.
158
See generally BIS Website, Standards for Clearing and Settlement Systems: Review by CPSS-IOSOC,
available at http://www.bis.org/press/p100202.htm (visited July 24, 2011).
159
Romano, supra note 19, at 2421. See also supra note 148.
21
Crisis, but there is nothing inherently flawed with securitization. Its advent in the 1960s
& 1970s allowed for new kinds of liquidity that benefited the economy. 160 However,
since then poor regulatory policy and a disregard for market-based risk pricing in favor
of internal pricing by intermediaries caused many of these securities to become toxic.161
Scholars generally believe that originators of securitized products created products that
masked risk to the originating intermediary but did not actually spread risk or remove it
from the intermediaries’ balance sheet. 162 In turn, capital requirements remained too low
to mitigate such risk. 163 Combined with government or other derivatives-based
guarantees (swaps) against risk, this created a decline in standards for origination of the
underlying assets namely home mortgages. 164
Governments and regulators chronicle their own failure in some of the reforms that
follow the 2008 Financial Crisis. 165 The failure of risk pricing for securitization markets
shows that lawmakers must conceptually set self-discipline of intermediaries against
incentives for higher profitability and realize the higher profitability will usually trump
prudential behavior where markets legally permit. 166 If governments allow intermediaries
to price risk internally, and in turn remove this function from efficient markets, they
160
See e.g. Christopher W. Frost, Asset Securitization and Corporate Risk Allocation, 72 TUL. L. REV. 101,
104-50 (1998) (explaining new sources of liquidity available to corporation because of securitization);
Kenneth W. Dam, The Subprime Crisis and Financial Regulation: International and Comparative
Perspective, 10 CHI J. INT’L L. 581, 622-3 (2010) (highlighting positive aspects of securitization).
161
See McCoy, Pavlov & Wachter, supra note 23, at 498-9 (describing how lax regulatory policies caused
a failure in risk pricing for securitized products).
162
See Acharya, Schnabl & Suarez, supra note 28, at 1, 33 (discussing original impetus of securitization to
transfer risk and describing how during the 2008 Financial Crisis this did not happen).
163
See id. See also Acharya, Cooley, Richardson & Walter, supra note 27, at 184, 475-6 (discussing
regulatory arbitrage).
164
See McCoy, Pavlov & Wachter, supra note 23, at 523, 536 (discussing how CDS exacerbated failure of
risk pricing). “CDS issuers were under little scrutiny by regulators and were not required to post reserves
against the CDS they issued if they were AAA rated.” Id.; Acharya, Cooley, Richardson & Walter, supra
note 27, at 475 (discussing how participants in securitized products benefited from solvency guarantees by
the US government thus distorting incentives); Maddaloni & Peydro, supra note 53, at 28 (discussing
causes of decrease in lending standards as being result of low real and nominal lending standards as well as
poor bank supervisions).
165
The Dodd-Frank act addresses securitization in a few ways. It applies the “skin in the game” theory
making originators of securitized products retain a portion of the credit-risk on their balance sheets. See
Dodd-Frank § 941(b)(1). In turn, this is through harmonize incentives between originators and investors.
See e.g. CCH ATTORNEY-EDITOR STAFF, DODD FRANK WALL STREET REFORM AND CONSUMER
PROTECTION ACT LAW, EXPLANATION AND ANALYSIS 410 (2010) (citing S. REP. NO. 111-176, at 31-2
(2010)) [hereinafter CCH DODD-FRANK]. But see Acharya, Cooley, Richardson & Walter, supra note 27, at
479 (“To our knowledge, however, there has been no empirical study of the extent to which securitizers
had skin in the game. The legislation there may be based on false premise…”). The second method is
through disclosure. See Dodd-Frank § 942(b) (amending 33 Act, § 77g(c) (describing modification to
Securities Act that will require disclosures about “asset-level or loan-level” data)).
166
See Acharya & Schnabl, supra note 78, 67-8 (discussing bank incentives for securitization as “free[ing]
up costly equity capital that banks could deploy elsewhere… banks no longer collected revenues from
holding and managing risk, thus operating at weaker margins in their traditional business. As a result,
banks started to explore how to reduce capital requirements while still earningcompensation for holding
risk.”); Acharya, Schnabl & Suarez, supra note 28, at 35 (finding ABCP would not have been profitable in
required to hold capital against the investment). See also McCoy, Pavlov & Wachter, supra note 23, at 525
(discussing how SEC allowed large banks to use internal risk pricing models). See also Arteta, Carey,
Correa & Kotter, supra note 81, at 25 (finding evidence that lack of large shareholder incentivized bank
sponsorship of ABCP conduits because of increased demand for profitability even though risks were not
understood).
22
must supplement this with detained prudential standards. 167 The problem with this is that
it requires regulators to be constantly one-step ahead of the market-makers something
that may essentially be impossible, 168 especially considering intermediary lobbying
power. 169 A more efficient approach may be to institute policies that guarantee
intermediaries expose risks to the market so that they cannot under price risk to expand
profitability. 170
McCoy illustrates how this problem manifested in the 2008 Financial Crisis in the
relationship between intermediary-created (“Private-Label”) securitized products and
Credit Default Swaps (CDS). 171 Private-label securitized US home mortgages were
internally unique products such that they were illiquid to the point that risk pricing
became difficult and thus set by intermediaries. 172 To compound the problem sellers of
credit protection issued CDSs, which could have helped risk pricing of securitized
mortgages, under non-prudential standards. 173 Consequently, this exacerbated the
problem by offering buyers of protection the illusion that the securitized investment was
guaranteed against default by the swap. 174 Hence, regulators permitted financial
intermediaries to construct the risk to benefit their own profitability. 175 When this
happens, intermediaries are incentivized to risky behavior believing that the government
or other credit protection instruments are guaranteeing their interests. 176 Investors may
reinforce this behavior to the extent they do not stand to lose greatly from banks
insolvencies. 177 This is a closed regulatory system. 178
167
See Acharya, Cooley, Richardson & Walter, supra note 27, at 184, 476-7, 482-3 (discussing how
securitization regulation exists in trade-off between aligning incentives and regulatory arbitrage).
168
See Charnovitz, supra note 31, at 748-9 (discussing how there is no reasons to expect new regulatory
structures will be able to stay ahead of intermediaries on systematic risk better than the previous
structures).
169
See Tom Braithwaite & Aline Van Duyn, Regulatory Reform a Disappearing Act, FINANCIAL TIMES (
July
20,
2011),
available
at
http://www.ft.com/intl/cms/s/0/9c61755a-b2c0-11e0-bc2800144feabdc0.html#axzz1TTGF9P54 (visited July 29, 2011). (discussing continuing shortfalls in DoddFrank’s implementation). See also Trachtman, supra note 99, at 732 (noting “experience of states engaging
in competitive reductions of capital requirements in order to promote their own financial services firms.”).
170
See e.g. Charnovitz, supra note 31, at 749 (criticizing regulatory management of systematic risk);
Acharya, Cooley, Richardson & Walter, supra note 27, at 475 (citing literature showing banks had a
“tend[ancy] to hold on to the good loans and sell off the poor quality ones.”); Antje Berndt & Anurga
Gupta, Moral Hazard and Adverse Selection in the Originate-to-Distribute Model of Bank Credit, 56 J.
MONETARY ECON. 725, 726-7 (2009) (suggesting fixes for the fact that syndicated loans may comprise
underlying assets that banks know are bad due to their superior information position). The authors suggest
various information fixes such as, “retaining a portion of the loans on their balance sheet,” “additional
disclosure requirements,” and “loan trading exchange or clearinghouse.” Id., at 727.
171
McCoy, Pavlov & Wachter, supra note 23, at 536
172
Id., at 535-6 (describing relationship between MBS and CDS in relation to 2008 Financial Crisis).
173
Id., at 529, 535-6.
174
Id., at 536 (discussing how protection against default was consequently too cheap and this prevented
adjustment in prices of securitized products from being adjusted through the price of credit protection).
175
See id., at 537. See also Acharya & Schnabl, supra note 78, at 45-6 (discussing how ABCP was
structured for lower capital charges).
176
See Arteta, Carey, Correa & Kotter, supra note 81, at 20-21 (finding government guarantees to be a
factor in a bank’s decision to sponsor ABCP conduits); Acharya, Cooley, Richardson & Walter, supra note
27 , at 475-6.
177
See Arteta, Carey, Correa & Kotter, supra note 81, at 25. Cf. also Andrea Beltratti & Rene M. Stulz,
Why did Some Banks Perform Better During the Credit Crisis? A Cross-Country Study of the Impact of
Governance and Regulation, 3 (Eur. Corp. Gov. Working Paper No. 254/2009) (finding that “banks that
were more shareholder friendly performed worse during the crisis”), available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1433502 (visited October 10, 2011).
23
Investors and counterparties can be set up to play a role in risk pricing but this is
difficulty because many of these activities occur are off balance sheet. 179 To do this,
investors in these intermediaries in a sense must look through to the every-day business
operations of the company, which is more difficult than looking facially at the financials,
and additionally they may simply not have access to this information. Congruently, many
cited weak accounting practices that cosmetically hid the riskiness of intermediaries as
one of the causes 2008 Financial Crisis. 180 Another failure, however, is that information
transmission mechanisms simply did not exist, or regulations incorporated interested
information transmission mechanism like rating agencies into the regulations. 181 This
outsourced their own regulatory function and created a closed information system
between regulators and intermediaries, marking the market impotent. 182
Poor securitization regulations also exacerbated international contagion owning to the
international quality of the 2008 Crisis. 183 This is the case of Asset Backed Commercial
Paper (ABCP) conduits as outlined by Acharya and Schnabal. 184 ABCP conduits were
investment vehicles set up by leading banks to securitize long-term debt and issue short
term financing against it. 185 “As long as banks are solvent, conduits [were] risk-free for
outside investors but… generate[d] significant risks for banks. In exchange for bearing
these risks, banks…[had] access to low-cost funding via asset backed commercial paper
market.” 186 Significant banks in all major financial centers had ABCP conduits tied to
the US mortgage market. 187 When the bubble burst, the resulting global economic
downturn was not due to simple contagion, rather direct losses by foreign intermediaries
in the US market caused foreign intermediaries to fail. 188 According to Acharya and
Schnabal contagion was a function of the ability to create such securitized products
178
To distinguish by closed regulatory system the paper means a system where markets are denied
information about intermediaries or their transactions. It is not necessary the same as the “skin in the
game.” See supra note 165. Rather closed regulatory system refers to where markets are unable to make
assessments because of regulatory policy. For example, off balance sheet rules accounting, and regulatory
arbitrage. See generally Acharya, Schnabl & Suarez, supra note 28. Or allowing ratings agencies to do risk
pricing. See McCoy, Pavlov & Wachter, supra note 23 at 536; Langevoort, supra note 38, at 810.
179
See McCoy, Pavlov & Wachter, supra note 23, at 524, 532 (noting markets could have been set up to
price risk with proper regulation). See also e.g. FCIC REPORT, supra note 26, at XX (discussing off
balance sheet accounting).
180
See e.g. FCIC REPROT, supra note 26, at 227 (discussing pros and cons of “mark-to-market”
accounting).
181
See Langevoort, supra note 38, at 810 (“The assumption seems to have been that credit rating agencies
were vetting that data, not individual buyers, and that ratings were reliable.”).
182
See id.
183
See generally Acharya & Schnabl, supra note 78 (discussing ABCP conduits). ABCP is both a form of
“shadow banking” and securitization. See id., at 42.
184
See id., at 38. “Conduits are forms of securitization in which banks use off-balance sheet vehicles to
purchase long-term and medium-term assets financed with short-term debt. However, contrary to other
forms of securitization, such as mortgage-backed securities or collateralized debt obligations, banks
effectively keep the credit risk associated with the conduit assets.” Id.
185
Id.
186
Id.
187
See id., at 48-9 (“[i]t was lax financial sector regulation in a world with global banking that contributed
to the fully global nature of the crisis right from its inception. In particular,…weakly regulated financial
sectors – of both capital surplus and deficit countries – expanded rapidly by taking in capital flows into the
United States and creating assets there.”).
188
See id., at 41
24
combined with weak prudential standards to govern the products. 189 The finding is
significant because it points to the transactional-structural elements that exacerbated
economic downturn into crisis as opposed to macro-economic ones. 190 As the authors go
on to point out these, and similar instruments, are par for securitized products and can
come in many iterations. 191
Thus, the risks associated with securitization, apart from lying in the institutions that
structure them, is in not knowing the extent of the securitized products effects.
Regulators handle this by classifying these assets according to the Basel rules and
requiring capital charges against them. 192 Where these charges are inaccurate there is
essentially a regulatory failure that leaves markets with little ability to ascertain the
riskiness of these products. 193 In the case of ABCP, intermediaries designed these
securities to consolidate risk in the institution, and evidence suggests they performed this
function causing widespread global bank insolvencies. 194 Ergo, the information
requirement for certain types of securitization is inherently vested in the risk
guarantor. 195 Regulators must acknowledge this incentives calculus because
counterparties will not discipline where they take no risk. 196 In turn, shareholders of the
intermediary need to perform this function directly if regulators do not. Other securitized
products will affect investors directly in terms of their own risk apatite. Considering this
there is no single method for regulation for securitization. Nor is there any one set of
risks other than the risk of opacity or failure of the product. Regulators must in turn
communicate relevant information regarding intermediaries to help control when the
intermediary is unwisely or secretly betting its soundness against shareholder preferences
for profitability. While those securitized instruments that affect investors directly will
have to communicate information that reveals the underlying nature of the product. 197
2.2.3
Over the Counter (OTC) Derivatives
OTC derivatives are the pariah of the 2008 Financial Crisis. 198 Swaps in particular
engender a large amount of scorn from the public and amongst the various kinds of
189
Id., at 69-70.
See id.
191
Id., at 69 (noting that similar motivations that drove the ABCP market may have driven MBS and CDO
investments).
192
See id., at 49, 53 (discussing varying national regulations, based on Basel rules, regarding ABCP
conduits as “liquidity enhancements.”). ABCP were structured to be liquidity enhancements. See id., at 49.
A liquidity enhancement is a conditional guarantee to pay investors so long as the underlying assets of the
conduit were not delinquent. See id. Delinquency was defined so that it was highly unlikely to trigger nonpayment to investors. See id.
193
See McCoy, Pavlov & Wachter, supra note 23, at 498.
194
See Acharya & Schnabl, supra note 78.See also Acharya, Schnabl & Suarez, supra note 28, at 32
(finding most losses in ABCP were to banks not investors).
195
Cf. Acharya, Schnabl & Suarez, supra note 28, at 33 (“find[ing] that stock returns were lower for banks
with higher conduit exposure.”). The authors also note that the results are not severe because “investors
may have underestimated at first the severity of the downturn or may not have been fully aware of the
(relatively opaque) credit guarantees provided to conduits.” Id., at 34.
196
See Acharya & Schnabl, supra note 78.
197
See Acharya, Cooley, Richardson & Walter, supra note 27, at 482 (discussing both need for more
information and way to make that information effective); Dodd-Frank §942(b) (amending 33 Act, §
77(g)(c) (delimitating information disclosure requirements for securitization)).
198
See e.g. FCIC REPORT, supra note 26, at XXIV
190
25
swaps CDSs occupies a distinct echelon. Generally, the OTC market falls into three
branches. 199
The first, the bilateral OTC market, is a fully decentralized market in which participants
trade – and clear their trades – directly with one another. The second is an OTC market
with decentralized trading but with centralized clearing through [central counterparties]
CCP. In the third type, an exchange-based market, both trading and clearing are
centralized through an exchange that is typically linked to a CCP. 200
OTC derivatives created many opacity problems during the 2008 Financial Crisis. 201 The
level of opacity scaled with the method of trade. Hence, the US response will require
central clearing for many OTC derivatives attempting to limit this fist kind of market.202
Financial intermediaries are generally bound to the clearing requirement. 203 Moreover,
new regulatory reforms in the US will increase information requirements for OTC, even
if not centrally cleared. 204 On the international-level, there are strong and rapidly
progressing efforts to put information about OTC products onto Trade Repositories
(TR). 205
Derivatives can act as important risk pricing mechanisms. 206 In this regard, quality of
information is important, and whereas the US and other jurisdictions are moving in this
direction, some are falling behind. 207 Information from some sources may by
inconsistent and thus impossible to compare, 208 which does little to either rectify
problems that arose during the 2008 Financial Crisis or allow markets to assess risk for
199
See Stephen G. Cecchetti, Jacob Gyntelberg & Marc Hollanders, Central Counterparties for Over-thecounter Derivatives 47, BIS QUARTERLY REVIEW (September 2008), available at
http://ssrn.com/abstract=1472960 (visited July 9, 2011).
200
Id.
201
See id., at 50-52. See also e.g. McCoy, Pavlov & Wachter, supra note 23, at 529.
“Most CDS are traded over-the-counter and no on an exchange . This means that each CDS is the product
of private negotiation between two parties, usually with a dealer in-between. In each transaction, the buyer
depends on the credit quality of the seller for assurance of protection. The buyer, however does not know
how much total CDS exposure the seller has assumed. Similarly, the buyer does not know if the seller has
bought protection from someone else to defray its CDS obligation to the buyer. Furthermore, the buyer
does not know whether that someone else is good for the money. An unlike insurance, CDS are not backed
by statutorily mandated reserves or government guaranties…”
202
See Dodd-Frank, § 723(a)(3) (amending Commodities Exchange Act, 7 U.S.C. §2(h) (making swaps
which are not centrally cleared illegal)).
203
See id., § 723(a) (amending 7 U.S.C. §2(h)(7)(A)(i)-(iii) (exempting “[non -]financial entities,” swaps
used for “hedg[ing]…commercial risk”, or, upon notification, otherwise justifiable swaps from the central
clearing requirement).
204
See id., § 727 (amending 7 U.S.C §2(a)(13) (outlining public disclosure rules for swap transactions
irrespective of clearing); Acharya, Cooley, Richardson & Walter, supra note 27, at 373.
205
For a discussion of international efforts towards mandatory swap data repositories see infra notes 368377 and accompanying text. See also Dodd-Frank § 728 (amending 7 U.S.C. §24(21)(a) (requiring all
swap transaction to be reported to swap data repository)
206
See supra note 164. See also Scott, supra note 16, at 780; Scott, supra note 96, at 774-6.
207
See FSB Derivatives Progress Report, supra note 25 at 6, 15 (expressing concern about the disparity of
implementation regarding Trade Repositories (TR) between various jurisdictions). See also Acharya,
Cooley, Richardson & Walter, supra note 27, at 380 (discussing US transparency regulations for OTC
derivatives).
208
See FSB Derivatives Progress Report, supra note 25, at 6-7 (noting inconsistent levels or progress
regarding, data collection, substantive data standards, and data dissemination).
26
products that reach beyond borders. The disparity between various jurisdictions may
come to a point where US regulators would push rules beyond its borders in lieu of
rendering these regulations ineffective. 209 For example, proposed EU OTC reforms do
not include the same rules as the US as regards new execution facilities, market making,
or restrictions on banking enterprises engaging in OTC transactions. 210 Not to suggest
that one policy is better than the other is, but this is an example of the political problems
that exist in financial regulation. 211 Consequently, regulators are liable to apply these
rules extraterritorially as is the case with public securities markets. 212
Substantive information standards also remain politically contentious between
jurisdictions. 213 The move to global TR 214 reflects the belief that transparency is possibly
an optimal enforcement strategy for OTC products. 215 However, this is contingent on the
ability compare data sets across countries. 216 Meaning such requirements are essentially
meaningless if countries cannot agree. Moreover, domestic public disclosures can be
limited to aggregate information of market level data, which may keep individual
investors, who are concerned with firm-level aggregation, outside the regulatory loop. 217
That said, market discipline is not the only benefit derived from transparency. So long as
information reaches relevant counterparties, risk pricing can be improved. 218 In this
respect, scholars also note it may be sufficient to compel transparency of already existing,
albeit traditionally non-public, information. 219 Meaning the marginal increase in costs to
additional disclosure to these firms would be minimal 220 while providing benefit to the
market, counterparties, or regulators.
Conclusively, the risk of opacity is prodigious but this can be offset with central clearing
and TRs. However, fixed standards imply the risk of regulatory failure or noncooperation,
which given the extremely international nature of these products seems high. 221 Market
209
See Dodd-Frank § 738. As well as restriction on participating in foreign boards that have “linked
contracts” with the US unless the foreign board meets certain minimum standards. See id. See also
Acharya, Cooley, Richardson & Walter, supra note 27, at 376. The regulation allows the CFTC to set other
requirements for the foreign board. Cf. Dodd-Frank, § 738 (amending 7 U.S.C. 6(b) (allowing CFTC to
require “registration…for a foreign board of trade” that has members or allows access to US participants).
210
See Financial Regulator Reform: The International Context, Hearing Before H. Comm. on Financial
Services, 112th Cong. 5-8 (Testimony Mr. Stephen O’Connor Managing Dir., Morgan Stanley &
Chairman,
Int’l
Swaps
and
Derivatives
Assoc.),
available
at
http://financialservices.house.gov/UploadedFiles/061611oconnor.pdf (visited July 31, 2011).
211
Cf. id.
212
See supra notes 147-151 and accompanying text.
213
See FSB Derivatives Progress Report, supra note 25, at 7 (expressing concern over non-uniform
substantive disclosure standards).
214
See Financial Stability Board Implementing OTC Derivatives Market Reforms 6-7 (October 25, 2010),
available at http://www.financialstabilityboard.org/publications/r_101025.pdf (July 20, 2011) [hereinafter
FSB OTC Derivatives Oct 2010] (discussing the need for TR). For a detailed discussion of the move
toward global TR repositories see infra notes 362- 379 and accompanying text.
215
See Acharya, Cooley, Richardson & Walter, supra note 27, at 391 (discussing advantages of
transparency over margin requirements).
216
See FSB Derivatives Progress Report, supra note 25, at 7.
217
See Acharya, Cooley, Richardson & Walter, supra note 27, at 380 (discussing possible improvements to
OTC disclosure requirements and noting the need for “institutional level aggregation”).
218
See id.
219
Id., at 391
220
Id., at 391-2.
221
See supra notes 207- 211 and accompanying text.
27
restructuring to resemble public securities market may cabin some of these information
risks at least in terms of preventing counterparty risk. 222 Additionally, international
information cooperation in this area is proceeding through the implementation of TR.223
However, domestic jurisdictions must still compel their swaps participants to report to
the TR or intermediaries must view reporting in their interest. 224
2.3 Internationally Recognized Information Asymmetries
The following is a summary and analysis of parts of two joint reports by the FSB and
IMF highlight some of the information risks that the international financial architecture
is currently attempting to solve. 225 The reports focuses on substantive risks and risk
investigation more so than specifically how to solve those risks, although they highlight
various current initiatives. Following the 2008 Financial Crisis the FSB made twenty
recommendations, subsequently endorsed by the G20, for closing “information gaps”
that exacerbated the 2008 Financial Crisis. 226 To that end, the report recognizes that
222
See supra notes 134-138, 200-204 and accompanying text.
See infra Part 3.1.1.
224
For a discussion of TR implementation see infra notes 362-377 and accompanying text. For a
discussion of intermediary motivations to self-report information see infra notes 433- 439 and
accompanying text.
225
See generally FSB Info Oct 29, 2009, supra note 52; FSB Information Gaps, supra note 21 (providing
an update on implementation of FSB Info Oct. 29 2009).
226
See FSB Info Oct 29, 2009, supra note 52 at 6-8. “Recommendation # 1” address further administrative
work towards solving the asymmetries the nineteen substantive recommendations are as follows
223
Monitoring Risk in the Financial Sector
(2) The IMF to work on increasing the number of countries disseminating Financial Soundness
Indicators (FSIs), including expanding country coverage to encompass all G20 members, and on
other improvements to the FSI website, including preferably quarterly reporting. FSI list to be
reviewed.
(3) In consultation with national authorities, and drawing on the Financial Soundness Indicators
Compilation Guide, the IMF to investigate, develop, and encourage implementation of standard
measures that can provide information on tail risks, concentrations, variations in distributions, and
the volatility of indicators over time.
(4) Further investigation of the measures of system-wide macroprudential risk to be undertaken by
the international community. As a first step, the BIS and the IMF should complete their work on
developing measures of aggregate leverage and maturity mismatches in the financial system,
drawing on inputs from the Committee on the Global Financial System (CGFS) and the Basel
Committee on Banking Supervision (BCBS).
(5) The CGFS and the BIS to undertake further work in close cooperation with central banks and
regulators on the coverage of statistics on the credit default swap markets for the purpose of
improving understanding of risk transfers within this market.
(6) Securities market regulators working through IOSCO to further investigate the disclosure
requirements for complex structured products, including public disclosure requirements for financial
reporting purposes, and make recommendations for additional improvements if necessary, taking
account of work by supervisors and other relevant bodies.
(7) Central banks and, where relevant, statistical offices, particularly those of the G20 economies, to
participate in the BIS data collection on securities and contribute to the further development of the
BIS-ECB-IMF Handbook on Securities Statistics (Handbook). The Working Group on Securities
Databases to develop and implement a communications strategy for the Handbook.
International Network Connections
(8) The FSB to investigate the possibility of improved collection and sharing of information on
linkages between individual financial institutions, including through supervisory college
arrangements and the information exchange being considered for crisis management planning. This
28
“[w]hile the financial crisis was not the result of a lack of proper economic and financial
work must take due account of the important confidentiality and legal issues that are raised, and
existing information sharing arrangements among supervisors.
(9) The FSB, in close consultation with the IMF, to convene relevant central banks, national
supervisors, and other international financial institutions, to develop by end 2010 a common draft
template for systemically important global financial institutions for the purpose of better
understanding the exposures of these institutions to different financial sectors and national markets.
This work should be undertaken in concert with related work on the systemic importance of financial
institutions. Widespread consultation would be needed, and due account taken of confidentiality
rules, before any reporting framework can be implemented.
(10) All G20 economies are encouraged to participate in the IMF’s Coordinated Portfolio Investment
Survey (CPIS) and in the BIS’s International Banking Statistics (IBS). The IMF and the BIS are
encouraged to continue their work to improve the coverage of significant financial centers in the
CPIS and IBS, respectively.
(11) The BIS and the CGFS to consider, amongst other improvements, the separate identification of
nonbank financial institutions in the consolidated banking data, as well as information required to
track funding patterns in the international financial system. The IMF, in consultation with the IMF’s
Committee on Balance of Payments Statistics, to strive to enhance the frequency and timeliness of
the CPIS data, and consider other possible enhancements, such as the institutional sector of the
foreign debtor.
(12) The IMF to continue to work with countries to increase the number of International Investment
Position (IIP) reporting countries, as well as the quarterly reporting of IIP data. The Balance of
Payments and International Investment Position Manual, sixth edition (BPM6) enhancements to the
IIP should be adopted by G20 economies as soon as feasible.
(13) The Interagency Group on Economic and Financial Statistics (IAG) to investigate the issue of
monitoring and measuring cross-border, including foreign exchange derivative, exposures of
nonfinancial, and financial, corporations with the intention of promoting reporting guidance and the
dissemination of data.
(14) The IAG, consulting with the FSB, to revisit the recommendation of the G-22 to examine the
feasibility of developing a standardized template covering the international exposures of large
nonbank financial institutions, drawing on the experience with the BIS’s IBS data, other existing and
prospective data sources, and consulting with relevant stakeholders.
Sectoral and Other Financial and Economic Datasets
(15) The IAG, which includes all agencies represented in the Inter-Secretariat Working Group on
National Accounts, to develop a strategy to promote the compilation and dissemination of the
balance sheet approach (BSA), flow of funds, and sectoral data more generally, starting with the G20
economies. Data on nonbank financial institutions should be a particular priority. The experience of
the ECB and Eurostat within Europe and the OECD should be drawn upon. In the medium term,
including more sectoral balance sheet data in the data categories of the Special Data Dissemination
Standard could be considered.
(16) As the recommended improvements to data sources and categories are implemented, statistical
experts to seek to compile distributional information (such as ranges and quartile information)
alongside aggregate figures, wherever this is relevant. The IAG is encouraged to promote production
and dissemination of these data in a frequent and timely manner. The OECD is encouraged to
continue in its efforts to link national accounts data with distributional information.
(17) The IMF to promote timely and cross-country standardized and comparable government finance
data based on the accepted international standard, the Government Finance Statistics Manual 2001.
(18) The World Bank, in coordination with the IMF, and consulting with the Inter-Agency Task
Force on Finance Statistics, to launch the public sector debt database in 2010.
(19) The Inter-Secretariat Working Group on Price Statistics to complete the planned handbook on
real estate price indices. The BIS and member central banks to investigate dissemination on the BIS
website of publicly available data on real estate prices. The IAG to consider including real estate
prices (residential and commercial) in the Principal Global Indicators (PGI) website.
Communication of Official Statistics
(20) The G20 economies to support enhancement of the Principal Global Indicators website, and close the
gaps in the availability of their national data. The IAG should consider making longer runs of historical
data available. (reformatted).
29
statistics, it exposed a significant lack of information as well as data gaps on key
financial sector vulnerabilities relevant for financial stability analysis.” 227 In this way,
there is a tacit understanding that the problem does not lay so much in what information
is present but where and to whom that information should go.
In turn, the report consolidates the need to improve information in three broader areas. 228
These areas are “[t]he build-up of risk in the financial sector,” [c]ross-border financial
linkages,” and “[v]ulnerability of domestic economies to shocks.” 229 The first category
address risks related to intermediaries in their own proprietary activities. 230 Moreover,
the risks associated with non-regulation of those activities, 231 such as securitization as
well as OTC derivatives. The second recommendation addresses counterparty risk. 232
Specifically, how swaps counterparties during the financial crisis exposed themselves to
the same triggering event forcing the other counterparty to default. 233 Finally the last area,
addresses “[d]ata availability to monitor the behavior and exposure of economic agents
within the domestic economy.” 234
The recommendations themselves are broad mandates to the international financial
architecture to work on various iterations of the information asymmetry problem in the
three areas listed above. As such, they themselves do not do much to identify risk.
However, FSB categorized them and their potential responses into four categories: “[1]
monitoring risk in the financial sector, [2] international network connections; [3]
sectorial and other financial and economic datasets; and [4] communication of official
statistics.” 235 The reporters then go on to illustrate some of the tangible risks that these
recommendations seek to address.
The first category focuses on what information is required and identifying indicators that
may tip off regulators to problems before they exacerbate into a crisis. 236 It seems the
FSB is concerned primarily with macro indicators and macro-level monitoring. 237
Positively, however, the notes to “recommendation # 2” acknowledge that data needs to
go beyond pure macroeconomic indicators. 238 Macro indicators are necessary but many
data sets are already widely available and in addition to this kind of data, the information
that domestic markets would need to price risk for individual transactions will pertain to
those products and companies specifically, as well as the interconnection between those
227
Id., at 9.
See id.
229
Id., at 10.
230
See id.
231
See id.
232
See id.
233
See id.
234
Id.
235
Id., at 13.
236
See id.
237
See id.
238
See id., at 14 (discussing tail risks). The idea of a tail risk is that an event has a higher probability of
moving “more than three standards deviations from the means greater than what is shown by a normal
distribution.” Investopedia, Tail Risk, available at http://www.investopedia.com/terms/t/tailrisk.asp
(visited July 18, 2011).
228
30
companies and products. 239 In this sense, the nature of the data is more useful for
domestic regulators that are concerned with imbalances that may harm the system.
Despite the general state-to-state focus, specific transactions do not escape the FSB and
IMF. The report mentions four specific risks, related to financial products and
transactions, and associated with lack of information namely : “[f]unding and liquidity
risk”, 240 “[c]redit [r]isk [t]ransfer [i]nstruments” 241 , “[s]tructured [p]roducts” 242 , and
“[s]ecurities and [s]ecuritization.” 243 In regards to the latter two transaction-classes, the
FSB and IMF recommend improved systems for transmitting information directly to the
market. 244 In contrast, for “funding and liquidity risk” the recommendation specifically
points out regulators as the target of the disclosures. 245 For “credit transfer instruments”
the report does not specify say who the target of the information is. 246 The descriptions
focus on data collection, through data mining, and inter-regulator cooperation. 247 In turn,
it seems to be geared towards regulators, at least to the degree data mining reaches either
non-public information, or macro indicators.
239
See FINANCIAL STABILITY BOARD PEER REVIEW REPORT, THEMATIC REVIEW ON RISK DISCLOSURE
PRACTICES 21-2 (March 18, 2011) [hereinafter FSB Thematic Risk Disclosure] (discussing risk disclosure
practices for securitization). BCBS identified securitization “disclosure requirements in…six areas…” all
of which have implications for intermediaries. See id., at 24-5 (“(i)[s]ecuritisation exposures in the trading
book; (ii) [s]ponsorship of off-balance sheet vehicles; (iii)[i]nternal Assessment Approach and other ABCP
liquidity facilities; (iv) [r]e-securitisation exposures; (v) [v]aluation with regard to securitisation exposures;
and (vi) [p]ipeline and warehousing risks with regard to securitisation exposures.”) . There are also more
generalized recommendations for intermediary level risk disclosures such as “timeliness” and the
“meaningful[ness] of information.” See id., at 33. In this respect, there is an understanding of a greater
need for guidance on “[t]he level of disaggregation (or granularity) at which risk disclosures need to be
provided…” as well as the need for “comparability.” Id. (emphasis omitted); cf. Technical Committee of
the International Organization of Securities Commissions , Disclosure Princeiples for Public Offerings and
Listings of Asset-Backed Securities at §§IV-X (June 2009) [hereinafter IOSCO disclosure on ABS],
available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD296.pdf (visited July 19, 2011)
(describing good substantive disclosure standards for securitization regarding the nature of the assets and
their relationship with the securitized product); supra notes 164, 166, 186, 170, 194 (discussing
information failures for risk pricing in various contexts of securitization, mostly arising from risk
guarantees that disincentivized due diligence). See also Acharya, Cooley, Richardson & Walter, supra note
27, at 380, 391-4 (advocating aggregation on the intermediary level for OTC products); Cecchetti, supra
note 199, at 51 (advocating for more information on “exposure levels or the nature of counterparties”);
supra note 213. See also Marco A. Espinosa-Vega & Juan Sole, Cross Border Financial Surveillance: A
Network Perspective 3 (IMF Working Paper No. WP/10/105) (discussing need to evaluate
interconnectedness of financial intermediaries).
240
See FSB Info Oct 29, 2009, supra note 52, at 15 (discussing risk associated with authorities not having
information regarding “leverage and…maturity mismatches”). Liquidity risk is “[t]he risk that markets will
not exist for certain transactions or that they can only be executed with delay and wide margins.” OXFORD
DICTIONARY OF FINANCE AND BANKING 263 (4th ed. 2008).
241
See FSB Info Oct 29, 2009, supra note 52, at 15 (discussing risks associated with OTC derivatives
particularly “cross-border exposures related to CDS and CDS statistics”).
242
See id., at 15-16 (discussing need for banks to disclose risks of complex products to markets).
243
See id., at 16-17.
244
See id., at 15-17. As to “structured products” the report states, “…it is important for risk disclosures to
continue to be sufficiently informative and relevant to investors and market participants as to the overall
exposures of these institutions to troubled asset classes based on the market conditions at the time of
disclosure.” Id., at 16. For “securities and securitization” the report notes a “BIS…project to improve its
published domestic and international securities statistics…” and recently published data on “relevant
aggregate European and US data for securitization markets.”
245
See id., at 14-15.
246
See id., at 15.
247
See id., at 15.
31
The second category is about intermediaries; a few things are notable in respect to
allowing markets to price the risk of those intermediaries. First, the recommendations
explicitly acknowledge the need for possible institutional restructuring in this area. 248
This conceptual body would have a data management function to help assess the
instrumental nature of certain financial intermediaries as they operate across borders. 249
Second, it stresses the need to consider the international positions of domestic firms. 250
Finally, the need to publish data on non-bank enterprises such as investment banks and
hedge funds operating across borders. 251 Although this is an intermediary focused
regulation – as was seen in Part 2.2 above – it sometimes impossible to bifurcate the
effect of intermediaries on information asymmetries. 252 For these kinds of transactions,
like ABCP, firm specific markets disclosures, may be a more meaningful to cure
information asymmetries than aggregate transaction data. 253 To that extent, clarity in this
area will aid the international financial systems and will help cure information
asymmetries between the international space and the market. Alternatively, the
information can help regulators but this places a greater burden on them to withstand
political pressure.
The third category deals with the financial sectors implications on the physical
economy. 254 Specifically, it acknowledges how non-financial elements of economies
effect financial stability. 255 Moreover, this part brings to light some of the problems
associated with government financial data, especially as concerns fiscal deficits. 256 In
light of some of the fallout related to the crisis, the central problem for many policy
makers is the effect that imprudent portfolio activities have on the health of non-financial
sector companies due to their more visible relationship with underlying aspects of the
economy, such as jobs. Or, in a regulatory sense, with companies using mechanisms to
borrow money while hiding their ability to repay. 257 Fiscal deficits, especially to the
extent that financial products can hide those deficits are relevant to foreign and global
policy makers, particularly in the European context, where they can help stability by
making currency less volatile and easing skepticism about the Euro. Additionally, this
information may help in improving accuracy in country-level balance sheets. For
example, China may currently be buying dollar reserves through unnamed intermediaries
to disguise the level of its dollar exposure. 258
248
See id., at 19.
See id.
250
See id., at 18-19.
251
See id., at 22. This area pays particular attention to the need of intermediary and financial product data.
See id.
252
See supra notes 162-164, 171- 178, 183-191and accompanying text, discussing Private Label ABS and
ABCP.
253
See Acharya & Schnabl, supra note 78 (discussing how ABCP was designed to centralize risk onto
intermediaries).
254
See id., at 23.
255
See id., at 23.
256
See id., at 24-25.
257
See FSB Information Gaps, supra note 21, at 15.
258
See David Barboza, China's Treasury Holdings Make U.S. Woes Its Own, NY TIMES, July 19, 2011, at
B1 (explaining how total China holding of US treasuries may not be known because of purchasing through
third countries using intermediaries).
249
32
Finally, the fourth category, which the report gives the least amount of attention, is the
most relevant for this article. It relates to how to convey the above information. In this
respect, the Interagency Group on Economic and Financial Statistics (IAG) 259 maintains
a website of the relevant information. 260 Unfortunately, the information is mostly
macroeconomic country level economic data. 261 Moreover, the site consolidates existing
data provided by other sources, meaning the site intends only to make information more
accessible and not to provide new information. 262 Although this function is beneficial mostly to the new set of systematic risk regulators that governments have established in
response the 2008 Financial Crisis 263 - it does not do much to give relevant international
data to the investor or intermediary levels in domestic markets. For that matter, it is hard
to ascertain what new information is given to the regulatory institutions. 264 There is,
however, value in consolidating and presenting such data as this may more efficiently
transmit information to regulators, or make it more apparent to markets; there is even an
iPhone App. 265
The purpose here was to evaluate the extent of the international-level response in terms
of information asymmetries between the international space and the market and not to
opine about possible shortcomings. In general, the recommendations are state-to-state
recommendations and focus mostly on cooperation. They seem to go far in this area,
such that domestic regulators may have significantly more, and eventually better,
information to promote financial stability. In terms of providing relevant disclosure to
markets, at this point, the recommendations do not go far enough, however it is
premature to declare what the consequences of some of these initiatives will be. Notably,
market oriented disclosures were probably not the intent of the IMF, FSB, or G20 in
undertaking the project. Nevertheless, despite the state-to-state focus, the subsequent
progress report continues to highlight some aspects of information disclosure that should
259
See FSB Info Oct 29, 2009, supra note 52, at 12 (“The Interagency Group on Economic and Financial
Statistics (IAG) was established at end-2008 to coordinate work on the improvement of economic and
financial statistics (methodologies and data collection) among international agencies. Members of the IAG
are the…BIS, the European Central Bank (ECB), Eurostat, the IMF (Chair), the OECD, the UN, and the
World Bank.”). This article is unable to ascertain why US agencies are notably absent from direct
participation other than to surmise that participation is limited international organization of which the ECB
is technically one. The US also achieves participation through its membership role in many of these other
intuitions.
260
See IAG
Principle Global Indicators, available at http://www.principalglobalindicators.org/default.aspx (visited
November 18, 2011) [hereinafter IAG Website] (offering datasets on global, mostly macro indicators of
economic health).
261
See id. (citing indicators such as “GDP”, “consumer confidence”, and “oil price” however information
organized by country provides aggregate data of amounts held by various financial intermediaries in
centralized institutions such as central banks and deposit and clearing corporation). Data aggregation gives
information about cross-border holdings in various intermediaries and institutions. See id.
262
See id. (Follow “About PGI”) (describing that information is available from other sources).
263
See Dodd-Frank §§111(a) (establishing the Financial Stability Oversight Council (FSOC)). See also
Council of the Europen Union, Financial Supervision: Council Adopts Legal Texts Establishing the
European Systemic Risk Board and Three New Supervisory Authorities (November 17, 2010), available at
http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/117747.pdf (visited July 19,
2011) (announcing “establishing… of European Systematic Risk Board (ESRB)… European Banking
Authority (EBA)… European Insurance and Occupation Pensions Authority (EIOPA)… and European
Securities Market Authority (ESMA)…”). “The four new bodies will be part of a European system of
financial supervisors.” Id.
264
Cf. IAG Website, supra note 260 (Follow “United States” then follow “Financial Sector Indicators”).
265
See id. (Follow “now available on iTunes”).
33
be given directly to markets. 266 For example, it notes the importance of assessing
financial networks of individual financial intuitions. 267 Moreover, the progress report
points to some standards setting bodies developing substantive rules, such as the
International Organization of Securities Commissions (IOSCO) standards for ABS
disclosures, 268 and the “BIS-ECB-IMF Handbook on Securities Statistic Handbook” that
establishes securities reporting standards for regulators. 269 These reforms are home
country regulator focused and will likely stay that way. That said, good disclosures at the
home country level that includes information on cross-border activities can possibly be
data-mined into more comprehensive systems and transmitted back to markets, which is
partially the project of Part 3 of this articlearticle. This may not be the best system but it
is a step towards curing information asymmetries.
2.4 The International Financial Architecture: Structure and Authority
To consider mechanism that can solve some of the risks outlined in Part 2.1 and 2.2 a
brief outline of the international financial architecture, its interactions, and legal
authority is necessary. There are few binding commitments in international finance and
almost no treaty institutions with the exception of the Bretton Woods organizations and
the BIS. Even after the G20’s “2009 restructuring,” 270 where the system was somewhat
remolded to be more organized, the essential character of normative structure of
institutional financial regulators remains almost wholly soft. 271 Giovanoli has generally
characterized the new structure as follows. This article, however, highlights a few recent
developments as well as some different observations and opinions. The key coordinating
organization is the Financial Stability Board (FSB). 272
The FSB has been established to coordinate at the international-level the work of
national financial authorities and international standard setting bodies and to develop and
promote the implementation of effective regulatory, supervisory and other financial
sector policies. It brings together national authorities responsible for financial stability in
significant international financial centers, international financial institutions, sector-
266
See generally FSB Information Gaps, supra note 21, at 14-15, 17, 26, 28, 29 (noting instances where
better disclosure to markets is necessary, work in this is often done through standards setting organization
associated with the FSB).
267
See id., at 26. See also generally Espinosa-Vega, supra note 239 (discussing “financial linkages”). For a
discussion about the importance of substantive standards and aggregation level see supra note 239
268
See FSB Information Gaps, supra note 21, at 28 (describing the IOSCO work towards securities
disclosures of ABS). See also IOSCO disclosure on ABS, supra note 239, §§II(A)-(B), (stating that
“Investors and other interested parties need to know who is involved in the offering or listing of the
securities.” and listing other public disclosure principles).
269
FSB Information Gaps, supra note 21, at 29 (emphasis omitted) (describing handbook that encourages
uniform and comparable statistical reporting). See also generally Bank for International Settlements,
European Central Bank & International Monetary Fund, Handbook on Securities Statistics HANDBOOK ON
SECURITIES STATISTICS, available at http://www.imf.org/external/np/sta/wgsd/hbook.htm (visited July, 19
2011).
270
See Giovanoli, supra note 49, at 98 (discussing reforms of international financial architecture after the
2009 London Summit).
271
See id., at 84 n. 8.
272
See id., at 109 (discussing importance of creation of FSB)
34
specific international groupings of regulators and supervisors, and committees of central
bank experts. 273
Despite the organizations centrality and seemingly opportune position to function as the
primary regulator it is a non-legal intuition. 274 The BIS, that houses the secretariat of the
FSB, has international legal personality, but this does not extend to the FSB. 275 Similarly,
the FSB Charter is also nonbinding so members are not obligated to any of the
commitments in the charter or to any standards that the FSB propagates. 276 In turn, the
FSB cannot compel any institution or intermediary to undertake any obligation in the
course of prompting financial stability. 277
The most authoritative, regulator in the international finance is thus the IMF but its
mission over the last half century has changed to the point where it now plays an
appurtenant role to national governments and soft organizations. 278 In reality the various
domestic jurisdictions govern finance and cooperate for various reasons. 279 The Bretton
woods institutions supplement the system by providing for specific rights or services. For
example, WTO’s role is to guarantee the transnational character of international finance
through the General Agreement on Trade in Services (GATS) agreement. 280 The IMF,
like the World Bank, functions as a lender to emerging markets and makes efforts
towards macro-economic stability in various ways. 281 For instance, it is acting as a
lender in the current European sovereign debt crises. 282 Unfortunately, in terms of the
normative transactional elements of international finance the IMF, under its current
mandate, cannot do much more than the various non-legal standard setting organizations
273
Financial Stability Board, available at http://www.financialstabilityboard.org/about/overview.htm
(visited July 12, 2011).
274
See FSB Charter §16 (“This Charter is not intended to create any legal rights or obligations.”).
275
Giovanoli, supra note 49, at 109 n. 89 (describing how in legal matters the BIS must act proxy for the
FSB).
276
See FSB Charter §16; Giovanoli, supra note 49, at 101 (describing how despite being soft law many
standards are implemented through EU directives). Although the obligations are technically non-binding
the FSB is an example of transgovernmentalism, where cooperation on standards takes place at the
international level but is adopted by national regulators. See Raustiala, supra note 4, at 24 (discussing
advantages to transgovernmental networks). Transgovernmentalism is through beneficial where the
underlying nature of cooperation is technocratic. See id. It is also, however, a way for powerful countries
to impose standards on less powerful countries. See e.g. id., at 24-5.
277
Giovanoli, supra note 49, at 114 (discussing internal governance problems of the FSB in relation to
other standards setting bodies).
278
See e.g. Zaring, supra note 1, at 479, 493 (describing changed role of IMF); Giovanoli, supra note 49,
at 106-9 (describing IMF’s position in international financial architecture); Pan, supra note 1, at 251-2
(noting IMF is without authority to be a true administrator). See also ANDREAS F. LOWENFELD,
INTERNATIONAL ECONOMIC LAW 629-33 (2d ed. 2008) (discussing changes to IMF from the 1970s).
279
See supra notes, 16-18, 273, 276. See also Gadinis, supra note 12, at 452 fig. 1 (presenting overview of
motivations for coordination).
280
See Pan, supra note 1, at 251. See also generally General Agreement on Trade in Services, 33 I.L.M.
1167 (1994).
281
See Zaring, supra note 1, at 478-79, 490-92 (noting how the IMF is becoming a “development
agenc[y]” like World Bank as well as other activities of IMF); See Lowenfeld, supra note 278, at 638-9
(describing guidelines under which IMF conducts Article 4 surveillance).
282
See Alan Beattie, Let Europe Pay for Its Policy Failures, FINANCIAL TIMES (July 19, 2011), available
at
http://www.ft.com/intl/cms/s/0/80c8210e-b248-11e0-9d80-00144feabdc0.html#axzz1TekCGzQe
(visited November 18, 2011) (noting IMFs initial participation in the Greek crisis was positive).
35
govern transactions. 283 The IMF, however, does “monitor…the implementation [of
certain standards] through” its Financial Sector Assessment Programs (FSAPs) and
Reports on Observance Standards and Codes (ROSC), which is a subsidiary program of
FSAP, 284 this “can also take place outside of the context of the FSAP.” 285 In September
of 2010 the FSAP program become mandatory for twenty-five countries. 286 This
mandatory element only encompasses the stability part of the review consistent with the
Article IV power, and does not make the entire FSAP assessment mandatory. 287 For
instance, evaluations of individual institutions are excluded as well as internal working
of capital markets such as payments systems. 288 Moreover, the ROSCs that are routinely
part of FSAP remain voluntary. 289 The last element of the international financial
architecture is self-regulating organizations that set standards but fall outside of the
purview of the FSB. The International Swaps Derivatives Association (ISDA), which
wrote the standard form swap contract, is one such organization that can significantly
impact the normative elements of international financial transactions. 290
283
See Zaring, supra note 1, at 479 (IMF has not been “source of global governance” as intended) ; cf.
Giovanoli, supra note 49, at 115, 155 n.108 (quoting Joint Letter from Dominique Strauss-Kahn, IMF
Managing Dir., and Mario Draghi, FSF Chairman, to the G20 Ministers and Governors (November 13,
2008), available at http://www.financialstabilityboard.org/publications/r_081113.pdf (visited October 3,
2011) (describing role of IMF as being mostly in an oversight and standard setting capacity)). For a
detailed discussion of the current authority and suggestion for improvements to that authority see
generally, Sean Hagan, Enhancing the IMFs Regulatory Authority, 13 J. INT’L ECON. L. 955 (2010).
284
Giovanoli, supra note 49, at 84, 106 (citing Francois Gianviti, Legal Aspects of the Financial Sector
Assessment Program, 3 CURRENT DEV. IN MONETARY AND FIN. L. 219 (2005) (discussing structure of the
ROSC and FSAP programs)). These programs, however, are not new having been established in 1999. See
Website,
Financial
Sector
Assessment
Program,
available
at
IMF
http://www.imf.org/external/NP/fsap/fsap.aspx (visited October 8, 2011). Moreover, their role is
substantially unchanged from prior to the 2008 Financial Crisis. See Arner, supra note 2, at 78-79
(discussing ROSC and FSAP roles in financial stability in 2007 prior to recent reforms); but see IMF
Website,
Financial
Sector
Assessment
Program
Fact
Sheet,
available
at
http://www.imf.org/external/np/exr/facts/fsap.htm (visited October 5, 2011) [hereinafter FSAP Factsheet]
(highlighting some changes to the program post crisis). The real difference is that traditionally these
reports are prepared upon request of a member state to the IMF, however the FSB Charter has elicited a
soft commitment for FSB members to engage in these program. See FSB Charter § 5(1)(d); Giovanoli,
supra note 49, at107 (“All G-20 and FSB members committed themselves to undertake FSAPs and to
support the transparent assessment of their national regulatory systems.”); Gianviti, supra note 284, at 222
(describing process of preparing FSAP and ROSC as “beginning prepared in response to a request by
member countries”). In addition the IMF through its independent power has made the programs mandatory
for certain leading financial countries. See infra note 286 and accompanying text. For a discussion of the
normative aspects FSAPs and similar program as they relate to information asymmetries see infra Part
3(C). See also generally, Hagan, supra note 283.
285
Gianviti, supra note 284, at 219.
286
See IMF Website, Financial Reform Top 25 Financial Sectors to Get Mandatory IMF Checkup,
available at http://www.imf.org/external/pubs/ft/survey/so/2010/new092710A.htm (visited October 8,
2011).
287
See id. For a listing of all elements included in an FSAP assessment see IMF Website, Financial Sector
Assessment
Handbook
(September
29,
2005),
available
at
http://www.imf.org/external/pubs/ft/fsa/eng/index.htm (visited October 4, 2011).
288
See IMF Website, supra note 286.
289
See FSAP Factsheet, supra note 284. For a listing of standards involved in the ROSC see IMFWebsite,
List of Standards, Codes and Principles Useful for Bank and Fund Operational Work and for which
Reports on the Observance of Standards and Codes Are Produced, available at
http://www.imf.org/external/standards/scnew.htm (visited October 4, 2011).
290
See e.g. Pan, supra note 1, at 248, 263; ISDA Website, available at
http://www.isda.org/publications/isdamasteragrmnt.aspx (visited Oct. 3, 2011).
36
Political authority over the international financial architecture lies with the G20. 291 Given
its informal nature but high influence, David Zaring has called the G20 a modern day
“Concert of Europe.” 292 The G20 has no legal structure and so its ability to direct any of
these organizations results from de facto control. 293 Organizations such as the FSB,
BCBS and IOSOC are controlled by the fact that bureaucrats and representatives from
domestic administrative agencies make up the working parties in these institutions.294 In
this sense, some members of the G20 derive legitimacy from the fact that their
bureaucrats are beholden to their national governments. 295 However, Membership in
every FSB subsidiary organization is not cotemporaneous and may include members not
in the G20. 296 Restructuring has provided for a greater overlap in membership, 297 but
there are persistent legitimacy problems that arise when this is taken in light of the nonlegal nature. 298 Moreover, skepticism by Giovanoli, Zaring, and Pan about the informal
role of the G20 299 has been given credence due to the G7 trying to take the lead in
quelling market concern about the US sovereign credit downgrade. 300 Use of the G7 by
the US and other major economies may be a quasi- “membership sanction” 301 aimed at
China for its comments regarding US fiscal policy. 302 Such a sanction cuts against the
integrity of the G20 and G7 and consequently hurts the legitimacy of both. 303
G20 de facto control is more formalized in terms of the IMF, which the G20 can control
through the majority power the countries that comprise the G20 have over the executive
291
See e.g. Giovanoli, supra note 49, at 98-100, 105 (describing international financial architecture and
noting “G20 has no formal legitimacy or competence to impose rules on its participants or on other
countries or institutions.”).
292
See Zaring, supra note 1, at 485-86
293
See id., at 496-98 (describing non-legal nature of G20 as highly political); Giovanoli, supra note 49, at
105, 108 (describing G20 interactions with other international financial institutions as “horizontal interstate
cooperation” as opposed to “vertical cooperation”); Pan, supra note 1, at 252.
294
See Giovanoli, supra note 49, at 100 Graph 2 (showing G20 membership is cotemporaneous with FSB
and BCBS).
295
See id., at 104 (discussing G20 legitimacy issues and representation in various international financial
organizations). See also Zaring, supra note 7, at 292 (describing IOSCO as comprising mostly of
“securities regulators like the SEC”).
296
Giovanoli, supra note 49 at 100 Graph 1, 104.
297
Id., at 110- 11 (describing change of Financial Stability Forum to FSB as including more members).
298
See Frank, supra note 6, at 725 (describing “legitimacy of the rule –its ability to exert pull to
compliance and to command voluntary obedience” as being contingent on the degree it “communicates”
“authority”). One source of such communication is “pedigree” as “when the United Nations admits a new
state to membership, this partly symbolic act has broad significance. It endows the new entity with a range
of entitlements and duties…” Id., at 726. The process is reciprocating and arises from the fact that
“groupings of states…legitimizes the exercise of power.” Id. In Franks context then it can be inferred that
with its non-legal nature legitimacy is communicated by the grouping of the state and inconsistent
groupings may ineffectively transmit the correct notion of authority as being vested in the FSB, which in
may create governance problems.
299
See supra notes 48 -50.
300
See Alan Beattie, G7 pledge on Stability Gets Cool Reception, August 8, 2011, FINANCIAL TIMES,
available
at
http://www.ft.com/intl/cms/s/0/09fdb37e-c1dc-11e0-bc7100144feabdc0.html#axzz1UEkgUqMV (visited October 10, 2011). (describing G7 action but also citing
commentary that expressing confusion about why the G20 was not involved in the pronouncement).
301
See Chayes, supra note 34, at 68, 85-86 (discussing “membership sanctions” in international institutions
but concluding these are untimely detrimental and unsuccessful). Certain exclusions make the organization
ineffective. See id. at 86. This is paramount sentiments about excluding China from the G20
pronouncement. See Beattie, supra note 300.
302
Beattie, supra note 300.
303
Cf. id. Compare also supra notes 298, 301.
37
board, due to the IMF’s weighted voting structure. 304 The IMF describes the interactions
between itself and the G20 as advisory but in reality the G20 acting in concert, in fact
just the EU and US, can formally direct the IMF as they desire. 305 That said, legal
justifications for interactions between the G20 and IMF must still be made in terms of
the IMF Charter. 306 Control over the IMF, and in turn the obligations countries owe the
IMF, gives the G20 teeth as it maintains its incoherent status. Legally, however, to the
extent the G20 is exerting collective authority it undermines the legitimacy of the IMF as
it is not structured to take direction from this collective. Nonetheless, the actions the G20
and the IMF took during the 2008 Financial Crisis have been praised; 307 and subsidiary
parts of the international financial architecture, that have been around of some time and
essentially took no actions, have come under criticism. 308 Inferentially, this suggests the
current political construction of the G20 should be retained as the global financial
governor. 309 The problem (aside from degradations of the G20 itself) 310 is that crisis
response is only one part of international financial governance. 311 However, the G20s
role as crisis-responder is in the forefront of international financial policy; in turn
normative elements have been somewhat re-characterized as crisis avoidance or
development initiatives through soft commitments to the FSAP and ROSC. 312 In this
304
Giovanoli, supra note 49, at 108.
See IMF Website, Governance Structure, available at http://www.imf.org/external/about/govstruct.htm
(visited October 4, 2011) (showing G20 as advisor), compare IMF Website, International Monetary Fund
Organization Chart , available at http://www.imf.org/external/np/obp/orgcht.htm (visited (October 4,
2011) (showing absence of G20 in formal organization); IMF Website, IMF Executive Directors and
Voting Power , available at http://www.imf.org/external/np/sec/memdir/eds.aspx (visited October 4, 2011)
(showing US Germany, France, and UK together can exercise 31.19% of vote including Japan 37.43%).
The IMF describes its relationship with the G20 in terms of accountability, where there are no formal
interactions such as the Mutual Assessment Program. See IMF Website, Accountability , available at
http://www.imf.org/external/about/govaccount.htm (visited October 4, 2011); infra note 306 (discussing
Mutual Assessment Program).
306
Cf. International Monetary Fund, The G20 Mutual Assessment Process and the Role of the Fund ¶ 12
(December 2, 2009), available at http://www.imf.org/external/np/pp/eng/2009/120209a.pdf (visited
October 4, 2011) (describing authority of IMF to participate in the G20 Mutual Assessment Program as
arising out of the “Article V(2)(b)” technical assistance powers and stating the G20 undertook IMF help
‘“upon request”’). The Mutual Assessment Program is a framework to achieve growth after the 2008
Financial Crisis. See IMF Website, G20 Mutual Assessment Process, available at
http://www.imf.org/external/np/exr/facts/g20map.htm ( visited October 4, 2011).
307
See e.g Zaring, supra note 1, at 498; Christing Lagarde, How the G20 Can Prevent another Financial
Crisis, FINANCIAL TIMES (January 24, 2011), available athttp://www.ft.com/intl/cms/s/0/3172c19c-255611e0-93ae-00144feab49a,s01=1.html#axzz1U28vGJlG (visited October 5, 2011) (describing some
measures G20 took during the 2008 Financial Crisis to help avert disaster).
308
See generally Zaring, supra note 1; See also Pan, supra note 1, at 246 (describing failure of international
financial architecture during the 2008 Financial Crisis as “failure of states to provide for an international
legal regime capable of conducting prudential supervision and systematic risk regulation.”).
309
See Zaring, supra note, 1, at 479, 498 (describing G20 response as political governance and not
administrative governance).
310
See supra notes 298 - 303.
311
See supra notes 1- 11 and accompanying text. See also Pan, supra note 1, at 245 (“G20 does little to
advance international legal norms”).
312
This propositions assert that normative commitments have not gone beyond soft commitments to
existing programs. See supra notes 286 -288. Although there has been some commitment to the stability
elements of FSAP, the elements that would reinforce underlying standards remain soft. See supra notes
287 - 288. Moreover, these normative monitoring systems have been couched in the concept of crisis
response. See Giovanoli, supra note 49, at 102 (discussing G20, international financial standards, and
FSAP, ROSCs in terms of promotion of stability); See IMF WEBSITE, supra note 286 (“[T]hese financial
stability assessments do not evaluate the health of individual financial institutions and cannot predict or
305
38
way, few inroads are being made into the regulatory gap that exists between the
international space and domestic jurisdictions outside of the informal state-to-state
context. 313 FSAP and ROSC can give various kinds of underlying market information
and although there have been some reforms after the 2008 Financial Crisis, 314 and some
indication that participation in FSAP could identify some vulnerabilities that lead to the
crisis, 315 the commitment and the frequency needed to make this a normative tool for
domestic markets is wanting. 316 Hence, just as FSAP could not do anything to improve
risk pricing prior to the crisis – either the information was insufficient, presented in a
useless (semi-useless) way, or markets and regulators simply did not care about such
information 317 – it cannot do much more now. In this way, a drive for harder
commitments in information disclosure, separate from the financial zeitgeist, would be
beneficial. 318 In turn, “[D]ependence on high politics and state-centric forums like the
G20 to prevent and manage future financial crises is deeply unsatisfying from both a
financial law and international law perspective[].” 319 Concurrently, history teaches the
reliability of the state-to-state model can be dismantled as domestic intermediaries lobby
for more beneficial regulatory treatment. 320 In this respect, the real test of G20
management will be how they abate competitive concerns during changing economic
concerns and national policies.
Some authors believe that the current system offers a slow path to the formation of hard
law agreements. 321 The point, however, is suspect. International financial regulations
have come out of crisis and every crisis reveals different aspects of regulatory burden. 322
But more than that each crisis brings new political concerns to the forefront. In the case
of this crisis, it is executive pay. Executive pay, however, may be a red herring; there are
incentives for management pursuing overly risky behavior without this principal
behavior being reinforced by perverse pay schemes. 323 Although perverse pay schemes
prevent financial crises, they identify the main vulnerabilities that could trigger one.”) In this sense, they
are primarily a form of state-to-state policing, not a mechanism for transmitting information to markets,
although they may have pertinent information for markets so long as states elect to disclose that
information.
313
In terms of the information provided to the FSB the FSAP is acting as a limitation to the information
that the FSB has access to, the FSB itself has shown limited initiative to seek core information outside of
this context, with the exception of sending questionnaires. See infra notes 399- 409 and accompanying
text.
314
See supra note 284.
315
FSAP Factsheet, supra note 284.
316
See supra note 284. See also Hagan, supra note 283, at 961-2 (discussing prospect of mandatory
FSAP).
317
Cf.. supra note 227 and accompanying text.
318
See Pan, supra note 1, at 245.
319
Id., at 244.
320
See supra note 108.
321
See e.g. Langevoort, supra note 38, at 800 -1 n. 6.
322
See e.g. supra notes 1-3 and accompanying text; See Arner, supra note 2, at 57-74 (discussing reforms
after Mexican and Asian Financial Crises).
323
See Arteta, Carey, Correa & Kotter, supra note 81, at 3 (noting two reasons for “excessive risk taking”
either “government guarantees” or “owner-manager agency problems” including “equity based
compensation”). See also generally Rudiger Fahlenbrach & Rene M. Stulz, Bank CEO Incentives and the
Credit Crisis, 99 J. FIN. ECON. 11, 24 (2011) (examing various incentives for CEO’s during 2008 Financial
Crisis but finding incentives “cannot be blamed for the credit crisis or for the performance of banks during
the crisis.”).
39
obviously, do reinforce this behavior. 324 In turn, proper incentives for managers are
important, but from another perspective, the difference in the amount of money financial
intermediaries lost through publicly unpopular bonuses versus the amount they lost
through inadequate risk pricing is astronomical. 325 Bailouts are another example. In
reality, the system may be better off incorporating tools for saving fundamentally
indispensable intermediaries into the laws in a way that shifts costs onto them or at least
minimizes it for taxpayers. 326 Nevertheless, Dodd-Frank makes them outright illegal in
certain cases owing to their political unpopularity. 327 Consequently, priorities in
international finance are rapidly changing such that the slow pace of international law
may be too slow to have any effect. 328 The rapidly changing dynamic of finance
combined with the high prevalence of cross-border transactions requires strategies that
can cope with some of the risks that occur in the international space. 329 To that end, the
next part will address the value of certain mechanisms in relation to the amount of
intuitional restructuring required for their implementation.
3. Administrative Tools to Cure Information Asymmetries between Domestic
Markets and the International Space
The following looks for minimized areas of restructuring that can be adapted into the
international financial architecture toward curing information asymmetries. The goal is
to find a partial solution to the information asymmetry that exist between the market and
the international space. This Part will consider domestic regulatory mechanisms that
could be applied on a global scale. Moreover, it will look at proposed and existing
systems for information sharing at the international-level, which could be legalized or
reformed to become more effective. The article has particular interest is those reforms
which will not only bridge the gap from international to domestic but from foreign
324
See Arteta, Carey, Correa & Kotter, supra note81, at 4 (finding “financial institutions with better
compensation practices were less likely to sponsor ABCP vehicles.”); Financial Stability Board, Principles
for
Sound
Compensation
Practices
3
(September
25,
2009),
available
at
http://www.financialstabilityboard.org/publications/r_090925c.pdf (visited October 5, 2011) (“Subdued or
negative financial performance of the firm should generally lead to a considerable contraction of the firm’s
total variable compensation, taking into account both current compensation and reductions in payouts of
amounts previously earned, including through malus or clawback arrangements.”).
325
See Mark Landler, I.M.F. Puts Bank Losses From Global Financial Crisis at $4.1 Trillion, NY TIMES
(April, 21, 2009), available at http://www.nytimes.com/2009/04/22/business/global/22fund.html (visited
October 5, 2011) compare Louis Story, Executive Pay, NY TIMES (March 3, 2011), available at
http://topics.nytimes.com/top/reference/timestopics/subjects/e/executive_pay/index.html?scp=3&sq=execu
tive%20pay%20credit%20crisis&st=cse (visited October 5, 2011) (noting bonuses totaled $18 billion in
2008).
326
See Coffee, supra note 63, at 799 -800.
327
See id.; Dodd-Frank § 716 (preventing bailout of swap participants).
328
See Pan, supra note 1, at 246, 263-9 (arguing soft law system is insufficient). Concerning in terms of
hard commitments is a supervisions system. See id., at 265; Langevoort, supra note 38, at 801 (asserting
there is need for “strong enforcement and dispute resolution are the most crucial elements of global
securities regulation, and we are far from seriously trying to create that capacity.”). Supervision is a
different process that requires more active involvement of regulators. See Pan, supra note 1, at 265-7.
329
See supra notes 14 - 15. See also Pan, supra note 1, at 246 (arguing inadequacy of international
financial architecture and the need for hard law framework). But see Karmel & Kelly, supra note 8, at 8969 (arguing benefits of soft law noting they can elicit higher compliance than hard law).
40
jurisdiction to private domestic market and foreign market to domestic regulator. In this
way, some of the problems related to “embeddedness” can be addressed. 330
To do this various mechanism will be explained and analyzed against the risks in Part 2.2
and 2.3 then set against the international financial architecture presented in Part 2.4.
Mechanism will require different amount of restructuring depending both on the choice
to implement, and on how much legal authority regulators put behind the mechanisms.
For example, mechanisms that get information from compelled disclosure will require
more restructuring than mechanisms that consolidate already existing data sets. The
tradeoff will sometimes determine the effectiveness of the mechanism but it is also
possible equal outcomes might be available at different levels of restructuring. This
could occur if minimal (or non-legal) restructuring accompanies harmonization or
reputable oversight at the domestic-level.
The main concern for an international administrative tool is legitimacy. 331 In the
international space, where there is limited obligation, legitimacy alone can determine the
extent of compliance. 332 But more than state compliance markets will also be receptive to
a legitimate agency so long as the information they are receiving from that agency is
pertinent and timely. 333 In this way, for a mechanism to bridge the gap between the
international space and domestic markets it must be authoritative enough to incentivize
those markets to listen to the information it is disseminating or there will be no effect to
restructuring. 334
When legitimate the value of an administrator is really in its functionality, administrative
agencies can perform both judicial and legislative functions. 335 However, more
330
See supra notes 13- 15, 102 and accompanying text.
See Esty, supra note 6, at 1509-11 (describing conditions of legitimacy in international governance);
Pauly, supra note 6, at 82-6 (discussing the need for legitimacy for effective global governance of finance).
See also generally Lisa Schultz Bressmna, Beyond Accountability: Arbitrariness and Legitimacy in the
Administrative State, 78 N.Y.U. L. Rev. 461 (2003) (suggesting legitimacy model beyond accountability of
the agencies supervising authority). See also supra note 34 and accompanying text.
332
See Karmel & Kelly, supra note 8, at 897 (discussing legitimacy and international legal obligations).
333
Cf. Christopher M Bruner, States, Markets and Gatekeepers: Public-Private Regulatory Regimes in an
Era of Economic Globalization, 30 MICH. J. INT’L L. 125, 139 (2008) (discussing legitimacy from
‘“Epistemic’ authority, associated with ‘recognized expertise and competence in a particular domain,’
giving rise to ‘an authoritative claim to policy-relevant knowledge within that domain or issue-area…’”).
Bruner’s discussion of “epistemic” authority pertains to ratings agencies, which share a number of
underlying features with potential information disseminators at the international-level, particularly
regarding the fact that they are designed to convey new and hard-to-get information to the market. See id.,
at 134 (describing ratings agencies as an “information intermediary”). However, authority of the rating is
no just in its “epistemic” quality but also the fact that the “[SEC], which regulates securities markets and
intermediaries has since 1975, incorporated the ratings of a set of designated agencies – so-called
Nationally Recognized Statistical Rating Organizations…into a wide range of securities regulations, and a
number of other regulators have followed their lead.” Id., at 139-40. In turn, legitimacy and authority of an
international information disseminator (like a private rating agency), which investors will incorporate into
their information, can be attained through “epistemic authority” as well as through backing by established
administrators. See id.; Pauly, supra note 6, at 77 (describing how authority in international finance will
depend on “interdepend public authorities” and delegation to international space). For a discussion of the
empirical qualities of information in relation to market incorporation see infra notes 424 - 429 and
accompanying text.
334
For a further discussion of market receptiveness to information from the international space see infra
Part 4.
335
See 2 AM. JUR. 2D. Administrative L. § 29.
331
41
importantly they can perform a set of in-between functions, such as approval, licensing,
monitoring, make recommendations, and write reports. All are essential to the governing
of modern societies. Financial administration is even more innovative. It can actively
make quality judgments, or it can influence market discipline by curing information
asymmetries and correcting the principal-agent problems. 336 In this way, the
administrative state in the case of finance is both a facilitator as well as a rule maker.
Internationally mechanisms are less diverse. In finance, for the most part they only
perform the function of rule maker. 337 Actual administration is left to the domestic
regulator. 338 Where there are obligations, they are soft, and mostly involve country-level
oversight of rules and governance practices. 339 Forms of complex, wholly legal,
international administration, however, do exist; the WTO Dispute Settlement Body is
probably one of the strongest general examples of this. 340 But there are other examples,
especially when the rules are based on “technical issues” and there is “deep
interdependence” between states. 341 Examples are, “The SARS crisis, in which the
[World Health Organization] WHO played a leading role, and the effort to phase out
chlorofluorocarbons (CFCs) that damage the Earth’s protective ozone layer, in which the
United Nations Environment Program (UNEP) organized the global response…” 342
Finance is deeply interdepend but highly political and thus international governance
cannot formalize in the way the WTO can. 343 In this respect, an iteration of one or a few
of following mechanisms could be inserted into the system to make it more viable.
3.1 Data Repositories
One of the key tools that domestic governments use is data repositories. In the US the
primary information system for securities regulation is called the EDGAR repository.
Public companies must put all SEC filings, which provide for an extensive amount of
information, onto EDGARS, with only a few exceptions. 344 EDGARS is open to the
336
See SEC Homepage, The Investor's Advocate: How the SEC Protects Investors, Maintains Market
Integrity, and Facilitates Capital Formation, available at http://www.sec.gov/about/whatwedo.shtml (
visited June 6, 2010) (“The laws and rules that govern the securities industry in the United States derive
from… [the] concept […that] all investors…should have access to certain basic facts about an investment
prior to buying it, and so long as they hold it…the SEC requires public companies to disclose meaningful
financial and other information to the public.”). Homepage
337
See e.g. Pan, supra note 1, at 263 -4.
338
See id.; Giovanoli, supra note 49, at 102.
339
See Giovanoli, supra note 49, at 102 (“[F]inancial Intermediaries are not directly the addresses of the
‘recommendations’ contained in [International Financial Standards] …, which are rather aimed at national
legislatures, regulators, and supervisors who are ‘invited’ to implement them in their respective
jurisdictions.”). See also supra notes 285- 289, 312 -317 (discussing the FSAP and ROSC programs); infra
Part III(C) (discussing regulatory audits).
340
See Esty, supra note 6, at 1509 Matrix 1.
341
See id., at 1512-13.
342
Id. 1513.
343
Cf id., at 1513. The issues is that despite the need for supra-national rule making the costs are too high
to justify the formalization. See id.
344
See Thompson, supra note 94, at 1128; SEC HOME PAGE, supra note 39 (noting limited exception to
EDGAR). See also 33 Act Regulation D, 17 C.F.R. § 230.504 (exempting SEC registration for offerings
up to $1,000,000 so long as other conditions are met). But even if the Reg. D requirement is met issuer
must still file Form D on EDGAR. See id., § 230.503.
42
public and provide essential primary information for investors. 345 Moreover, the
information it contains, which is organized by various searchable metrics, 346 is statutorily
mandated 347 ergo similar information is available from similar types of filings making it
comparable. However, more than being comparable across similar filers EDGAR is also
an active oversight repository where the SEC actively reviews certain filings for
compliance with the statute. 348 Other filings are guaranteed through strict liability of
their accuracy, 349 subject to a few exceptions.
The EDGAR example shows that the usefulness of a data repository is contingent on
authoritativeness and information quality. Information in EDGARs has the total
protection of US securities law and thus investors can rely on it fully. Importantly, the
value, from an information asymmetry perspective, is not only in what information there
is but also in the fact that the SEC determines when such information becomes effective
and where it can be received in an accurate form. This routing is a way to solve a
potential information imbalances between end users. It also breaks closed regulatory
systems. Juxtapose ratings agencies, which are also designed to convey information but
about opaque products, where markets do not have full knowledge, 350 and to reinforce
this seemingly beneficial endeavor regulators have incorporated ratings into their
regulatory scheme. 351 The 2008 Financial Crisis showed, however, that ratings were not
able to accomplish what regulators intended. 352 In some contexts they actually hurt risk
pricing by offering disincentives for parties to do their underlying due diligence. 353
Additionally, the fact that ratings were given at the request of the originator 354 and the
fact that ratings were, and continue to be, highly incorporated into the regulations,
including SEC regulations, 355 routed markets into relying on them as information signals.
In this way, there was a system-wide failure of channeling of information and in quality
345
See SEC HOMEPAGE, supra note 39.
See SEC Homepage, Search Company Filings, available at http://www.sec.gov/search/search.htm#note
(visited October 6, 2011).
347
See SEC Regulation S-T, 17 C.F.R § 232.101 (requiring electronic submission of SEC filings).
348
See 33 Act Section 8, 15 U.S.C. § 77h (giving review powers over registration statements). See also
Thompson, supra note 94, at 1131 (“US securities laws require ‘full disclosure’ by issuers, meaning
companies listing in the United States must continuously keep investors apprised of virtually all material
information on the company –that is, all information, a reasonable investor would consider important in his
investment decision, and in a timely manner.”).
349
See 15 U.S.C §77k (registration statements must simply be “untrue” to incur liability); 34 Act Rule
10(b)(5), 17 C.F.R. §240.10b-5(b) (“It shall be unlawful…[t]o make any untrue statement of material fact
or to omit to state a material fact necessary in order to make the statements made, in light of the
circumstances under which they were made, not misleading…”)
350
See Bruner, supra note 333, at 134 (discussing ratings agencies as “information intermediary[ies]”)
351
See id., at 139-40, 144-5 (discussing regulatory incorporation of ratings agencies and products which
rely on such ratings); Langevoort, supra note 38, at 810 (discussing reliance on ratings agencies in ABS
market); FCIC REPORT, supra note 26, at 119 (discussing information disparity between ratings agencies
and investors); Ingo Fender, & Janet Mitchell, The Future of Securitization: How to Align Incentives BIS
QUARTERLY REVIEW, September 2009, at 33, 35 (discussing overreliance and ratings and better ratings
policies).
352
See Bruner, supra note 333, at 145-6 (discussing fault rating agency methodologies); Langevoort, supra
note 38, at 810 -11 (suggesting regulators “abolish the regulatory privilege” to incentivize markets to
examine underling assets); FCIC REPORT, supra note 26, at XXV (holding rating agency failures as
contributing to the 2008 Financial Crisis).
353
See Langevoort, supra note 38, at 808-9; McCoy, Pavlov & Wachter, supra note 23 at 536. See also
supra notes 164, 181.
354
See e,g. Bruner, supra note 333, at 134-5
355
See e.g. id., at 139-40.
346
43
of underlying information. For a rating to be meaningful it must either convey new
information 356 or it must be incorporated into the regulatory scheme. 357 That said, only
new information is actually beneficial to the market, and if there has been regulatory
incorporation but the system is not providing new information the benefits are nonexistent, 358 but the potential to distort markets remains. 359 In this way, data repositories
can potentially offer information on underlying metrics that can intervene into the threeway tacit undertaking that exists between financial firms, ratings agencies, and the
government, making the system less prone the regulatory inefficiencies.
To implement an EDGAR style repository at the international-level, be it for securities or
other financial instruments, would require a high amount of restructuring. Regulators can
achieve an intermediate position where internal standards as opposed to obligations
comprise the reporting rules. But even so, an EDGAR style data repository at the
international-level with global participation of the most significant capital markets and
banking economies is highly unlikely because much of the benefit comes from active
oversight by the SEC. In turn, a global EDGARs would be the byproduct of a
multilateral treaty organization. As seen by the IAG example the simple collection and
dissemination of statistics does not pose a substantial barrier to the international
system. 360 However, formalizing the rules and oversight that backs those disclosures is a
more difficult and the principal legal challenge.
Even without formalized disclosure IAG style repositories are still useful in the fact that
they present information in a consolidated place thus making transmission easier.
However, IAG suffers from the other end of the spectrum, namely over generalized
information that consequently does not do much to solve asymmetries for individual
investors. 361 IAG is consequently routing of information without substance. Hybridizing
this kind of system with an EDGAR style repository may be the most efficient course of
action. Taking the active oversight function out of a global EDGAR and keeping the
356
See Frank Partnoy, The Siskel and Ebert of Financial Markets?: Two Thumbs Down for the Credit
Rating Agencies, 77 WASH. U. L.Q. 619, 657-58 (discussing perceived benefits of ratings agencies).
357
See Bruner, supra note 333, at 139-40.
358
Consider the recent downgrade of the US sovereign rating from AAA to AA+. There is some consensus
that the short run impact will not be that large because markets already know the status of the US political
system and the cost of credit already reflects that belief, irrespective of the rating. See Clive Crook’s Blog,
S&P Revises its Outlook for US Debt, FINANCIAL TIMES BLOG (April 18, 2011), available at
http://blogs.ft.com/crookblog/2011/04/sp-revises-its-outlook-for-us-debt/#axzz1UehCBWrC
(visited
October 11, 2011) ; see Partnoy, supra note 356, at 658 (quoting JAMES VAN HORNE, FINANCIAL MARKET
RATES AND FLOWS 181 (1990) (“While the assignment of rating for a new issue is current, changes in
ratings of existing bond issues tend to lag behind the events that prompt the change.”)); compare Richard
Milne & Dan McCrum, Investors Pray for Political Actions –but Watch Asia, FINANCIAL TIMES (August 8,
2011),
available
at
http://www.ft.com/intl/cms/s/0/846e2c80-c10d-11e0-b8c200144feabdc0.html#axzz1UEkgUqMV (visited October 6, 2011) (discussing differing beliefs about the
degree that the market has incorporated information prompting the US downgrade in the market). But in
another sense much of the worry comes from the fact that investors unsure about the regulatory impact the
downgrade will have. See Mary Pilon, Leslie Scism & Steve Eder, Companies Search Small Print for
Financial Impact; Weekend of Work, WALL STREET JOURNAL (August 8, 2011), available at
http://online.wsj.com/article/SB10001424053111904480904576494710280650504.html?mod=WSJ_hp_L
EFTTopStories (visited October 8, 2011) (discussing legally created implications to the US downgrade).
359
See supra notes 164, 181.
360
See supra notes 259- 264 and accompanying text.
361
See supra note 261 and accompanying text. Cf. also Cecchetti, supra note 199, at 51 (discussing
dangers of overgeneralized information for OTC derivatives).
44
monitoring function at the domestic-level would allow aggregate meaningful data with
limited institutional restructuring. Countries, however, would have to agree on disclosure
standards and a surveillance apparatus to make sure that domestic regulator are
implementing the correct standards, something that FSAP could likely do. In turn, by
framing the system in this way the need for active international oversight is replaced by
the need to monitor conformance to obligations and the need for harmonization.
3.1.1
Trade Repositories (TR)
Trade repositories are centralized databases that provide information on open trades to
the public or regulators. 362 They exist to “improve market transparency” and can help
solve some of the risks related to swaps seen in the 2008 Financial Crisis. 363 In this sense,
the focus of TR is narrower than an EDGAR style repository, as the securities laws of the
US require various forms of company information or other information depending on the
type of security, for example, things related to the type of business. 364 TR on the other
hand, are used for assessing the relative positions of counterparties and generally
“improve the ability of relevant authorities and the public to identify and evaluate the
potential risks posed by OTC derivative markets to the broader financial system and
strengthen the ability of relevant authorities to monitor risks of individual market
participants and market practices.” 365 Regulators will institute OTC trade repositories in
the US as part of Dodd-Frank. 366 This will assess information such as total exposures to
help the public risk price counterparty risk. 367
A similar but more passive initiative is being undertaken by the FSB to establish OTC
trade repositories. 368 “TRs will play a vital role in increasing transparency to authorities.
The data maintained in TRs will allow authorities to address vulnerabilities in the
financial system and to develop well-informed regulatory, supervisory and other policies
(and assess the effects of such policies) that promote financial stability and reduce
systemic risks.” 369 Moreover, the FSB acknowledges how TRs will directly empower
markets. 370 To that end, “the use of TRs also will encourage standardisation of legal and
362
See BIS CONSULTATIVE REPORT BY COMMITTEE ON PAYMENT AND SETTLEMENT SYSTEMS &
TECHNICAL COMMITTEE OF THE INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS,
CONSIDERATION FOR TRADE REPOSITORIES IN OTC DERIVATIVES MARKETS, (May 2010) [hereinafter BIS
OTC Report] (defining the benefits of trade repositories).
363
See id.
364
See generally SEC Regulation AB, 17 C.F.R. §§ 242.1100 – 242.1123 (proscribing rules for AssetBacked Securities).
365
BIS OTC Report, supra note 362, at 6 (discussing “risks managed by a trade repository”); see Acharya,
Cooley, Richardson & Walter, supra note 27, at 372-3, 380 (discussing US OTC trade repository reforms).
366
See Dodd-Frank § 728.
367
See Acharya, Cooley, Richardson & Walter, supra note 27, at 380-83.
368
See FSB OTC Derivatives Oct 2010, supra note 214, at 49, (discussing benefits of TR for international
swaps markets). For a list of TRs currently in operation as well as the level of public reporting and the
types of information they report see id., at 63 (annex 10 listing “TriOptima,” “Warhouse Trust,” and
“DTCC/MarkitSERV” as designated TRs). See also generallyTrioptima , Rates Repository Bringing
Transparency to the Market, available at http://www.trioptima.com/repository.html (visited July 20,
2010); Markitserv, About MarkitSERV, available at http://www.markitserv.com/ms-en/about/about.page?
(visited October 7, 2011); DTCC, About DTCC The Warehouse Trust Company LLC, available at
http://www.dtcc.com/about/subs/derivserv/warehousetrustco.php (visited October 7, 2011).
369
FSB OTC Derivatives Oct 2010, supra note 368 at 44.
370
See id.
45
operational terms, as some degree of homogeneity is crucial for effective transaction
reporting by counterparties and for related services offered by the trade repository.”371
However, in a more recent progress report the FSB noted the difficulties that domestic
economies are having in adopting uniform rules regarding TR. 372 The BIS recommends
that “all TRs should make available aggregate data on open positions and trading
volumes…[and] authorities…should have the ability to require the TR to make more
data publicly available…” 373 However, prominent scholars have noted while TRs will
have an overall positive effect, aggregate data should be on the level of individual
intermediaries to truly help markets evaluate counterparty risk. 374
Repositories, international or domestic, function as private corporations or trusts so
setting them up does not require substantial restructuring. 375 The corner stone of TR
success is, however, domestic jurisdictions compelling derivative dealers to list with
these platforms. 376 In this way, the current construction relies heavily on domestic
regulators to provide enforcement. Hence, there is concurrently no long-term insulation
against political pressure from OTC originators or dealers to erode disclosure standards
or keep certain products off the platforms. 377
Summarily, TRs perform an essential function towards curing information asymmetries
between the international space and domestic markets as regards derivatives. If TRs keep
derivatives sound from a systematic standpoint they can then serve other functions such
as risk pricing for private securitized products. 378 Moreover, regulators can implement
TRs at the international-level through cooperation on underlying information
requirements. 379 However, if the international system opted for certain minimum hard
standards of mandatory disclosure this would go far to aid against the propensity for
declining standards when the global economy enters a more robust stage
3.1.2 Decision Making Non-Public Repositories
371
Id.
See FSB Derivatives Progress Report, supra note 25, at 6 (noting concern that unless jurisdictions
implement TR uniformly that “the data collected on OTC derivatives transactions may not be able to be
readily aggregated on a global basis and that authorities may not have effective and practical access.”).
373
BIS OTC Report, supra note 362, at 7.
374
Acharya, Cooley, Richardson & Walter, supra note 27, at 380.
375
See supra note 368.
376
See supra note 372.
377
See Jeremy Grant, Alert on Splintering Derivatives Reform, FINANCIAL TIMES (April 17, 2011),
available
at
http://www.ft.com/intl/cms/s/0/be383054-68f8-11e0-904000144feab49a.html#axzz1UEkgUqMV (visited October 7, 2011) (discussing divergent implementation of
OTC reforms).
378
See supra notes 172 -173 and accompanying text.
379
Standards “on data reporting standards and aggregation” were due to be released on July 2011 as part of
the joint work of the BIS Committee and Payments and Settlement systems and the IOSCO, however this
report appears to be delayed at the time of this paper. See FSB Derivatives Progress Report, supra note 25,
at 7. However, the consultation report on “financial market infrastructures,” which speaks to related
concerns has been released. See id.; see also generally Bank for International Settlements Committee on
Payments and Settlement Systems & Technical Committee of the International Organization of Securities
Commissions, Principles for Financial Market Infrastructures (March 2011),
available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD350.pdf (visited October 7, 2011).
372
46
This is a method used by the OCC, a primary US bank regulator, to help oversee certain
information disclosure requirements of the Bank Secrecy Act, 380 which is designed to
fight money laundering and financial terrorism. 381 In conjunction with the act the OCC
dictates certain information that banks must report to the Financial Crimes Enforcement
Network of the Department of the Treasury (FinCEN), “when they detect a known or
suspected violation of Federal law…related to money laundering…or violation of the
Bank Secrecy Act.” 382 FinCen is not a repository in the sense that EDGARs is, rather it
resembles supra-organizer for entities, including international entities, involved with the
enforcement of financial crimes. 383 However in this respect it is responsible for
collecting and channeling vast amount of information from various parties. 384 Making it
functionally a repository with decision making ability over large amounts of nonpublic
information.
Nonpublic information concerns are not only limited to criminal regulators. For example,
new systematic risk regulations can keep information secret to avoid adverse market
reactions such as guarantees associated with “too-big-to fail.” 385 In a more general
context certain intermediaries would also prefer non-public repositories because of “freerid[ing]” concerns. 386 They would like to prevent other intermediaries from coping their
portfolios and in turn reduce the benefit of the working intermediary relative to the
market. 387 In this way, there are several potential applications for nonpublic repositories.
The opacity problems seen in Part 2 would, however, not be solved by this kind of
institution. Moreover, a closed data system like this on the international-level by its very
nature would requires large institutional restructuring because the value of this system is
in the active oversight, compulsion, and hard enforcement. A more limited approach
would be for regulators to allow each other access to such their domestic systems, if they
exist. This is not implausible for criminal issues as the Financial Action Task Force
(FATF) acts as a global criminal enforcement forum that undertakes active monitoring of
the standards it propagates. 388 However, in the case of transactional regulations, as was
noted earlier there is incentive for countries to keep the health of their intermediaries,
380
See 31 U.S.C. 5311-5313e.
See id., § 5311 (“It is the purpose…to require certain reports or records where they have a high degree
of usefulness in criminal, tax, or regulatory investigation or proceedings, or in the conduct of intelligence
or counterintelligence activities, including analysis, to protect against international terrorism.”).
382
OCC Regulations Suspicious Activity Report, 17 C.F.R. §21.11(a) (2011).
383
See FINANCIAL CRIMES ENFORCEMENT NETWORK UNITED STATES DEPARTMENT OF THE TREASURY
WEBSITE,
Frequently
Asked
Question,
available
at
http://www.fincen.gov/about_fincen/wwd/faqs.html#org (visited October 7, 2011).
384
See Financial Crimes Enforcement Network United States Department of the Treasury Website, What
We Do, available at http://www.fincen.gov/about_fincen/wwd/ (visited October 7, 2011).
385
See Acharya, Cooley, Richardson & Walter, supra note 27, at 98; Dodd-Frank § 154(b)(6) (discussing
reports by Office of Financial Research). “The office shall, after consultation with the member agencies
provide certain data to financial industry participants and to the general public to increase market
transparency and facilitate research on the financial system, to the extent that…the sharing of such
information poses no significant threats to the financial system of the United States.” Id.
386
See Mary Margaret Frank, James M. Poterba, Douglas A. Shackelford & John B. Shoven, Copycat
Funds: Information Disclosure Regulation and the Returns to Active Management In the Mutual Fund
Industry, 47 J.L. & ECON. 515, 517-18 (2004)
387
Id., at 517.
388
See Financial Actions Task Force Website, Mutual Evaluations Program, available at http://www.fatfgafi.org/pages/0,3417,en_32250379_32236982_1_1_1_1_1,00.html (visited October 8, 2011).
381
47
especially banks, opaque. 389 In turn, such repositories do not have a place in the
international financial architecture in the near or intermediate term.
3.2 Organizational Non-Adjudicatory Review Boards
Elements of this are seen in the European Securities Market Authority (ESMA) which
performs numerous non-binding review functions under the EECS program. “EECS is
the analysis and discussion of decisions taken by independent EU National Enforcers in
respect of financial statements published by issuers with securities traded on a regulated
market and who prepare their financial statements in accordance with [International
Financial Reporting Standards] IFRS.” 390 The EECS forum consequently provides
consultations on decisions of other bodies and does not “approve[] nor reject decisions
taken by EU National Enforcers…” 391 In turn, EECS’s function is transparency but,
moreover, they perform a sorting and selection function that lets interested parties know
what is important. EECS limits review to accounting decisions; 392 however a comparable
system could easily be set up to review and consolidate any number of financial
decisions by tribunals across borders. Including domestic decisions about what is
adequate capital, or it could sort the various information to be provided by systematic
risks boards.
The benefit to EECS is that the database has a judgment and sorting function as opposed
to pure data mining. The sorting increases the quality of information making better
information accessible to more parties. 393 The value in this model consequently lies it
ability to identify and give implicit certification to information. In this way, such as
system may have stronger effects than anticipated. However, the necessary conditions is
that the legitimacy of the authority must be strong. Such legitimacy must overcome the
fact that an EECS type body lacks formal, or even informal, teeth. 394 Summarily, market
participants will pay attention to these bodies only to the extent they are correct. 395 Even
so, “yielding good outcomes” is a way to gain legitimacy, 396 here success is defined by
consistently choosing relevant and meaningful information that influences the market.
Review boards would require some institutional restricting although it is possible that
this kind of review can be brought inside an existing intuitions, such as the IMF through
an informal process, or given some teeth under the IMFs surveillance capabilities,
389
See supra note 44, and accompanying text.
See European Securities Market Authority, Report 10th Extract from the EECS’s Database of
Enforcement 3 (February 23, 2011), available at http://www.esma.europa.eu/popup2.php?id=7492 (visited
October 8, 2011) (Follow “Documents” then Ref. [2011/62] “View Document”).
391
Id.
392
See id.
393
Cf. Richard A. Lambert, Christian Leuz, & Robert E. Verrecchia, Information Asymmetry, Information
Precision, and the Cost of Capital 3, 31-34 (Nat’l Bureau of Econ. Research, Working Paper No. 14881
(2009)),
available
at
http://faculty.fuqua.duke.edu/~qc2/BA532/2006%20WP%20LLV%20disclosure%20and%20COC.pdf
(visited October 8, 2011) (finding generally that in many instances lower cost of capital will track the
quality of information across different investors not the quantity).
394
See e.g. Karmel & Kelly, supra note 8, at 897 (discussing legitimacy and compliance with
unenforceable norms); supra note 34.
395
See supra note 333 (discussing legitimacy through technical competence).
396
See Esty, supra note 6, at 1517 (discussing “[r]esults-[b]ased [l]egitimacy”).
390
48
depending on the objectives of the review. 397 The key point is funding. Sorting through
various data sets is an editing of financial and legal information that will require a large
staff. This, however, implementing EECS type systems minimizes the need for
harmonization at the domestic-level, with the exception of accounting standards, and a
few other metrics that are necessary for comparison. In turn, substantive laws do not
need to define relevant criteria rather the body can do this.
3.3 Audits of Regulatory Policy or Information
Such audits were discussed in Part 2.4 in regards to the FSAP program. Another version
exists as part of the FSB charter, which encourages members to participate in “peer
reviews” of their financial policies “using among other evidence IMF and World Bank
public Financial Sector Assessment Program reports.” 398 The FSB supplements the
information with questioners. 399 Peer reviews are either thematic or country based.
Currently, only a few countries have undergone peer review, while thematic reviews
were done on “Risk Disclosure Practices,” “Mortgage and Underwriting Obligations,”
and “Compensation.” 400 The FATF has a similar audit process regarding criminal
standards. 401 These kinds of audits are essentially a compliance monitoring
mechanism. 402 FSB thematic peer reviews, however make some attempt to reach
intermediary level concerns, such data is received from “input” by industry associations
and intermediaries, in turn it is an attempt at inclusiveness regarding general regulatory
policies. 403 Country level peer reviews seem relegated to issues that arose during the
countries FSAP ergo they can include evaluations of the supervision of intermediaries
but not evaluations of that countries intermediaries themselves. 404
397
See IMF Articles of Association, Art. 4. § III(a).
FSB Charter, Art. 5(1)(d).
399
See FSB Thematic Risk Disclosure, supra note 239, at 40-44 (Annex 2: FSB Risk Disclosure Review
Template) [hereinafter FSB Thematic Risk Disclosure]; cf. FINANCIAL STABILITY REVIEW REPORT, PEER
REVIEW OF SPAIN 3 (January 27, 2011) [hereinafter FSB Peer Review Spain] (“The analysis and
conclusions of the peer review are largely based on the Spanish financial authorities’ responses to a
questionnaire designed to gather information about the initiatives undertaken in response to the relevant
FSAP recommendations.”)
400
See
FSB
Website,
Publications
Peer
Reviews,
available
at
http://www.financialstabilityboard.org/list/fsb_publications/tid_141/index.htm (visited October 8, 2011)
(listing “Spain,” “Italy” and “Mexico” as well as reviews on thematic reviews)
401
See Financial Action Task Force Website, Mutual Evaluations, available at http://www.fatfgafi.org/pages/0,3417,en_32250379_32236963_1_1_1_1_1,00.html (visited October 8, 2011) (discussing
FATF peer review).
402
See e.g. Arner, supra note 2, at 79.
403
See FSB Thematic Risk Disclosure, supra note 239, at 1 (noting “the review benefited from input from
financial institutions, industry associations, and other stakeholders on practical experiences as users of
resulting disclosures or in the implementing the risk disclosure recommendations…”); Financial Stability
Board, Thematic Review on Mortgage Underwriting and Origination Practices Peer Review Report 1
(March 17, 2011), available at http://www.financialstabilityboard.org/publications/r_110318a.pdf (visited
October 8, 2011).
404
The Spanish FSAP covered had recommendations on “Real estate markets and financial stability,”
“Regulatory framework for industrial participations,” “Regulation, supervision, and governance of the
cajas,” “Inter-agency coordination and supervisory autonomy,” “Insurance supervision,” and “Securities
settlement systems.” See FSB Peer Review Spain, supra note 399, at 34-7. Hence the peer review covered
these topics. See generally id. The Italian peer review followed a similar methodology regarding the
integration with FSAP. See generally Financial Stability Board, Peer Review of Italy Review Report
(January 27, 2011), available at http://www.financialstabilityboard.org/publications/r_110207b.pdf
398
49
The prospect for an auditory process that will directly address transactional asymmetries
is unlikely. Primarily to be effective the audits would have to assess information other
than compliance with standards and macro-economic indicators; they would have to look
at the connections of individual intermediaries. 405 Something FSAP cannot do as per the
IMF articles. 406 Additionally, there is the issue of the budget, as the “FSAP is [already] a
time-consuming and resource-intensive exercise.” 407 Nonetheless, the way the current
system aids standards enforcement and harmonization is useful. As with other aspects of
the state-to-state cooperation, however, regulators must be cognizant that non-legal
cooperation is more effective to the degree countries believe it is in their self-interest. 408
Without this incentive the only pillar that international regulators can rely on is
legitimacy. 409
3.4 Conclusions
Each mechanisms can be utilized or restricted based of various metrics, such as the level
and quality of information, if such disclosure will be enforced, where information will
come from, or who will be responsible for making judgments about such information. In
turn, each mechanism can be tuned to close the gaps outlined in Part 2. TR, is ideal for
OTC derivatives while IAG-type data mining activities may be more than enough to
move information between public capital markets. Securitization will need reporting
similar to public capital markets but with due account of the underlying assets. 410 In turn,
giving the markets tools to price risk. In this sense, audits or even a non-public disclosure
system may be effective if they are backed by an accountability mechanism. Moreover,
regulators can apply an EECS models to affect various types of information pools. They
can then indirectly harmonize underlying standards by consolidating and valuing the
information. Generally, the best system may be to combine data repository functions
with EECS in this way passive EECS style review can supplement active oversight. In
this way even domestic harmonization does not need to be extreme as EECS will
determine what is relevant. EECS, however, will be highly contingent on legitimacy.
(visited October 8 2011). Ergo under the current peer review structure, which does not seem binding in any
way, topics are those as delineated by those available to an FSAP. See IMF WEBSITE, supra note 287
(Scroll to “Chapter 5 Evaluating Financial Sector Supervision: Banking, Insurance, and Securities
Markets” and “Chapter 6 Assessing the Supervision of Other Financial Intermediaries”) (discussing FSAP
assessment criteria for financial intermediaries). The reason for this might be FSAP information is readily
available hence the burden of collecting information is mitigated.
405
See Espinosa-Vega & Sole, supra note 239, at 3 (“Effective financial system surveillance requires the
monitoring of… financial linkages, whose disruption could have… implications for the stability of the
entire financial system…the recent financial crisis has underscored the need to go beyond the analysis of
individual institutions’ soundness and assess whether the linkages across institutions may have systemic
implications.”); Hagan, supra note 283, at 962 (noting concern IMF does not have adequate information
from members); cf. Pan, supra note 1, at 273 (discussing the importance of information sharing between
national regulators). See also supra note 239.
406
See Hagan, supra note 283, at 962-3. (noting IMF articles prohibit IMF from requiring company level
information). “Short of an amendment of the Articles, the only way the Fund could obtain such [companylevel] information would be on a voluntary basis.” Id., at 963.
407
Id., at 962.
408
Esty, supra note 6, at 1514.
409
See supra note 34.
410
See supra note 197.
50
Different variables will create legitimacy which can determine both the amount of
compliance and the degree markets will care about such information. 411 Now,
governments are essentially listening to each other. Certainly, this is not bad, and the
current regulatory audit system solves many problems associated with this by utilizing
soft surveillance. However, the notion that surveillance and in turn enforcement is the
most critical piece missing from international finance 412 is significant of the greater
problem of international financial regulation. Governmental players in international
finance are concerned with monitoring their peers rather than servicing the market.
Naturally, monitoring is an imperative to stability, but the notion that governance must
essentially remain at the domestic-level with cross-country connections is indicative of
the basic “embeddedness” problem. 413 In turn, existing mechanisms are characteristic of
this desire to monitor above the desire to facilitate and in turn stabilize the cross-border
nature of international finance. Hence, the article has tried to show that principal
domestic interests, namely the interest in having informed markets to evaluate risk, can
be partially solved through administrative mechanism. In doing so the goals of stability
are served by those who are effected most by the consequence of instability, namely
markets. In this way, concerns about international governance can shift from a focus on
compliance to stabile cross-border facilitation.
4. Translating Information to Domestic Markets
The crux of this examination is really the extent that markets will incorporate
information given to them by an international body, or through an international
mechanism, into their risk assessments. In that sense, transmission may be very effective
but there might be nobody on the other end to care about what it being said. To the extent
that markets do not care global regulators must pursue other regulatory policies. Hence,
there is considerable need to investigation what information markets desire from the
international space. But more than that, the value will be tied to who is giving them the
information. For example, the IMF can add credibility to international lending packages,
which in turn effects market perception of those efforts. 414 This was the original impetus
for getting it involved in the in the current EU sovereign debt crisis. 415 Moreover, Basel
Accords captivate the attention of financial markets because domestic regulators care
about Basel and subsequent implementation effects the ability of banks to undertake
proprietary activity. 416 This then has effects on the profitability of those intermediaries.
Other intuitions, however, are somewhat ignored or simply play subsidiary roles. The
411
See supra note 34; Esty, supra note 6, at 1515-23 (discussing various kinds of legitimacy in supranational governance).
412
See e.g. Pan, supra note 1, at 246; Langevoort, supra note 38, at 801.
413
See supra notes 13- 15, 102.
414
See Beattie, supra note 282 (discussing IMFs role in Greek debt crisis).
415
See id.
416
See Michael Barnier, Basel III Will Bolster Banks, WALL STREET JOURNAL (June 2, 2011), available at
http://online.wsj.com/article/SB10001424052702303745304576358911333711564.html?KEYWORDS=M
arket+Reaction+to+Basel (visited October 9, 2011) (discussing Basel III implementation in EU and
addressing concerns about rising costs to banks); cf. Tracy Alloway, All Hail the Basel Banking Regime
(December
17
2009),
available
at
Change,
FT.COM/APLHAVILLE
http://ftalphaville.ft.com/blog/2009/12/17/115326/all-hail-the-basel-banking-regime-change/
(visited
October 9, 2011) (describing “market reaction” to announcement of stronger Basel rules).
51
FSB publishers a significant number of reports, 417 but there is no clear evidence
anecdotal or otherwise that markets care about its recommendations.
The difficulty in evaluating an institutional reaction is parsing out to what degree
markets care about the institutions versus the substance of a disclosure. These two
factors are inextricably linked. Consequently, even if regulators implement the most
efficient information transmission system to reach markets, if the underlying information
is valueless the system is essentially ineffectual. Moreover, if there is effective
information but the mechanism is not there such information is also valueless. 418
The article is not aware if any empirical research that directly addresses this point but
inferential evidence can be gained by looking at studies that address similar issues.
Accounting research for example suggests that institutional features influence the quality
of disclosures, 419 and along these lines higher investor protection laws have benefits to
the quality of such information. 420 The study, done by Leuz, Nanda & Wysocki looks at
enforcement and the role of investors to “discipline” information insiders. 421 Where
investor protection is weak “management [is better able to] alter[] [the] the firms’
reported economic performance…to either mislead some stakeholders or to influence
contractual outcomes.” 422 In turn, managers have a natural incentives to conceal
information so that they do not lose their control over these abilities. 423 Applying these
findings to the international space primarily reinforces the notion that intermediaries
have an incentive for opacity. But also that the ability of TR, or data repositories to
increase the likelihood of investor oversight through better information and risk pricing
will subsequently help discipline overly risky behavior taken by management.
There is even some evidence that with similar underlying regulations better institutional
factors can give more benefit to investors. 424 That said, the institutional factors this
article is concerned with versus the institutional factors discussed in these empirical
studies are somewhat different. By institutional factors the authors are using common
law and civil law characteristics to reflect the propensity of those systems to provide
certain underlying substantive standards regarding accounting practices. 425 In turn, the
authors are using these legal frameworks as a “proxy for political influence.” 426 The
study does not directly parse out the economic consequences of institutional bodies in
417
See generally
Financial Stability Board Website, available at http://www.financialstabilityboard.org/ (visited October 9,
2011).
418
See supra note 227
419
See Leuz & Wyosocki, supra note 152, at 58.
420
See id., at 59 (discussing Christian Leuz, Dhananjay Nanda, & Peter D. Wyosocki, Earnings
Management and Investor Protection: An international Comparison, 69 J. FIN. & ECON. 505, 506 (2003)).
421
See Leuz, Nanda & Wyosocki, supra note 420, at 506.
422
Id.
423
See id.
424
See Leuz & Wyosocki, supra note 152, at 59 (citing Ray Ball, S.P. Kothari & Ashok Robin, The Effect
of International Institutional Factors on Properties of Accounting Earning, 29 J. OF ACCOUNTING AND
ECON. 1 (2000)).
425
See Ball, Kothari & Robin, supra note 424, at 2.
426
See id., at 2-3 (discussing how “political influence is a dichotomous classification of countries into code
law systems with high political influence versus common law systems in which accounting practices are
determined primarily in the private sector.”).
52
relations to their information performance. 427 Rather, it identifies specific factors
associated with common law and measures how those factors affect certain metrics such
as “timeliness in incorporating negative economic income.” 428 The implication is that
common law and civil law legal frameworks have some kind of inherency to nurture
those underlying factors. Hence, it is hard to generalize this study past accounting
standards and the general conditions of common and civil law. In turn, because the
framework of international financial administration is neither common nor civil law the
same underlying characteristics cannot be expected. Even so, the premise that
institutional variation can determine the effectiveness similar underling standards is
meaningful for this article. First, in the sense that it gives validity to the fact that
institutional design, i.e. administrative mechanism can have meaning for markets.
Second, in the fact that such studies may elude to key underlying factors that the
international financial system should seek to replicate in terms of its information
requirements.
Turing to the economic effects of disclosure, cross-listing is relevant to the fact that
domestic markets desire more international information. 429 Some have linked this
directly to the more stringent regulatory system. 430 The problem, once again, is that cross
listing does not hold either institutions or level of disclosure constant to determine what
the true effect actually is. There is a simple reason for this: it cannot be measured
because no two countries have the same institutions or regulations. In turn, financial
economists can only measure “regulatory packages.” 431 Moreover, citing cross listing as
pure evidence of the benefits of better international mechanisms is a stretch because it
presumes international regulators are somehow equivalent to a domestic jurisdiction’s
regulators, 432 or that there are international securities markets. 433 It does however stand
for the more general proposition that better information can lead to what investors
perceive as better market conditions. 434
427
See generally id.
See id., at 3-4. Economic incomes is a “change in market value” as opposed to a change in accounting
value, to which there are different methods of incorporation based on accounting standards. See id., at 1. In
contrast accounting income is only the incorporation of “realized” profits or losses i.e. where there has
been a sale of an investment. See Wiki CFO The How to Manual for CFOs, Accounting Income vs.
Economic
Income,
available
at
http://www.wikicfo.com/wiki/Accounting%20Income%20vs%20Economic%20Income.ashx
(visited
October 9, 2011).
429
See Roosenboom & Dijk, supra note 153, at 18 (showing “cross-listing on more developed markets
create more value for shareholders.”). Notably, the key factor is better information as opposed to more
information in terms of information disparity. See Lambert, Leuz & Verrecchia, supra note 393, at 3.
Importantly, more information will not always tract positively with better information. See id., at 6.
430
See Leuz & Wysocki, supra note 152, at 55 (discussing cross-listing and regulation but noting
regulations can only be “too onerous”).
431
See Roosenboom & Dijk, supra note 153, at 5; cf. id., at 51-6 (discussing various cross-country
comparisons of disclosure regulations).
432
See generally Regis Bismuth, The Independence of Domestic Financial Regulators: An Underestimated
Structural Issue in International Financial Governance, 1 GOETTINGEN J. OF INT’L L. 93 (2010)
(discussing problems of international financial regulation related to independence of regulators in various
jurisdictions from international space).
433
See supra notes 139-147 and accompanying text.
434
See Roosenboom & Dijk, supra note 153, at 14 (discussing “cross-listing in the US” as generating
“investor anticipa[tion] that the improved information disclosure associated with cross-listing on the
NYSE or Nasdaq will reduced cost of capital.”); supra note 429. But see Leuz & Wysocki, supra note 152,
428
53
Finally, studies regarding the firm’s natural inclination to disclose can give insight into
the amount of information necessary. If firms will self-report, then institutional
restructuring only needs to focus on disbursing the information and enforcing standards,
and not on requiring extra information. Firms have some natural incentive to disclosure
information about themselves deriving from the fact that if the firm is really value
creating it will want to communicate that to the market. 435 Other firms in the market, to
avoid the impression that they are not value creating, will disclose out of competitive
concerns 436 with only the most undesirable firms not disclosing. 437 Resulting from this,
public solutions in turn must offer “better” or lower cost solutions than can be achieved
through market mechanism alone. 438 Applying the same rational to international
restructuring – assuming that there are natural barriers that prevent information
movement, 439 so at least some action is necessary – then if the benefits to mandatory
international rules go beyond the imperative to self-report they should be implemented.
If they do not, the international system should simply try to overcome fundamental
barrier to information. In this sense, improvements would be beneficial to the extent they
are reaching problems that domestic systems cannot handle themselves.
Empirical evaluations that target the true benefits of administrative tools are essential for
evaluating the tool. In this way, regulators can determine if these mechanisms, which
may be costly, are worth the effort. Unfortunately, empirical research is not within the
purview of this article. Rather this part simply presented some wide based observations
that give credence to the fact that solving the international information asymmetry would
be beneficial and that market, and that markets will incorporate this information into
their risk pricing and monitoring activities.
5. Conclusions
The argument of this article has been that minimized restructuring of the international
financial architecture using administrative tools can help solve the information
asymmetry problem that exists between the international space and domestic markets and
regulators. To ascertain which tools are valuable regulators must approach the problem
from a perspective of underlying market conditions. In this sense, they should be
cognizant of the effects they want to achieve and attempt restructure only to the amount
necessary to achieve these ends. A more comprehensive system of international financial
regulation may be desirable but given political problems and divergent national practices
this will not come about.
To do this the article first attempted to characterize the problem in real terms citing some
of the well-established risks and regulatory responses that have come about out of the
at 55 (citing literature that gives evidence that “market forces (rather than legal requirements) are
responsible for improvements in corporate transparency around US cross-listing.”).
435
Leuz & Wysocki, supra note 152, at 14-15
436
Id.
437
Id., at 15.
438
Id.
439
See Goodhart & Lastra, supra note 14, at 714-17 (discussing issues of cross-border international
financial regulation); supra note 227.
54
2008 Financial crisis. Next, it examined recommendations by the FSB and IMF to close
the asymmetry problem. In the context of these problems, reforms, and recommendations,
the article tried to show that international administrative tools can supplement reforms
addressing the well documented risk pricing problems that arose out of the 2008
Financial Crisis. It also hoped to show that there were benefits in avoiding a closed
regulatory system between regulators and intermediaries that could lead regulatory
failings like the ones seen during the 2008 Financial Crisis and discussed in Part 2.2. In
this way, markets will benefit from improved information. Moreover, tools can bolster
regulator-to-regulator cooperation while also servicing the market directly.
In the final part, the article attempted to show that markets will care about this
information by trying to extrapolate inferential evidence of the value of these
administrative tools to markets out of existing empirical research on related topics.
Although there is some evidence of general market propensities targeted empirical
research is necessary. The crux of this examination remains that even if information is
given to domestic markets and regulators, will they use or care about this information.
Moreover, will managers internalize this information into policies and practices that
serve stability and the normative interactions of finance.
Unfortunately, a definitive result as to the value of any particular tool is not ascertainable.
However the combination of an EECS type tool with data repositories may offer an
optimal and easy to implement solution to some problems. A few tools, however, are
already in the process of implementation, specifically TR and IAG, regulators must feel
that these are either essential or easy to implement. In time, the relative successes of
these policies can be measured and future steps can me made toward the problem. This,
however, must always be set against the changing economic situation and the fact that in
robust times efforts to ensure stability give way to competition between jurisdictions. As
such, the article did not recommend a total-fix or an integrated system but simply sought
to highlight concerns and possible solutions surrounding the information asymmetry that
exists between the international space of the domestic capital markets and jurisdictions.
55
SHAREHOLDERS’ GENERAL MEETINGS AND THE ROLE OF PROXY ADVISORS
AND JAPAN
IN FRANCE
Edouard Dubois
Introduction
Fastidious and ceremonial, general meetings of listed companies differ little around the
world. General meetings in Japan used to last no more than thirty minutes and were
described as “shan shan” (clap clap) meetings. 1 In France meetings might have lasted
longer but the result was the same: the management was undisputed and shareholders were
apathetic. 2 The rise of foreign institutional investors in the capital of French and Japanese
companies has brought some change. Voting rights have gradually been considered as
assets which must be fructified. In order to increase investors’ participation regarding
corporate governance, mutual funds have been pressed to vote at shareholder meetings to
respect their fiduciary duty in countries like Canada, the United Kingdom, France and the
United States. 3 In Japan the Pension Fund Association has urged other pension funds to
draft voting policies and to force asset managers to vote accordingly. 4 In reaction, general
meetings are gradually transforming, more opened to debate and contestation, while
shareholders finally use their voting rights to protect their interests. 5
The complexity and high cost of proxy voting led to the development of a new business:
proxy voting advisory services. 6 This industry is dominated by one prominent company,
Institutional Shareholder Services. As one commentator describes it: “Most people have
probably never heard of Institutional Shareholder Services (hereinafter ISS), but it is one of
the most powerful players in the battle for control of the American corporation. It is the
800-pound gorilla in the room.” 7 These proxy advisors give recommendations to
institutional shareholders on how to vote on the basis of corporate governance principles
for general meetings of listed companies. More and more investors have gradually
outsourced their votes to those proxy advisors which can now sway the votes of trillions of
dollars of assets. 8 The influence of the proxy advisors has forced listed companies to react
and to improve their corporate governance in order not to face shareholders’ rebuff. The
proxy advisors, by publishing their own governance principles and selling their voting
1
E-mail from Koji Morioka, Head of Kabunushi Ombudsman, Professor of Economics, Kansai University, to
the author (April 4, 2011, 07:20:19 (PDT)) (on file with the author).
2
Report Working Group AMF, Improving the Exercise of Shareholders Voting Rights at General Meetings
in France, at 7-8 (2005).
3
Nicolas Cuzacq, Le vote des gestionnaires d’OPCVM [The Votes of Mutual Funds’ Managers], 3 REVUE
DES SOCIÉTÉS 491 (2006).
4
Bruce E. Aronson, A Japanese CalPERS or a New Model for Institutional Investors Activism? Japan’s
Pension Fund Association and the Emergence of Shareholder Activism in Japan, 7 N.Y.U. J. L. & BUS. 582
(2011).
5
See infra Part 1.2.
6
The denominations proxy advisors, proxy voting advisors, proxy providers are similar and will be used
interchangeably in this paper.
7
William J. Holstein, Is ISS Too Powerful? And Whose Interests Does It Serve?,
CBSNEWS (February 7, 2008), available at http://blogs.bnet.com/ceo/?p=1100&tag=content;col1 (visited
November 19, 2011).
8
See infra Part 3.1.
56
recommendations, have become soft-law makers as well as officious regulators of
corporate governance around the world. 9
This increasing influence of the proxy advisory activity has led issuers and regulators to
question their legitimacy and the lack of oversight of those actors. On March 2011 the
French financial market regulator, the Autorité des Marchés Financiers, released its first
recommendations to proxy advisors while the Securities and Exchange Comsission
(hereinafter SEC) and the European Commission have suggested some regulations and are
calling for comments. 10
Proxy advisors have become intrinsically linked to the proxy voting system and their
influence is increasing hand-in-hand with the expansion of institutional investors’
portfolios worldwide. They started to expand their activities to Europe and Asia in the
2000s but their role outside the United States has never been studied. This paper seeks to
study the role and influence of proxy advisors on the proxy voting system and on corporate
governance in France and Japan.
France and Japan present interesting points of comparison. They both have corporate
governance systems traditionally characterized as stakeholder models or “internal”
systems. 11 Corporations were protected by cross-shareholding (called noyaux durs in
France) or by family holdings. Governments played a key role in the national economy. 12
The need to attract capital, however, forced companies to turn towards foreign
shareholders and to gradually embrace the shareholder primacy principle. This pressure to
adopt a shareholder-model of corporate governance is now heightened by the systematic
voting of institutional investors, guided by proxy advisors’ recommendations.
This paper will proceed as follows. Part 1 outlines the role and powers of general meetings
of shareholders in France and Japan. The voting process will be discussed as well as the
legal reforms and market evolutions in both countries which have led to more shareholder
activism. Then Part 2 presents the factors explaining the emergence of proxy advisors in
the United States, France and Japan. Finally Part 3 reviews the influence of proxy advisors
on shareholders’ voting rights and globally on corporate governance. This section will also
cover the different regulations and proposals emitted by the authorities to offer a better
oversight of the proxy advisory industry.
1. Shareholders’ General Meetings in France and Japan
The first participation in a general meeting of a French listed corporation can be surprising
and disappointing. General meetings are somewhere between an expensive public-relations
show and a fastidious rubber-stamping ceremony. A majority of attending shareholders are
retirees impatiently waiting for the end of the meeting to run to the cocktail party,
9
Id.
See infra Part 3.2.
11
For a description of French corporate governance, see generally Peter Wirtz, The Changing Institutions of
Governance in Corporate France: What Drives the Process?, Working Papers FARGO, available at
http://www.u-bourgogne.fr/LEG/WP/1040701.pdf. For Japan (visited November 19, 2011). see generally
MASAHIKO AOKI, GREGORY JACKSON, AND HIDEAKI MIYAJIMA, CORPORATE GOVERNANCE IN JAPAN INSTITUTIONAL CHANGE AND ORGANIZATIONAL DIVERSITY (1st ed. 2008).
12
See YVES TIBERGHIEN, ENTREPRENEURIAL STATES – REFORMING CORPORATE GOVERNANCE IN FRANCE,
JAPAN, AND KOREA (1st ed. 2007).
10
57
sometimes booing when too many shareholders ask questions and exiting the room even
before they cast their vote. 13 So much for shareholder democracy. Those meetings can
therefore appear to be a waste of time and money. Mark D. West makes a similar
description for the general meetings taking place in the United States and Japan:
In both Japan and the United States, shareholders' meetings are usually meaningless rituals
that have all the entertainment value of watching wet paint dry. Occasionally they become
lively, such as in the context of contests for corporate control, the occasional shareholder
activist proposal, or shareholder protest situations such as the 1997 upheaval over outgoing
Disney president Michael Ovitz's $96 million severance package. But for the most part
they have little to do with accountability or governance, as corporate democracy in the
form of majority shareholder rule generally settles contentious issues before the meeting.
Still, shareholders' meetings are required by law to be held annually both in Japan and the
United States, and managers begrudgingly comply with the law. 14
The discussion about the inefficiency of general meetings seems to be common to most
countries. 15 General meetings are supposed to be the supreme organ of the corporation,
where shareholders can protect their interests by voting on the most important decisions
and electing their representatives. Its effectiveness as a decision-making body and as an
exchange forum for shareholders and managers will depend in the end on the actual
participation of shareholders to this event.
1.1 Shareholder Voting at General Meetings
Shareholders’ voting rights are often presented as a fundamental right. Scholars describe it
as “ ‘the prime right of the shareholder’, the essential characteristic of equity, the most
important administrative right of members or one of the shareholders’ essential
participatory and creative rights as co-owners of the company.” 16 Shareholders,
conceptualized as owners of the company, bear the risks of the business and therefore must
be protected. Voting rights give them a say in the most important corporate decisions and
the power to select the directors to represent their interests. Thus general meetings are
supposed to be a crucial element of the corporate life, embodying supreme powers.
However, to attain a true shareholder democracy and to give full potential to the general
meeting, the voting process must be simple and efficient.
1.1.1 The General Meeting, Supreme Organ of the Corporation
1.1.1.1 French Regulatory Framework of General Meetings
In France the annual general meeting must take place within six months after the end of the
financial year in order to approve the annual accounts. 17 Most French companies close
their accounts on Dec. 31st and therefore hold their meetings between March and June.
13
Denis Cosnard, L’art des assemblées générales [The Art of General Meetings], LES ÉCHOS, April 20, 2001.
Mark D. West, Information, Institutions, and Extortion in Japan and the United States: Making Sense of
Sôkaiya Racketeers, 93 NW. U. L. REV. 16 (1999).
15
MATHIAS M. SIEMS, CONVERGENCE IN SHAREHOLDER LAW 90 (1st ed. 2008).
16
Id., at 87-8.
17
French Code of Commerce (hereinafter FrCCom) Art. L225-100.
14
58
In general, French companies call their shareholders for “combined general meetings”
(assemblées générales mixtes), of which the agenda includes resolutions falling in the
domain of both ordinary and extraordinary meetings (“ordinary resolutions” and
“extraordinary resolutions”). The meeting is usually convened by the board of directors (or
the management board in a two-tier system company). 18 If not, it can be convened by an
auditor, controlling shareholders after a public take-over bid, exchange offer or the transfer
of a controlling block of shares, or a liquidator. Finally the convening of the meeting can
be organized by a representative appointed by the Court at the request of any interested
party (in emergency cases), a shareholder or a group of shareholders holding at least five
percent of the company's capital , a shareholders' association, 19 or the work council (in
emergency circumstances). 20
A specific quorum is required for both ordinary and extraordinary general meetings. An
Act of July 26, 2005 reduced the quorum due to insufficient shareholders’ participation.
Before that corporations with large free floats had difficulty reaching the quorum on the
first call. 21 For ordinary general meetings, a fifth of the company's shares must be present
or represented at the first convening. 22 No quorum is required at the second convening.
Items on the agenda must obtain at least half of the vote in order to be adopted. 23 During
those meetings shareholders have to vote on issues such as the appointment of directors 24
(or supervisory board members), the executive remuneration (through related-party
transactions, golden parachutes or severance payments), or the approval of annual accounts
and distribution of dividends.
For extraordinary general meetings, a quarter of the company's shares must be present or
represented on first convening and a fifth on the second convening. 25 Items on the agenda
must obtain at least two thirds of the vote in order to be adopted (with the exception of
certain capital increases as the issuance of warrants during a takeover offer for which a
simple majority is required). 26 Items dealt with by the extraordinary general meeting
include the amendments of the articles of association, 27 the approval of all capital-related
decisions 28 (e.g. capital increase/decrease, issuance of authorized capital, waiving of preemption rights), or the approval of corporate restructuring (e.g. merger, split).
Listed companies must publish two convocations for their general meetings (avis de
réunion and avis de convocation). The first convocation is published in the Official
Bulletin and indicates to shareholders that the general meeting will take place in at least 35
calendar days. Items on the agenda are not final and are subject to any amendment or
counterproposal either from the board or from shareholders. The second convocation is
published at least fifteen calendar days before the date of the general meeting. 29
18
FrCCom Art. L225-103.
FrCCom Art. L225-103.
20
Code du travail (French Employment Code) Art. L2323-67.
21
Report Working Group AMF, supra note 2, at 8.
22
FrCCom Art. L225-96.
23
FrCCom Art. L225-98.
24
FrCCom Art. L225-18.
25
FrCCom Art. L225-96
26
FrCCom Art. L225-96 and Art. L233-32.
27
FrCCom Art. L225-96.
28
FrCCom Art. L225-129.
29
FrCCom Art. R225-69.
19
59
A shareholder or a group of shareholders holding at least five percent of the capital might
add a resolution to the agenda. 30 The proposal must be sent to the company at least twentyfive days before the general meeting. 31 The scope of these shareholders’ proposals is
limited to issues in the competence of the general meeting otherwise the board could refuse
to register the proposal. Unlike in the United States, voted proposals are binding the board
of directors to implement them.
The Decree of June 23, 2010, in transposition of the European Directive 2007/36/CE on
shareholders rights, has increased the disclosure rules that issuers have to respect. Thus all
listed companies must have a Website and publish on it all the necessary documents at
least twenty-one days before the general meeting. 32 The list included the notice of meeting,
the agenda, the financial accounts, the number of votes and shares, as well as the proxy
ballots. Voting results must also be disclosed on the same site. 33 In fact most companies
were already respecting those requirements so only small capitalizations might have to
improve their disclosure.
1.1.1.2 Japanese Regulatory Framework of General Meetings
Listed companies in Japan must hold their annual general meeting within three months of
the close of the fiscal year. Seventy-six percent of them close their financial accounts at the
end of March. 34 “This is partially the result of an effort to make corporate fiscal years
uniform with the government's fiscal year and Japan's academic year.” 35 Most Japanese
general meetings thus organize their meeting at the end of June. The record date for an
annual general meeting is set by the company in the articles of association and must be set
within three months before the general meeting. 36 The fiscal year end is usually the record
date. Thus the discrepancy between the voting rights’ owners and the actual shareowners at
the meeting date can be important and cause a problem of “empty voting”.
The shareholder’s meeting is convened by the directors. 37 Shareholders holding at least
three percent of the voting rights for six months consecutively can also ask the directors to
call a general meeting. 38 If the directors fail to comply, the shareholders can then call the
meeting with the permission of the court. 39
There is a two-week legal notice period to call a meeting. 40 This notice is sent in writing or
by an electronic method if approved by the shareholders, 41 and includes the agenda of the
meeting. 42
30
FrCCom Art. L225-105.
FrCCom Art. R225-73 II.
32
FrCCom Art. R210-20 and R225-73-1.
33
FrCCom Art. R225-106-1.
34
Tokyo Stock Exchange, White Paper on Corporate Governance2009,
http://www.tse.or.jp/english/rules/cg/white_paper09.pdf (visited November 25,2011).
35
ISS, Japan Market Profile, 2005.
36
Japanese Companies Act (hereinafter JpCA) Art. 124.
37
JpCA Art. 296 (3).
38
JpCA Art. 297 (1).
39
JpCA Art. 297 (4).
40
JpCA Art. 299 (1).
41
JpCA Art. 299 (2) and (3).
42
JpCA Art. 299 (4).
31
60
available
at
According to the Companies Act, the general meeting is competent for the organization,
operations and administration and any other matters regarding the company. 43 However,
the meeting’s competence is limited to the matters enumerated in the Code and the articles
of association. 44 The Japanese Companies Act requires a quorum of a majority of the
outstanding shares for ordinary meetings and extraordinary meetings. 45 This quorum can
be reduced in the articles of association. A simple resolution is needed for matters such as
the approval of cash dividends, approval of financial statements, and election and dismissal
of directors, or election of statutory auditors and accounting auditors. They need to be
approved by the affirmative votes of a majority of the shares represented at the meeting. 46
Shareholders can have cumulative rights for the election of directors if they request it but
only if the company did not opt for a single right system in its articles of association. 47
More important matters related to amending the articles of association need an affirmative
vote of two thirds of the shares represented to be accepted. 48 An important difference with
France is that some authorized capital issuances can be approved by the board of directors
without a previous delegation by the general meeting, consequence of the US legal
transplant in 1950. 49
Shareholders holding at least one percent of the total voting rights or more than three
hundred voting rights (both amounts can be reduced in the articles of association) during
the previous six months can ask the directors to add a proposal in the agenda. 50 This
proposal must be sent at least eight weeks before the meeting. Other shareholders must be
notified of the summary of the proposals. 51 In practice this eight weeks notice period
means shareholders have to submit their proposals even before knowing the date of the
meeting since the meeting notice must be sent no later than two weeks before the meeting.
The Financial Services Agency of the Japanese government has amended the Cabinet
Office Ordinance on Disclosure of Corporate Affairs in 2010 to improve the disclosure
regarding corporate governance. 52 The new regulation requires listed companies to publish
without delay the voting results of general meetings. 53
In conclusion, France and Japan have a similar division of powers between the
shareholders and the board of directors, which is coherent with the theories of global
convergence of corporate law. General meetings are supervisory bodies whose more
important power is to decide who will be the directors to represent them and to dismiss
them if their interests are not protected. 54 The powers are set by the law in both countries,
leaving only a little room for the articles of association. However, shareholders of French
companies have been more empowered as they have to be consulted on all capital-related
43
JpCA Art. 295 (1).
JpCA Art. 295 (2).
45
JpCA Art. 309 (1).
46
JpCA Art. 309 (1).
47
JpCA Art. 342 and 342 (1).
48
JpCA Art. 309 (2).
49
Siems, supra note 15, at 163.
50
JpCA Art. 303 (1) and (2).
51
JpCA Art. 305.
52
See the Financial Services Agency’s Website, available at http://www.fsa.go.jp/en/news/2010/201003261.html (visited November 19, 2011).
53
Id.
54
Siems, supra note 15, at 150.
44
61
decisions as well as the compensation packages of the officers which are now considered
related-party transactions.
1.1.2 The Voting Process for Shareholders
1.1.2.1 The Voting Process in France
Shareholders’ voting rights are gradually converging in Europe thanks to the European
Commission’s efforts to ensure that shareholders exercise their votes and that Member
States and corporations remove any barriers.
The European Commission issued a cross-border voting directive on Jan. 5, 2006, which
recommends that European countries switch to a record-date system. A Decree of
December 11, 2006 replaced in France the share-blocking by a record-date system,
effective since January 1, 2007. The record-date has been set at three business days before
the meeting. Thus, the shareholders registered in the company’s account for the nominative
shares or in the intermediary’s account for the bearer shares three days before the meeting
are the only ones who can vote. Before the introduction of the record-date system, bearer
shareholders had to block their shares during the five days preceding the general meeting.
In fact non-resident investors often had to block their shares two weeks in advance due to
the number of financial intermediaries. 55 It was an important factor explaining low
participation from foreign investors who did not want to take the risk not to be able to trade
their shares. The disadvantage of the record-date system on the other hand is that the vote
bearer may have already sold his shares at the time of the general meeting. Being fully
aware of that problem, French legislators decided to set the record-date only three days
before the meeting. 56
According to French law, shares might be registered or held as bearer certificates. 57 For the
shares registered in companies’ accounts, the voting process is managed directly by the
issuers. For bearer shareholders, a number of financial intermediaries make the process
long and costly (Fig. 1).
A chain of intermediaries has to handle requests for information and voting
materials, such as ballots and proxies, and the collection of marked ballots.
This chain includes the commercial bank (i.e. the branch), the securities
services department of the commercial bank (the custodian), the agent
banks, and the issuer. When shareholders are non-residents, the chain is
even longer and involves several layers of financial intermediaries 58 (Fig.
2).
55
Report Working Group AMF, supra note 2, at 10.
Since a 2005 reform the title of the share is transferred three days after the trade (Art. 570-2 Règlement
Général de l’AMF).
57
French Monetary and Financial Code Art. L211-3.
58
Report Working Group AMF, supra note 2, at 13.
56
62
Figure 1: Voting Process for Shareholder General Meetings in France
Company
Services Agreement
Securities
Account
Agent Bank
Custodian
Securities Account
Bank
Securities Account
Registered Shareholder
Bearer Shareholder
Source: AMF.
This system creates an important problem of information circulation. Issuers do not know
the identities of their shareholders and have to pay high fees to banks so that they “push”
the information through the custodians to the final shareholders. 59 It is also unsatisfactory
for investors who may not receive necessary documents and proxy ballots or might not
have enough time to analyze the meeting agenda and vote. That also explains the success
of proxy advisers who can serve as a successful intermediary between issuers and
investors.
59
Report Working Group AMF, supra note 2, at 14.
63
Figure 2: The Voting Process for Non-Resident Shareholders
Source: AMF.
In order to vote at the general meeting, shareholders can decide to attend the meeting. In
that case the custodian bank will issue an attendance card at his request. They can also vote
by mail by filling in the voting form provided by the bank. 60 Another possibility is to give
a blank proxy to the chairman of the meeting who will vote on their behalf. Finally, they
can give a mandate to a third person.
Until the end of 2010 only the shareholder’s spouse or another shareholder could serve as a
representative. 61 In transposition of the directive 2007/36/CE relative to the exercise of
shareholders’ rights in listed corporations, the Code de commerce was modified on Dec. 9,
2010 to allow shareholders to give a proxy to any third party. Corporations were afraid that
a third party (or proxy advisors) could gain too much power by soliciting shareholders’
proxies. Receptive to issuers’ concerns, the government decided to frame this right with a
number of requirements: a person soliciting proxies from shareholders need to disclose a
voting policy62 and to disclose any potential conflict of interests. 63 If the proxy does not
disclose all the required information or does not respect his voting policy, the company or
the shareholders can request the court to deny the proxy’s rights to participate in a general
meeting for a period of up to three years. 64
60
FrCCom Art. L225-107.
There is an exception concerning non-resident shareholders who could be represented by the financial
intermediary holding the share.
62
FrCCom Art. L225-106-2.
63
FrCCom Art. L225-106-1.
64
FrCCom Art. L225-106-3.
61
64
Those requirements have been criticized by investors as they were not in the European
directive and they create disproportionate obligations on the shoulders of proxies in
contrast to the managers who can still receive blank proxies or pay professional proxy
solicitors without any disclosure. Thus the International Corporate Governance Network,
an investors organization, claims that
The end result of the French Ordonnance is therefore to protect management
of French companies by allowing them to cancel if needed the vote
instructions coming through proxy agencies such as ISS, IVOX, GlassLewis or Broadridge. These votes can be cancelled simply by questioning
whether the final voting instructions are in line with the intentions of the
beneficial owner or because of inconclusive proxy voting policies. 65
Their concerns could be legitimate if the courts decided to take an extensive construction
of this ordonnance.
Electronic voting has been enabling by French law in 2001 but there has been a lot of
controversy regarding the value and recognition of electronic signatures. 66 Therefore, in a
quite antediluvian way, French bearer shareholders still have to fill in by hand proxy
voting cards, provided by the company, the custodian bank or by their proxy advisors.
Another common critique to the French system is the impossibility for shareholders to
track their votes. Due to the number of intermediaries in the system, especially for crossborder voters, the risk of lost votes or even errors in the votes is very high. 67 Still, there is
no system enabling a shareholder to follow his vote until the end of the “proxy plumbing”
in the general meeting. This lack of transparency led the corporate raider Guy Wyser-Pratte
to initiate an investigation by the Autorité des Marchés Financiers (hereinafter AMF), the
French Stock Market regulator. Indeed, Wyser-Pratte had launched a proxy fight against
the French media conglomerate Lagardère in 2010 and he claims that his proposals
received 21 percent of the affirmative votes instead of the 44 percent that were sent. 68 The
AMF argues that the mistakes must come from foreign custodians outside his regulatory
competence. 69 Cross-border voting is still a costly and inefficient process. Financial
intermediaries are said to be the source of most problems, imposing strict deadlines to
shareholders to vote even before companies had the time to disclose their proxy
documents.
65
See for example the letter to the French Senate by the International Corporate Governance Network, an
international
investors’
organization,
available
at
http://www.icgn.org/files/icgn_main/pdfs/comment_letters/icgn_comment_letter_to_franch_senate_projet_d%27ordonnance_droits_des_actionnaires__august_2010.pdf (visited November 19, 2011).
66
Report Working Group AMF, supra note 2, at 27.
67
The issue is mainly due to the fact that intermediaries do not keep separate accounts to register the shares
of each individual client but “they combine their holdings on behalf of all of their clients into one or more so
called omnibus accounts intheir name with another intermediary. As result, it is impossible to track
individual chains of securities accounts through which the shares of a specific investor are being held.”
European
Corporate
Governance
Forum,
Annual
Report
2006
available
at
http://ec.europa.eu/internal_market/company/docs/ecgforum/ecgf-annual-report-2006_en.pdf
(visited
November 19, 2011).
68
Guy Wyser-Pratte repart à l’assaut de Lagardère [Guy Wyser-Pratte Launches a New Assault on
Lagardère], Challenges, March 10, 2011.
69
Manifest Blog, Vote Transparency – Send In the Marines(May 20, 2011), available at
http://blog.manifest.co.uk/2011/05/5015.html (visited June 29, 2011).
65
1.1.2.2 The Voting Process in Japan
Shareholders of Japanese companies are entitled to one voting right for each share they
hold. The articles of association can also provide for share units, in that case shareholders
are entitled to one vote per share unit. 70
Issuers must send the proxy documents only fourteen days before the general meeting. 71
The timeframe is therefore very short. As in France, the proxy materials need to be sent to
registered shareholders through a chain of intermediaries (custodians and global custodians
for foreign investors) and the votes will have to go down the same road (Fig. 3). At the
end, the investor may have only two days to analyze the materials and vote on thousands of
meetings. 72 The reason is that, on one hand, the issuers might send the proxy documents at
the last time legally possible and, on the other hand, “institutional investors […] must cast
their vote according to deadlines set by their global custodian bank, not by local law. These
deadlines are typically around 10 days before a meeting, with some a more reasonable 7-8
days before and others a surprising 11-15 days before.” 73 Considering the general absence
of English translations and this time constraint, low foreign participation is not a surprise.
Thus in 2004 only 25 percent of foreign investors were estimated voting against more than
95 percent domestic investors. 74
70
JpCA Art. 308.
JpCA Art. 299 (1).
72
Interview with Shigeo Imakiire, Chief Operating Officer, Investors Communication Japan, in Tokyo, Japan
(February 24, 2011).
73
Asian Corporate Governance Association, ACGA Asian Proxy Voting Survey 2006, available at
http://www.acga-asia.org/public/files/ACGA_Asian_Proxy_Voting_Report_2006.pdf (visited November 25,
2011).
74
Tokyo Stock Exchange: Opening Corporate Japan to Foreign Investors, Global Custodian - Sponsored
Section 1 (2004), available at http://home.globalcustodian.com/sponsored/article.do?articleId=164 (visited
November 19, 2011).
71
66
Figure 3: Voting Process for General Meetings of Listed Companies in Japan
Source: Tokyo Stock Exchange.
Some Japanese issuers also take more shareholder-friendly dispositions and send notices of
convocation of general meetings before the two-week legal notice period. From only 38.4
percent in 1999, they were 75.2 percent in 2008 to do it. 75 Another progress is the
expanding use of the electronic voting. The company law reform of 2001 allowed the
exercise of electronic voting. 76 To develop this practice an electronic platform has been
created by the company Investors Communication Japan (ICJ) in 2004 for foreign and
institutional investors. ICJ is a joint-venture between the Tokyo Stock Exchange,
Broadridge, an American company specialized in proxy processing services, and the Japan
Securities Dealers Association. Their new platform allows a direct connection between
issuers and beneficial shareholders, by-passing all intermediaries (Fig. 4). Around 380
large listed companies are currently using this platform. 77
75
NIPPON KEIDANREN, TOWARDS BETTER CORPORATE GOVERNANCE 3 (2009).
JpCA Art. 298 (1) (iv).
77
Interview with Shigeo Imakiire, supra note 72 The list of companies is available at ICJ’s Website,
available at http://www.icj-co.com/english/introduction.html ( visited March. 11, 2011).
76
67
Figure 4: Voting Process with ICJ’s Electronic Voting Platform
Source: Tokyo Stock Exchange.
Issuers have an incentive to subscribe to ICJ services as the direct reception of proxy
ballots functions as an early alert system. Indeed, instead of receiving the ballots at the last
minute, issuers have an almost live feedback from investors. The company will instantly
see if an important number of shareholders are voting against a resolution. Management
will then have enough time to react, provide more disclosure and engage with shareholders
to convince them to change their votes. 78 It is therefore a mutually beneficial dispositive.
This new voting system removes one of the barriers to shareholders’ participation to
general meetings. There are still, however, some legal and non-legal factors explaining
why Japanese shareholders are apathetic for the most part. In its 2006 report on proxy
voting, the Asian Corporate Governance Association concludes that “Proxy voting systems
in Asia are, by and large, seriously antiquated and in need of improvement. Investors are
being disenfranchised.” 79 Japan was listed as one of the weakest voting systems of Asia. 80
“Japan did especially badly in areas such as notice of shareholder meetings, time to vote
before meetings, and clustering of meeting dates.” 81 There is still a lot of room for
improvement.
1.2 From Shareholder Apathy to Shareholder Activism
For shareholders it makes often more sense to be passive than active as the costs of active
participation would be superior to potential benefits. Moreover, each shareholder owns
78
Interview with Shigeo Imakiire, Id.
Asian Corporate Governance Association, supra note 73, at 7.
80
Id., at 21.
81
Id., at 22.
79
68
only a small portion of the company’s capital and would therefore only have a small
portion of the benefits; this collective action problem is called the “free rider effect.” 82 The
lack of attendance and of active participation is due to non-legal factors: concentration of
ownership, the feeling by retail investors that all important decisions are already decided
beforehand, high costs of voting for foreign investors combined with lack of knowledge of
foreign markets. Many shareholders see themselves as investors and not as owners. They
consider voting as burdensome and unnecessary since they cannot receive direct profits
from it. In France and Japan, countries with concentrated ownership and few active
institutional investors originally, management did not face any real controversies or proxy
fights.
1.2.1 Shareholder Participation in France
French law has extensively empowered shareholders compared to other European countries
or the United States. 83 General meetings’ agendas are thus much longer in average than in
other countries. The number of items, the complexity and length 84 of some resolutions,
especially regarding related-party transactions and executive remuneration, coupled with
the language-barrier has made proxy voting a difficult task to foreign shareholders.
Low attendance at general meetings in France has long been an issue. As in many
Continental European countries, most French corporations have a reference shareholder. In
a study of six hundred listed corporations in France, around 65 percent has a family
shareholding holding at least 20 percent of the shares. 85 This explains why there have been
much less proxy fights than in the United Kingdom or in the United States where
ownership is dispersed. Moreover, French law authorizes a lot of exceptions to the
principle of “one vote-one share”. The articles of association can give double voting rights
to long-term registered shareholders. 86 Limitations of voting rights are also allowed. 87
Shareholders can genuinely feel disenfranchised.
French shareholders’ meetings were often described as chambres d’enregistrement
(registration room) to illustrate the purely formal characteristic of the event. It was very
common that shareholders gave blank proxies to the chairman of the general meeting
(usually the CEO). Moreover the management would have discussed with the principal
shareholders before the meeting so all the important decisions have already been taken.
Therefore the participation to the meeting seemed useless for all the minority shareholders.
In 2005 the Autorité des Marchés Financiers (AMF), decided to create a working group
chaired by Yves Mansion, an AMF board member, to promote and ease the exercise of
voting rights by shareholders. The commission published a series of recommendations
which have been consequently implemented by the government for the most part: the
introduction of the record date system, the publication of all documents related to the
general meeting on the company’s Website, to make resolutions simpler to understand, to
82
Siems, supra note 15, at 89.
Report Working Group AMF, supra note 2, at 4.
84
France is second only to India for the length of its resolutions. Report Working Group AMF, supra note 2,
at 18.
85
Michel Albouy and Alain Schatt, Activisme et Proxy Fight – Quand les actionnaires déclarent la guerre au
management [Activism and Proxy Fights – When Shareholders Declare War to Management], 198-9 REVUE
FRANÇAISE DE GESTION 305 (2010).
86
FrCCom Art. L.225-123.
87
FrCCom Art. L.225-125.
83
69
translate the documents in English, a more active participation from institutional investors
and the promotion of electronic voting. The Report still had a managerial stance as it was
against the idea that non-shareholders could become proxies but in favor of giving proxies
to the chair of the meeting. It also called for more regulation regarding proxy solicitation
and proxy advisory services.
In 2012 an electronic voting platform should be finally available for all the listed
corporations who decide to use it, allowing residents and non-residents shareholders to
vote in a dematerialized method. 88 It is a huge improvement for institutional shareholders
who currently still have to print out proxy forms and to ask fund managers to vote for each
SICAV (mutual fund), 89 which can represent hundreds of documents per general meeting
for a large asset manager.
“Five years ago, the percentage of votes cast stood at approximately 40 percent, but in
2004, the average for the 44 companies in the SBF 120 index surveyed stood at 53 percent
(47 percent for companies in the CAC 40 index) of shares and 60 percent of voting
rights.” 90 With the instauration of the record date to replace the blocking share system,
participation has increased from less than 50 percent to more than 60 percent 91 in the CAC
40 and around 69 percent for the SBF 250 index, above the average European level. 92 With
more participation, more contestation came. In 2010 it hit a record with 64 proposals of the
management rejected by shareholders (Fig. 5). With 2.2 percent of resolutions rejected and
3.8 percent accepted with a dissent superior to 25 percent, France is the European country
facing the most disagreement by shareholders. 93
Source: Proxinvest.
88
Dernière saison « à l’ancienne » avant le vote électronique [Last « Old-Style » Proxy Season Before the
Electronic Vote], L’AGEFI HEBDO, March 24, 2011.
89
Id.
90
Report Working Group AMF, supra note 2, at 7.
91
Capitalcom, Bilan des AG 2010 [ General Meetings Report 2010], available at
http://www.capitalcom.fr/Documents/CP%20VF%20BILAN%20AGs%202010.pdf (visited November 19,
2011).
92
Proxinvest, Rapport Proxinvest sur les Assemblées Générales 2009 des sociétés françaises et européennes
[Proxinvest Report on French and European General Meetings2009], available at
http://www.proxinvest.com/index.php/fr/news/read/91.html (visited November 19, 2011).
93
ISS, 2010 Voting Results Report: Europe, at 11.
70
This increased contestation might be linked to the high ratio of foreign shareholders in
French firms:
Between 1985 and 1997, foreign owners increased their share of stock
exchange capitalization from 10 to 35% (compared to 9% in Britain, and 6%
in the US). By November 2000, of CAC 40 (top 40 French firms), the
average foreign equity holding was over 40% — a record among the world’s
leading industrial nations. 94
French controlling shareholders, usually called the noyaux durs, have reduced their
holdings while North American pension funds have significantly increased theirs to the
point where they sometimes become the largest group of shareholders. 95 At the end of
2010 more than 40 percent of French listed stocks were controlled by non-resident
shareholders. 96
With the rise of shareholder activism and the arrival of hedge funds in the shareholding of
French companies, there is a fear that shareholders have been given too much power. 97
1.2.2 Shareholder Participation in Japan
Japan seems to be living the same experience as France although at a slower pace and a
higher apprehension towards foreign shareholders. Japanese general meetings are a perfect
example for comparative scholars of how much the practice can change after a legal
transplant to another country with a different legal culture. Indeed, Japanese commercial
law has been mostly derived from the American model after the World War II but general
meetings had become purely ceremonial. To prevent any surprise during the meetings, it
became customary for companies to have their own employees to take front row seats, and
during the meeting call out, ‘No objection’ or ‘Next item’ in chorus to expedite
proceedings. 98 “In Japanese these meetings (or stage plays) were called ‘Shan, Shan’,
meaning ‘Clap, Clap’.” 99
“In the past, most of these meetings were rubber-stamp affair with almost no opportunity
for attendees to ask questions, and general shareholders did not give the [annual general
meeting] much thought.” 100 With cross-shareholding in place, it is no surprise that
Japanese shareholders are very passive. Japanese scholars speak of “a ‘skeletinization’
(‘keigaka’) of the general meeting into a mere ceremony.” 101 This phenomenon had been
94
Ben Clift, Debating the Restructuring of French Capitalism and Anglo-Saxon Institutional Investors:
Trojan Horses or Sleeping Partners?, 2 FRENCH POLITICS 338 (2004).
95
Id..
96
Julien Le Roux, Banque de France, La détention par les non-résidents des actions des sociétés françaises
du CAC 40 à fin 2010 [Non-Residents’ Ownership of French CAC 40 Corporations’ Shares at the End of
2010], 184 BULLETIN DE LA BANQUE DE FRANCE 94 (2011).
97
Charléty Patricia, Guillaume Chevillon, and Mouna Messaoudi, Stratégies de vote en AG face aux
résolutions externes [Voting Strategies during General Meetings Facing External Shareholder Proposals],
198-9 REVUE FRANÇAISE DE GESTION 278 (2009).
98
Koji Morioka, About Kanushi (Shareholders) Ombudsman – Its Goal and Activities, available at
http://www.zephyr.dti.ne.jp/~kmorioka/about%20KO_e.html (visited July. 20, 2011).
99
E-mail from Koji Morioka, supra note 1.
100
Masanobu Iwatani and Toshio Taki, Evolution of General Shareholders’ Meetings in Japan, 1 NOMURA
JOURNAL OF CAPITAL MARKETS 1 (2009).
101
Siems, supra note 15, at 90.
71
exacerbated by the creation of a “peak day.” 102 The aim of this practice was to limit the
influence of sôkaiya, corporate extortionists. Literally the term sôkaiya 総会屋 means
“general meetings operators.” 103 Those Japanese extortionists use hidden information
regarding the corporation or one of its executives to blackmail the company. If the
company does not pay, the sôkaiya would reveal the information during the general
meeting, ask embarrassing questions, create turmoil; anything that can disturb the
ceremony and make the President lose face.
The executives will pay well to avoid scandal. They buy sôkaiya silence at
meetings (a violation of the Commercial Code) or purchase the entire press
run of a publication. At the same time the executives may hire sôkaiya to
defend themselves against extortionate demands and thus play one group
against another. 104
In a survey of 1,200 Japanese firms realized in 1997, 67 percent of the corporations
admitted to having paid sôkaiya. 105 Executives would pay them to avoid the revelation of
possible embarrassing facts and ensure that the general meeting would not last longer than
the thirty minute-deadline. In response, under the recommendations of the Japanese
National Police Agency, 106 a majority of Japan’s listed companies had taken to the habit of
organizing their general meetings on the same day in the last week of June. 107 Indeed,
sôkaiya’s number is insufficient to attend thousands of general meetings taking place on
the same date. The problem then is that other more legitimate shareholders become
collateral victims of that practice, losing the ability to participate effectively in all the
meetings. “Japanese managers appear to be strategically using the threat of organized
crime as a way to reduce legitimate outside pressure. Firms having their meetings on the
national meeting day are less likely to be targeted by activists. They also under-perform in
terms of profitability and governance.” 108 It is more complex for non-resident investors to
analyze all resolutions and vote diligently for thousands of meetings on one day.
By many accounts things are finally going towards the good direction. Apparently sôkaiya
are becoming an endangered species thanks to successful legal reforms with stronger
penalties and more control from regulators. 109 The racketeers do not make the headlines
and the executives are not concerned by them anymore. 110 Consequently general meetings
last longer with shareholders taking a move active stance. They do not hesitate to ask
questions and make public statements (Fig. 6 & 7).
102
The terms “peak day” is used by the Tokyo Stock Exchange in the White Paper on Corporate Governance
2009 which defines it as “a date when the most of listed companies hold their ordinary general meetings of
shareholders (the most concentrated day in a year)”.
103
West, supra note 14, at 2.
104
KENNETH SZYMKOWIAK, SOKAIYA: EXTORTION, PROTECTION, AND THE JAPANESE CORPORATION
INTRODUCTION (1st ed. 2001).
105
Gilles Hilary and Tomoki Oshika, Shareholder Activism with Weak Corporate Governance: Social
Pressure, Private Cost and Organized Crime, 1 THE JOURNAL OF MANAGEMENT ACCOUNTING 56 (2006).
106
West, supra note 14, at 17.
107
Tokyo Stock Exchange, supra note 34, at 54.
108
Hilary and Oshika, supra note 105, at 72.
109
Iwatani and Taki, supra note 100, at 4.
110
Interview with Yoshiko Takawama, Chief Executive Officer, J-EURUS, in Tokyo, Japan (February 25,
2010).
72
Figure 6: Proportion of Companies with no Shareholder Statements/Questions
at Annual Meetings
Source : Nomura Institute of Capital Markets Research. 111
Still, old habits die hard and most companies continue to organize their meetings on same
dates despite foreign investors’ criticisms and Tokyo Stock Exchange’s multiple calls to
stop this practice. In 2011, 39 percent of listed companies organized their meetings on June
29 and 19 percent on June 24. 112 The Enforcement Regulations for the Company Act now
requires companies to disclose the reasons why issuers would organize their meetings
during the peak day. 113
Furthermore, in November 2007, the Exchange incorporated the Code of
Corporate Conducts into the Securities Listing Regulations, which stipulates
obligations to make efforts for facilitating the exercise of voting rights at
general shareholders meetings, including scheduling of the meetings to
avoid the peak day, early notification of general shareholders meeting,
English translation of convocation notices, etc., and exercise of voting rights
by electronic means. 114
111
Iwatani and Taki, supra note 100, at 3.
ISS, 2011 Proxy Season Preview: Japan, at 1.
113
Iwatani and Taki,supra note 100, at 4.
114
Tokyo Stock Exchange, supra note 34, at 53.
112
73
Figure 7: Proportion of Japanese Companies with Meetings
Lasting at Least 60 Minutes
Source : Nomura Institute of Capital Markets Research. 115
Many companies have also changed the way they conceptualize general meetings. They
understood that those meetings could be more than tedious ceremonies to become investor
relation platforms. Companies try to attract shareholders by offering free samples during
the meeting and organizing “roundtable discussions with shareholders following the annual
meeting as a forum for shareholders to share their opinions.” 116 Takeyuki Ishida, the
research manager of ISS in Japan, has noticed the same change of mindset in some
companies:
Japanese companies used to see general meetings as a legal issue so it was
managed by the legal department which was mainly concerned by protecting
the company against sôkaiya and not by shareholders rights. Now a new
breed of companies has an investor relations department which can be in
charge of the general meetings but small companies do not have one. 117
This evolution can also be explained by the need of Japanese corporations to look for new
individual shareholders as a source of stable shareholding due to the unwinding of cross
shareholding. 118 Shareholder activists have also appeared on the Japanese market. The
Kabunushi Ombudsman, a nonprofit shareholders’ association, became famous in the
media for their multiple actions against corporations. Their activities to improve corporate
governance of Japanese issuers include:
1) Monitoring corporate activities, criticizing antisocial acts by
corporations.
2) Campaigns to open a closed shareholder’ meeting.
3) Exercising the legal rights of shareholders such as derivative lawsuits
against top executives who have involved in illegal actions.
115
Iwatani and Taki, supra note100, at 4.
Id., at 2.
117
Interview with Takeyuki Ishida, Head of Corporate Governance Research, ISS, in Tokyo, Japan (February
21, 2011).
118
Iwatani and Taki, supra note 100 at 5.
116
74
4) Shareholder proposals for transparency and compliance. Especially we
have emphasized disclosure of individual directors' remuneration.
5) Investigation about actual conditions of corporate governance and
management, such as shareholders’ meetings, disclosure, employment,
gender equality, and food safety, political donation, and etc. 119
Finally the recent Fukushima crisis has shown that Japanese shareholders can react as any
other shareholder. During the Tepco’ shareholders’ general meetings on June 28, 2011,
more than 9 thousands shareholders came and many chorused for the dismissal of the
management during a six-hour long meeting. Four hundred shareholders submitted a
proposal requesting the decommission of nuclear plants and the stop of new
constructions. 120 The proposal even received the support of the Japanese Proxy
Governance Institute, a proxy advisor, who also recommended to vote against the sixteen
directors’ reelection. 121 Nevertheless, the proposal was rejected by shareholders but it
shows that shareholders do not hesitate to use the general meeting as an open forum and
that the good old thirty-minutes-no-questions-asked general meetings is a thing of the past.
1.3 Conclusion
There has been a global convergence to empower shareholders and facilitate investors’
participation to general meetings. Japan and France seem to be following the same path,
although at a slower rhythm for Japan. Both countries’ companies are facing more activism
and a pressure to improve their corporate governance standards by foreign institutional
investors. The market regulators (AMF for France and TSE for Japan) have taken an active
role in improving the exercise of shareholders’ voting rights and requiring companies to
improve their disclosure relative to general meetings. However, voting at general meetings
is still a costly and time-consuming process for most shareholders, especially for
institutional investors and banks with international portfolios. With more and more care to
corporate governance issues, it was paradoxical that investors were not paying more care to
their voting rights. It is therefore not surprising that States decided to intervene to make
investors fulfill their duty. This could lead to the development of the proxy advisory
business internationally.
2. The Rise of Proxy Advisors
Proxy advisors emerged at first in the United States in the 1980s but they have had to wait
until the 1990s and the corporate governance boom to develop. Some specific factors
regarding corporate regulations and the market explain why those companies successfully
grew first in America. Proxy advisors have quickly developed to become international
players with an intensive competition. However, the Institutional Shareholder Services has
successfully used its first mover advantage to become and stay the market leader.
2.1 The Emergence of Proxy Advisors
119
E-mail from Koji Morioka, supra note 1.
Kazuaki Nagata, Shareholders Hammer Tepco Over Nuclear Fiasco, THE JAPAN TIMES, June 29, 2011.
121
Some Power Firm Shareholders Wary of Nuclear Energy, ASAHI.COM, June 19, 2011.
120
75
Paul Rose, Assistant Professor of Law at the Ohio State University, identified two main
factors explaining the emergence of the “corporate governance industry”, including proxy
advisors, in the United States.
The first is structural: the existing regulatory regimes affecting corporate
governance are structured with sufficient regulatory space so that an
industry providing corporate governance advice has room to grow, but
regulatory space only provides an answer to how the corporate governance
industry could develop. The second factor, market demand from
institutional investors, explains why the corporate governance industry
developed. 122
2.1.1 The Factors of the Emergence of Proxy Advisors
2.1.1.1 The Corporate Governance Regulation
This “regulatory space” is due in one part to the states competition regarding corporate
law: this course to the bottom resulted in a low level of mandatory law. 123 Delaware’s
corporate law is mainly judge-made and amended only when required by litigants. 124
Listing requirements on stock markets are another source of rules. These listing standards,
usually including some corporate governance requirements, are rules from private actors
but under the SEC supervision. 125 Exchanges also compete between each other and so
listing requirements have been rather vague and flexible concerning corporate
governance. 126 Finally, according to Rose, “a traditional deference by Congress and the
courts to state and exchange regulation of corporate governance matters (Sarbanes-Oxley
notwithstanding) has limited SEC efforts to create substantive governance
requirements.” 127 Corporate governance rules have then been supplemented by soft law
mechanisms. In the 1970s, to avoid additional SEC regulation, the Business Roundtable
issued a first set of best practices rules for listed companies, 128 which was quickly followed
by other organizations as the Council of Institutional Investors 129 or the National
Association of Corporate Directors. 130 The Organisation for Economic Co-operation and
Development (hereinafter OECD) has also issued a Code of corporate governance
principles for listed companies. 131 Even though listing standards and federal corporate law
have created a mandatory framework regarding corporate governance, the vagueness of
most governance principles and lack of binding character created a perfect environment for
a corporate governance industry to grow.
122
Paul Rose, The Corporate Governance Industry, 32 J. CORP. L. 106 (2007).
Id., at 109.
124
Id., at 108.
125
Id., at 109.
126
Id.
127
Id., at 110.
128
BUS. ROUNDTABLE, BUSINESS ROUNDTABLE PRINCIPLES OF CORPORATE GOVERNANCE, 13 (2005).
129
Council of Inst. Investors, Corporate Governance Policy (2006), available at
http://www.cii.org/policies/2006%20(April)%20CII%20Policies%20(2).pdf (visited November 19,2011).
130
Rose, supra not 122, at 110.
131
Id.
123
76
2.1.1.2 Institutional Investors and Proxy Voting: A New Market
The most important factor for explaining the rise of proxy advisors was the existence of a
huge market of institutional investors in need of corporate governance advice and proxy
voting recommendations.
“In 1965, institutional investors held 16% of U.S. equities; by 2001, institutional investors
held 61%. The increasing numbers of institutional investors meant a lucrative, developing
market for corporate governance advisers.” 132 This means the market reached a critical size
where the number of potential clients was high enough for corporate governance advisers
to make profits with their research. A proxy advisor will sell the same voting
recommendations to all clients using the same voting policy; therefore each new client will
represent new profits for relatively no additional costs. Therefore expansion produces
important economies of scale for proxy advisors.
So the potential customers were finally there but why would investors pay somebody else
to give them recommendations on how to vote? As discussed previously, institutional
investors as well as other shareholders would act rationally by being apathetic. There are
several reasons explaining why institutional investors are not the gatekeepers we expect
them to be:
the limited number and types of institutional investors willing to undertake
activist strategies, institutional investors’ inability to coordinate effectively
to overcome shareholders’ collective action problem, limited resources
devoted to activism due to a free rider problem, a lack of competence and
expertise, and a preference for liquidity over control and for exit over
voice. 133
If they are displeased with the management or the performance of the company, they
would vote with their feet by selling their shares, it is called the “Wall Street Walk.”134
Otherwise they would just vote in favor of all management’s resolutions. This passivity
was criticized by the OECD in its report on the financial crisis: “In sum, shareholders have
contributed importantly to failures of boards and companies by being too passive and
reactive. One possible reason for this is that they are short term investors and the cost of
monitoring is in any case too high.” 135
However, some shareholders began to realize that voting at general meetings was a way to
improve companies’ corporate governance, which entails a diminution of risks and
improvement of performance, at least theoretically. The big shift came with the recognition
of proxy voting as a fiduciary duty of pension funds. In 1988 the Department of Labor
declared that all managers of ERISA-governed pension plans had to exercise their voting
rights in accordance with a “prudent man” standard. 136 “Not long thereafter, the SEC
132
Id., at 111.
Aronson, supra note 4, at 582.
134
Angela Morgan, Annette B. Poulsen, Jack G. Wolf, and Tina Yang, Mutual Funds as Monitors, Evidence
from Proxy Voting (2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1572049 (visited
November 19, 2011).
135
OECD, Corporate Governance and the Financial Crisis Key Findings and Main Messages (2009),
available at http://www.oecd.org/dataoecd/3/10/43056196.pdf (visited November 19, 2011).
136
See Letter from U.S. Dep’t of Labor to Helmuth Fandl, Chairman of Retirement Board, Avon Products,
Inc. (February 23, 1988).
133
77
Division of Investment Management issued a similar ruling that the fiduciary obligations
of registered investment advisors include voting all shares held in managed portfolios in
accordance with the fiduciary duties of loyalty and care.” 137 The voting right is assimilated
to a financial asset that managers must fructify 138. The “increasing regulatory focus on
proxy voting” 139 provided a miracle boost to the industry. It was followed by a 2003 SEC
requirement that mutual fund disclose their voting policy and actual votes and that
managers vote proxies in the best interests of their clients. The goal is to protect the
investors’ interests by clarifying the fiduciary duties of funds’ managers. 140 This
requirement would help to solve the agency problem between investment funds and their
clients. By requiring this disclosure of votes and the voting policy, funds’ managers were
no more able to blindly follow management recommendations regarding general meeting
votes. They had to become enlightened shareholders, studying each company meeting and
resolution before voting. They now feared a breach of their fiduciary duty by doing
otherwise. The “good” corporate governance principles gave them a basis to make their
voting decisions.
Forcing investors to vote and to disclose their votes when most of them would be unable to
do it at a reasonable price could only lead to more outsourcing to proxy advisors. Most
professional investors now need to vote at general meetings all over the world, with an
intense activity in spring when most companies hold their meetings. Given the periodic and
the labor-intensive nature of this activity, it made more rational sense for investors to
outsource proxy voting. To use a prominent proxy advisor as ISS gave to institutional
investors an easy solution, providing them with a way to vote in a consistent and reliable
manner in all the markets in which they invest while conferring them additional credibility.
The situation even reached a point where asset managers would not look serious when
competing to win a mandate if they were not using a proxy advisor.
Voting had to become a duty rather than a right to finally be used by investors. Thus the
combination of these elements explains the emergence and development of the proxy
advisory industry in the United States.
2.1.2 The Proxy Advisors Industry
2.1.2.1 The Role of Proxy Advisors
Institutional investors have to vote at general meetings and they must do so in an
“enlightened” way. This is a complex and time-consuming activity which gave birth to a
whole new industry and corporate governance experts. Indeed, what the regulators failed to
see was that most small institutional investors would not have the manpower or the will to
deal with the proxy voting.
For portfolio managers, active or quantitative, institutional or retail, the only
corporate governance (as opposed to economic) vote that counts is the buy
or sell decision. (…) The quantitative manager is even further removed from
137
Latham & Watkins LLP, The Parallel Universe of Institutional Investing and Institutional Voting,
CORPORATE GOVERNANCE COMMENTARY NEWSLETTER, April 6 , 2010.
138
Cuzacq, supra note 3, at 491.
139
Rose, supra note 122, at 111.
140
Cuzacq, supra note 3, at 491.
78
voting because its investment thesis is based on quantitative models that
operate on the basis of their internal logic. Voting shares is not just an
afterthought for the quantitative manager, it is simply irrelevant. 141
This has created a dichotomy between institutional investing and institutional voting.
Institutional investors make a rational choice in outsourcing proxy voting to proxy
advisors.
Another important element explaining proxy advisors services’ success was the
development of new technology enabling shareholders to cast their votes for all their
meetings in a simple manner electronically. This logistic “concerns the entire process, from
the shareholder's instructions to the service provider to vote in a particular way up to and
including the actual voting at the meeting on the institutional investor's behalf in
accordance with the latter's instructions, including, if necessary, the blocking of the shares
and the deposit of the proxy.” 142 The proxy advisors became a central part of the voting
process, which is now a lucrative business including an important number of
intermediaries (Fig. 8). Thus proxy advisors are very important for the logistics of the
votes: they gather the data relative to the general meetings around the world and transfer
them to the clients via Internet. Then the investor will be able to cast his votes on the
electronic platform also provided by the proxy advisor which will then transmit the
information to each local custodian of the shares. The custodians will send the votes to the
bank centralizing the votes which had been chosen by the issuer.
The offer is not limited to logistics issues. Most investors buy the services of a proxy
advisor who provide analyses and recommendations of each resolution submitted to their
vote. Those recommendations are based on the proxy advisor’s own voting guidelines or a
customized voting guideline created by the client. However, it is cheaper for an investor to
choose the global voting policy than a customized one. Still, an important number of ISS’
clients, representing around 60 percent of the assets under management, receive
recommendations based on a customized voting policy. 143
The proxy advisors begin their analysis when the company publishes the first notice of
meeting. Therefore the time-period for the analysis is very dependent on the country’s
legal requirement and if the company has a shareholder-friendly policy or not. The analyst
will gather all proxy documents related to the general meetings and engage with the
company in the case of insufficient information or if a point needs to be clarified.
Most big-caps companies, especially the ones with a large presence of foreign shareholders
or an important free-float, will often contact the proxy advisors by themselves as they are
the ones the most likely to face contested meetings. In case of “proxy fight”, proxy
advisors usually contact both parties to receive the different arguments and present them to
the shareholders. Based on that information, the analyst will write a proxy research and
recommendations based on the global voting policy. Then custom analysts might change
141
Latham & Watkins LLP, Future of Institutional Share Voting: Three Paradigms, CORPORATE
GOVERNANCE COMMENTARY NEWSLETTER July. 5,2010.
142
Albert Verdam, An Exploration of the Role of Proxy Advisors in Proxy Voting, unpublished
manuscript(2006), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=978835 (visited
November 19, 2011).
143
Interview with Catherine Salmon, Head of French Research, ISS France, in Paris, France, (March 21,
2011).
79
the recommendations in conformity with each client’s voting policy. The added-value of
those services is also that proxy advisors translate the information and provide background
information regarding recent legal reforms, companies’ particularities or market’s
corporate governance system.
The use of the global voting policy is sometimes criticized as having a “one-size-fits-all”
approach. Differences between companies and countries would not be taken into account
by proxy advisors. Global voting policies, however, are not monolithic. In order to take
into account each country’s specificities and level of development regarding governance
regulations, proxy advisors usually have market-specific rules. It would not make sense to
apply the same rule regarding directors’ independence in France and Japan except at the
risk of losing their credibility in the market and vis-à-vis their customers. ISS has a
European voting policy 144 and a Japanese voting policy. 145 Those policies are also updated
every year to include new regulations and markets’ developments. Thus, for example, ISS
follows the following procedure to update its policy with the help of investors:





After the proxy season each market’s analysts send a questionnaire
to clients to know their view regarding the voting policy and possible
updates;
A survey is sent and published on ISS’ Website on which all
investors and issuers can answer;
A regional reflection group (Four Policy Sub-Committees:
European, Asian, Emerging Markets, US) confront their ideas with
the questionnaire’s and survey’s results and then submit proposals to
a policy board composed of representatives of different markets.
If there are difficult questions, the board can decide to make a public
call for comments (usually three or four per year);
After the process is finished, the new voting policy is published on
the Website at the in November to let time to the issuers to acquaint
themselves with it. 146
This codified process shows the ISS’ efforts to answer to the critiques regarding its lack of
transparency and its one-size-fits-all approach. It is moreover only common sense for a
proxy advisor to be as close as possible to the market it covers and to maximize the
satisfaction of its customers. It also shows that investors are very implicated in the drafting
process. When choosing a voting policy and sharing their opinions on possible updates,
institutional investors do make a choice in the way their “voice” will be transmitted to
issuers. They are not giving up their voting rights to proxy advisors by hiring an
intermediary. This intermediary is paid to provide recommendations based on corporate
governance principles recognized as the best practices by institutional investors.
144
ISS,
2011
European
Proxy
Voting
Guidelines
Summary,
available
http://www.issgovernance.com/files/ISS2011EuropeanPolicySummary20110118.pdf (visited November
2011).
145
ISS,
2011
Japan
Proxy
Voting
Guidelines
Summary,
available
http://www.issgovernance.com/files/ISS2011JapanGuidelinesSummary20110131.pdf (visited November
2011).
146
Interview with Catherine Salmon, supra note 143.
80
at
19,
at
19,
Figure 8: The Proxy Voting Process in the United States
Note: RiskMetrics was the previous owner of Institutional Shareholder Services. Broadridge is a proxy
service provider which handles 98 percent of the proxy processing services in the U.S. GA stands for
Governance Analytics, the database of ISS.
Source: Shareholders Communication Coalition.
81
2.1.2.2 The Proxy Advisors
The Washington-based Institutional Shareholder Services (ISS) was founded in 1985 by,
among others, Robert A.G. Monks, the leading figure of shareholder activism and
corporate governance defender. ISS is the most prominent actor in the corporate
governance industry, providing corporate governance ratings, proxy voting
recommendations, and corporate governance advice. Its proxy advisory services represent
the most important share of its business (65 percent). 147 In addition to the electronic
infrastructure allowing investors to receive all the proxy documents and to cast their votes
on ISS’ platform, the clients receive detailed analysis and voting recommendations for all
the general meetings of their portfolios. More contentious is the ability for clients to have
their vote cast by default according to ISS’ recommendations.
The Pr. Rose details the list of services provided by ISS regarding proxy voting:
While ISS’ core business is built around a standard “best practices” proxy advisory service,
it also offers specialized proxy advice for clients interested in effecting social
responsibility initiatives (Social Advisory Services) (…). ISS also offers customizable
proxy voting services, M & A analysis services, and international proxy voting services.
Additionally, ISS sells “non-recommendation research” on various social and international
issues for clients that analyze proxies on a case-by-case basis. 148
The most controversial part of ISS business concerns its governance rating. Aside the
discussion about the value of those ratings, 149 the issue is that ISS is also providing
services to issuers to improve their governance ratings. ISS, however, claims that those
services are provided by a separate legal entity, ICS, which is divided by a ‘Chinese Wall’
from other activities. 150
With its first-mover advantage and almost no serious competitor, it was easier for ISS to
expand internationally. ISS only had to follow institutional investors’ expansion
worldwide. It made sense for a proxy advisor to have local offices to find new clients and
build regional research teams with market knowledge to analyze the general meetings. The
growth strategy of ISS was to buy or ally with local competitors. In the United Kingdom
ISS made a strategic alliance with the National Association of Pension Funds in 2003 to
create a new company called RREV (Research, Recommendation, and Electronic
Voting). 151 To reach the Australian and New Zealand markets, ISS bought in 2005 the
147
Rose, supra note 122, at 113.
Id.
149
See Robert Daines, Ian D. Gow and David F. Larcker, Rating the Ratings: How Good Are Commercial
Governance Ratings?, 98 J. FINAN. ECON. 439(2010) (We find that these governance ratings have either
limited or no success in predicting firm performance.).
150
A review of ISS’s conflict of interests policy was made by the firm Sullivan & Cromwell and is available
onISS’Website,
available
at
http://www.issgovernance.com/files/ISS_Corporate_Services_Conflict_Policy_Review_Project.pdf (visited
November 19, 2011).
151
“The British National Association of Pension Funds ('NAPF') started to offer services to institutional
investors in 1992 under the name NAPF Voting Issues Service. NAPF represents 1300 pension funds with
more than 10 million active participants and 5 million pensioners and has over £ 800 billion in pension fund
assets. (...) RREV focuses on UK-based institutional investors, offering services in the area of corporate
governance analysis and proxy voting services. As to companies based in the UK, the research and voting
148
82
Melbourne-based corporate governance research firm Proxy Australia. 152 The same year
ISS acquired the corporate governance division of Deminor, a minority shareholders
advocacy company based in Brussels with offices all over Europe. This new acquisition
opened the doors of the European market to ISS. 153
After this quick expansion, ISS became the world leader of proxy advisory services,
covering more than 40,000 meetings in over one hundred markets. 154 With 1,700 clients
managing $25 trillion worth of assets, ISS advises “24 of the top 25” and “81 of the top
100” mutual funds, all “25 of the top 25” asset managers, and “17 of the top 25” public
pension funds. 155 Thus ISS’s client are believed to represent “half of the world’s stock
market value”, 156 explaining its increasing influence on the vote results of general
meetings. “Another measure of the growing importance of the industry is the fact that, just
five years ago, market leader ISS was acquired for around $40 million. On November 1,
2006, RiskMetrics acquired ISS for an estimated $550 Million.” 157 RiskMetrics has since
then be bought by MSCI.
Seen as the most important competitor of ISS, Glass Lewis was a late comer on the proxy
advisory market. Founded in San Francisco in 2003, Glass Lewis is now owned by the
Ontario Teachers’ Pension Plan Board. 158 Its main business is also the sale of proxy
research and voting recommendations to institutional investors around the globe. Glass
Lewis covers general meetings of “18,000 companies in over 80 countries.” 159 Together
with ISS they are said to have a combined share of 90 percent of the market. 160 As Glass
Lewis does not provide any consulting services to issuers, unlike ISS, it has played on her
independent image to compete against ISS and is probably its only serious competitor on
the world market. However, its lack of offices and analysts in local markets might impede
its further development. Indeed, non-US investors are usually afraid of depending for their
proxy research on an American firm too far away of their markets.
A third US actor is Egan-Jones, established in 2002 as a division of Egan Jones Ratings
Company. Egan-Jones provides the same type of research and recommendations based
either on their voting policy or Taft-Hartley. 161
recommendations of RREV cover all the companies in the FTSE All-Share Index as well as a number of
other companies. The voting recommendations are based on NAPF's corporate governance policy guidelines.
For companies based outside the UK (companies in the United States, Europe, Asia and Australia) RREV
relies on the ISS organisation.” Albert Verdam, An Exploration of the Role of Proxy Advisors in Proxy
Voting, at 3. In 2006 NAPF disinvested from the joint-venture but signed a long-term licensing agreement
with RREV which will keep applying NAPF’s voting policy on UK companies. Meagan Rees, NAPFISS joint venture in ownership change, INVESTMENT & PENSIONS EUROPE, July 4, 2006.
152
Institutional Shareholder Services Acquires Proxy Australia, PR NEWSWIRE, June 22, 2005.
153
The new ISS Europe covered at its beginning over 3700 listed companies across 17 countries. Institutional
Shareholder Services Acquires Deminor International's Corporate Governance Unit, PR NEWSWIRE, May
25, 2005.
154
ISS’s Website, available at http://www.issgovernance.com/proxy/advisory (visited July 6, 2011).
155
Rose, supra note 122, at 103.
156
Dean Starkman, A Proxy Adviser’s Two Sides: Some Question Work of ISS for Companies It Scrutinizes,
WASH. POST, January 23, 2006, at D1.
157
Rose, supra note 122, at 104.
158
Glass Lewis & Co’s Website, available at http://www.glasslewis.com/company/ ( visited July 7, 2011).
159
Id.
160
Latham & Watkins LLP, supra note 141.
161
Egan-Jones’ Website, available at http://www.ejproxy.com/services.aspx (visited July 11, 2011).
83
The 2008 financial crisis has also made a victim in the proxy advisors camp. Proxy
Governance Inc. which had been established in 2004 has definitely closed down at the end
of 2010. With this disappearance, the competition against ISS is even more diminished.
2.2 The Proxy Advisors in France and Japan
French institutional investors have grown quickly during the last two decades. The amount
of assets under management grew from $878 trillion in 1995 to over $2,500 trillion in 2007
(Fig. 9). 162 In terms of size of assets, they are second in Europe after the United Kindgom
and fourth in the world. The U.S. and Japanese institutional investors stand above,
respectively with $24,220 trillion and $7,565 trillion worth of assets. 163 Their influence on
companies have grown accordingly. With the rise of foreign and national institutional
investing , it was natural for proxy advisors to develop in these markets.
2.2.1 The Rise of Institutional Investors and Proxy Voting in France and Japan
2.2.1.1 France
Led by the unification pressure of the OECD and the European Commission, Canada,
France and the United Kingdom have recognized a duty of disclosure regarding the voting
practices in order to promote proxy voting by managers. 164 The OECD states in its
Principles of Corporate Governance that “Institutional investors acting in a fiduciary
capacity should disclose their overall corporate governance and voting policies with
respect to their investments, including the procedures that they have in place for deciding
on the use of their voting rights.” 165
162
OECD, Recent Trends in Institutional Investors Statistics, at 5 (2009).
Japanese data are from 2006. Id.
164
Cuzacq, supra note 3, at 492.
165
OECD, Principles of Corporate Governance, at 19 (2004).
163
84
Figures 9: Financial assets by type of asset and investor in France and Japan
Source: OECD. 166
French regulations concerning proxy voting by management companies were significantly
modified in 2005. According to the new Article L.533-4 of the Monetary and Financial
Code portfolio management companies must exercise their voting rights “exclusively in
the interest of the shareholders or unit holders in such collective investment schemes.” 167
Under the new law funds managers are also required to disclose the reasons why they have
not voted. Moreover “Articles 332-75 et seq of the AMF General Regulation stipulates that
a portfolio management company must draw up a voting policy document setting out how
it intends to exercise voting rights, as well as an annual report on its voting record.” 168 It is
166
OECD, Recent Trends in Institutional Investors Statistics, at 14-6 (2009).
Report Working Group AMF, supra note 2, at 9.
168
Id., at 10
167
85
a commendable evolution as this reform applies the corporate governance principles to the
relationship between the capital managers and their shareholders.
The French market authority, the AMF, pushed further the requirements imposed on
mutual funds. In line with the best market practices, the AMF’s regulatory framework
(“Règlement Général de l’Autorité des Marchés Financiers”), approved by decree in
November 2004, requests the disclosure of all relevant information regarding the funds’
practices.
The creation of this new voting requirement was criticized by many professional investors,
afraid of the additional costs. That is the reason why the legislator decided not to force
fund managers to vote if their share percentage was too low or for foreign general
meetings. A more important and conceptual criticism focused on the nature of the
relationship between the funds and the issuers: they consider themselves as investors and
not as owners, they do not have any affectio societatis. 169 They are linked to the companies
by an investment contract and therefore they should not have to use the political rights
attached to their shares as they are only in the pursuit of profits. If they disagree with the
management of a company the fund manager will sell his shares in conformity with the
“Wall Street Walk”. This attitude is now getting difficult to defend after the corporate
scandals and financial crises of the last decade. Large listed corporations need a true
counter-power and there must be a dialogue between investors and issuers. 170
With these new regulations, French asset managers in particular became more involved in
the general meetings of their portfolios’ companies. They “sometimes play a decisive role
in delicately balanced general meetings.” 171 The Mansion Report also observed that
portfolio management companies are voting more independently, “including several
occasions where they have not voted the same way as their parent companies at general
meetings. When institutional investors, such as Fonds de Réserve des Retraites, sign
mandates with portfolio management companies, they often set out the voting policy that
their managers must follow beforehand.” 172
This reform was all the more necessary because there were doubts about the independence
of many French funds managers. Indeed, in France 75% of the OPCVM are linked to
banks and those ones are afraid to jeopardize their business relationships with current or
future clients. 173As in the US, the new regulation concerning the exercise of voting rights
by investors were intended on improving shareholder democracy but had the unintended
effect of essentially giving more business to proxy advisors.
According to the Association Française des Investisseurs Institutionnels, up to 90 percent
of the voting rights of French issuers would be at the hands of institutional investors,
including 30 percent by French institutional investors. 174 Regarding the SBF 120,
169
Affectio societatis is a legal concept from civil law countries referring to the intent of the partners to enter
into the partnership. Without it, there cannot be a legally formed partnership or corporation.
170
Cuzacq, supra note 3, at 4.
171
Report Working Group AMF, supra note 2, at 10.
172
Id.
173
Cuzacq, supra note 3,at 4
174
Patrick Viallanex, L’enjeu de l’exercice des droits de vote pour investisseurs institutionnels en France
[The Stakes of the Voting Rights’ Exercise for Institutional Investors in France]. Paper presented in Gestion
Institutionnelle Conference, Paris, France (March, 2006), available at http://www.afgeasso.org/index.php?option=com_docman&task=doc_download&gid=42 (visited November 19, 2011).
86
institutional investors were holding 31 percent of their shares in 2006 and they were the
majority shareholders in 19 of them. 175 Hence institutional voting has a strong impact on
shareholders’ meetings as they often have enough ownership to represent a blocking
minority.
2.2.1.2 Japan
Like France, Japan has experienced an institutionalization of its shareholding. “There has
been a slow but steady change in corporate ownership, maybe as a result of so-called
institutionalization in Japan, in step with the accumulation of personal assets, the aging
population and the financial deregulation since the 1980s.” 176
In Japan foreign shareholders represent now 26 percent of the share ownership of Japanese
listed companies (Chart 1). A large portion of them are American and European
institutional investors, pension funds in particular. 177 They have usually been more
activists than Japanese shareholders as they are more involved in the corporate governance
of the firms in which they invest. Consequently for the first time Japanese managers were
receiving an important number of votes against their proposals. 178 The California Public
Employees' Retirement System (hereinafter CalPERS) was one of the pioneers on the
Japanese market and had been really active. “As early as 1992, 179 when foreigners were
just beginning to ramp up their Japan investments, CalPERS owned US$3.7 billion in
Japanese equities. This stake constituted approximately 2.6 per cent of the total value of
TSE shares owned by foreign investors.” CalPERS began to vote its Japanese shares as
soon as 1990 despite all the constraints, following the activist techniques it had established
in the United States. 180 It did not hesitate to vote against takeover defenses or nonindependent auditors. 181
The Japanese Corporate Governance Forum (hereinafter JCGF), a think tank of academics
and businessmen, published the first corporate governance principles for Japan in 1997,
recognizing Japanese stakeholder model but defending the idea of maximization of
shareholder value. 182 The same year CalPERS published its own set of principles inspired
by the JCGF’s principles but without any reference to stakeholders. 183 CalPERS brought
the corporate governance to Japan and showed to other investors that it was possible to be
an active investor here, even though its results were mixed.
175
Jean Michel Sahut and Hidaya Othmani Gharb, Structure d’actionnariat et performance des firmes : Cas
des entreprises de l’indice SBF 120 [Firms’ Shareholding Structure and Performance: the SBF 120
Corporations], Association Française de Finance Conference, in Bordeaux, France(June 27, 2007), available
at http://affi2007.u-bordeaux4.fr/Actes/200.pdf (visited November 19, 2011).
176
Megumi Suto, New Development in the Japanese Corporate Governance in the 1990s – The Role of
Corporate Pension Funds, 100 Hamburg Institute of International Economics Discussion Paper 7 (2000).
177
Takaya Seki, Legal Reform and Shareholder Activism by Institutional Investors in Japan, 13 CORP. GOV.
382(2005).
178
Id.
179
Sanford M. Jacoby, Principles and Agents: CalPERS and Corporate Governance in Japan, 15 CORP.
GOV. 6(2007).
180
Id., at 6.
181
Id., at 7.
182
Id., at 8.
183
Id., at 9.
87
In Japan no voting duty has been attributed by the law or the courts to Japanese
institutional investors. However, for the first time in April 1997, the Ministry of Welfare
issued guidelines for the managers of pension funds clarifying their fiduciary duties and
responsibility, following the ERISA of the United States. Among those duties, managers
have to monitor the companies they invest in. 184 “After that, major institutional investors
voluntarily announced one after another that they would execute voting rights as a means
of taking fiduciary responsibility if necessary, or to draw up guidelines for execution of
voting rights on behalf of the pension funds.” 185
Chart 1: Distribution of Share Ownership in Japan by Type of Shareholder
Notes: 1. Survey has been conducted on a “Unit-of-Share” basis since 1985 Survey
2. The market value of financial institutions excludes that of City & Regional Banks
Source: Tokyo Stock Exchange.
The real promoter of change had been a private organization: “The Pension Fund
Association (PFA), an umbrella group for employee pension funds, has developed into a
key player by introducing aggressive proxy voting guidelines and speaking out on the need
for companies to adopt more shareholder-friendly governance practices.” 186 The PFA,
often cited as the “heir” of CalPERS in Japan, 187 encouraged other Japanese investors to
exercise their voting rights. It “put together a handbook on fiduciary responsibilities
(investment institution edition) in 2000, in which it noted the need for investment
institutions to properly exercise the voting rights of the stocks included in pension assets,
and the desirability of the pension funds (trustors) monitoring voting arrangement and the
184
Suto, supra note 176, at 25.
Id., at 28.
186
ISS, Japan Market Profile (2005).
187
Aronson, supra note 4, at 580.
185
88
votes cast.” 188 It was followed in 2001 by practical guidelines on the exercise of voting
rights and in 2003 by corporate governance principles and standards for exercising
shareholder voting rights. 189 PFA also created a corporate governance fund investing
US$100 million in Japanese companies respecting the best practices. 190 “In 2003, PFA
voted against 40% of the proposals made by corporate management.” 191 The influence of
the PFA is to be relativized though. It is a lone voice in the Japanese landscape and PFA
described itself as a “reluctant activist”. 192 According to Tomomi Yano, former executive
manager of the Pension Fund Association, “we did not get any support from other pension
funds when we initiated these governance activities. We had asked them in the past to
work with us, but nobody followed suit, so we were alone in conducting these
activities.” 193 PFA’s activist role was mainly due to the presence of Yano since 2001 but
he has now left his position there. Even though Yano left his mark, Japan has probably lost
its main corporate governance’s champion.
According to J-IRIS, a Japanese investor relations firm,
Most of the Japanese investment managers now vote according to their own
proxy guidelines. They are under pressure from pension funds to apply
stricter guidelines in voting, and to report to them. Pension funds, in their
turn, believe that better corporate governance leads to increase in
shareholders’ value and better performance. Disclosure of the voting results
by investment managers, promoted by Japan Securities Investment Advisers
Association, Trust Companies Association of Japan, and the Investments
Trust Association, Japan, has also resulted in the investment managers
taking a more serious attitude towards proxy voting. 194
The increase of institutional and foreign shareholder combined with the loosening of crossshareholdings in Japan has led to more pressure on Japanese corporations to improve their
corporate governance. “In 2002, asset managers only rejected 3% of proposals, but that
number has now risen to 10-15%.” 195 It was the sign that proxy advisors could become
influent on the Japanese market.
2.2.2 The Proxy Advisory Industry in France and Japan
As the number of investors is lower than in Anglo-American countries and that the proxy
voting of institutional investors was at a later stage of development, indigenous proxy
advisors had been relatively small players. Therefore the market is essentially controlled
by ISS, thus the recurring critiques of lack of competition.
188
Iwatani and Taki, supra note 100, at 8.
Aronson, supra note 4, at 580.
190
Jacoby, supra note 179, at 10.
191
Tomomi Yano, The Critical Role of Investors in Strengthening Corporate Governance in Japan, ACGA
7th Annual Conference, Tokyo, Japan (November 8, 2007), available at http://www.acgaasia.org/public/files/Tomomi_Yano_ACGA_Closing_Speech_2007.pdf (visited Novermber 19, 2011).
192
Aronson, supra note 4, at 580.
193
Yano, supra note 191,at 6.
194
E-mail from Yukari Suzuki, Japan Investor Relations and Investor Support, Inc., to the author (April 6,
2011, 20:56:57 (PDT)) (on file with the author).
195
Yano, supra note 191, at 4.
189
89
2.2.2.1 France
In France, ISS has one main competitor in the body of Proxinvest. Proxinvest is an
independent proxy advisor founded in 1995 offering research and recommendations on
French general meetings. It was the first Continental European company specialized in
providing voting recommendations. 196 It does not provide ratings or services to issuers to
protect its independence. It is also the exclusive advisor of a shareholders engagement
fund, Proxy Active Investors, a strong corporate governance militant on the French
market. 197 Proxinvest’s principal clients are French asset managers so its influence is quite
limited. 198 Indeed, it is a common practice for the biggest asset managers to buy the
analysis of multiple proxy advisors to get different point of views before making a voting
decision so Proxinvest’s services would often be in addition of ISS’ ones(or more rarely
GlassLewis)Local proxy advisors have tried to join together to better compete against ISS.
As they are usually specialized in only one market, they cannot offer the same services as
ISS. Therefore they have formed a partnership, European Corporate Governance Service,
in order to provide mutually a more important coverage of general meetings. 199
Another actor analyzing general meetings is a non-profit group. The Association Française
de Gestion Financière (hereinafter AFG), representing the interests of French assets
managers, is issuing recommendations to its members on the general meetings of the SBF
120 companies. They publish ‘alerts’ on their Website for free whenever a company is not
following AFG’s corporate governance recommendations. 200
2.2.2.2 Japan
ISS created a separate office in Tokyo in 2001 when sold by Thompson. Before that, ISS
and other proxy advisors like Investor Responsibility Research Center (IRRC) (bought by
ISS in 2006) were already covering the Japanese market from abroad. 201 The clients voting
at Japanese general meetings are mainly foreign investors. Japanese institutional investors
are apparently wary of outsiders giving voting recommendations and prefer manage
internally their votes. Moreover Japanese assets managers would often be over-staffed and
therefore it would be easier for them to ask internal employees to be in charge of the proxy
voting. 202 Therefore international proxy advisors do not really feel the need to open an
office in Japan as the commercial opportunities are scarce. Thanks to its local presence ISS
has gained some fame on the Japanese market, especially through the person of Marc
Goldstein, its former head of research for Japan. Companies gradually realized the possible
196
Proxinvest ou l'observatoire des assemblées générales [Proxinvest or the General Meetings’ Watchdog],
L’Agefi, February 12, 1998.
197
See Proxinvest’s Website, available at http://www.proxinvest.com/index.php/en/page/presentation.html
(visited November 19, 2011).
198
Id.
199
Their main partners are Proxinvest in France, DSW in Germany, Shareholder Support in the Netherlands,
Ethos in Switzerland, Responsible Investment Group in Canada, SIRIS in Australia. The complete list is
available at http://ecgs.com:8080/partners (visited November 25, 2011).
200
See AFG’s Website, available at
http://www.afg.asso.fr/index.php?option=com_docman&Itemid=151&lang=en (visited November 19, 2011).
201
Phone interview with Marc Goldstein, Head of Governance Research Engagement, Former Head of
Research Japan, ISS, in Fukuoka, Japan (January 20, 2010).
202
Interview with Yoji Yoshioka, Executive Officer, Japan Proxy Governance Institute, in Japan, Tokyo,
(February 22, 2011).
90
influence of ISS and now try actively to meet ISS’ analysts in Tokyo. 203 This is mainly
limited to the biggest capitalizations, the ones with many foreign shareholders, while
smaller corporations sometimes confuse proxy advisors with sôkaiya. 204
The first Japanese proxy advisor, Governance Visions (hereinafter GV), was created in
2005 by a former director of the American proxy advisor IRCC 205, Kuny Kobayaschi. 206
GV does not define itself as a proxy advisor as it does not issue any recommendations.
According to Kuniaki Matsumoto, the CEO of GV, their activity is slightly different as
they offer mainly technological support to investors. 207 Indeed, institutional investors set
up their guidelines in GV system which will then analyze all the general meetings of the
client’s portfolio to give a ‘for’ or ‘against’ recommendation. It is only a first automatic
assessment which must be completed by the qualitative analysis of the investor. 208
Governance Visions entered into a partnership agreement with Glass Lewis in 2009,
allowing both companies to have access to their marketing database while Glass Lewis is
now able to use GV’s operational support in Japan. 209 This will help Glass Lewis to cover
Japanese general meetings as it does not maintain a local office.
The only other indigenous proxy voting advisor on the Japanese market is the Japan Proxy
Governance Institute (hereinafter JPG). 210 It was instituted in 2006 as a partnership
agreement between ProxyGovernance Institute, an American proxy advisor, and
Governance Solutions, a Japanese investor relations firm. 211 It now covers the general
meetings of all the Nikkei 1000 companies. Since the disappearance of its counterpart,
ProxyGovernance Inc., in 2010 JPG has integrated Governance Solutions and is now
focused on selling proxy voting recommendations to Japanese investors. 212
We can observe that, contrary to the American or French market, proxy advisors did not
come to Japan to answer a demand from the local market but for the need of foreign
investors. Indeed, overseas shareholders have been willing to vote their Japanese shares but
the concentration of meetings combined with the short deadlines and the unavailability of
English documentation made it quasi-impossible. Only with the help of proxy advisors
they have been able to do so.
2.3 Conclusion
Proxy advisors emerged in the United States thanks to favorable market factors and legal
environment in the 1990s and have gradually increased their presence internationally
203
Interview with Takeyuki Ishida, Head of Corporate Governance Research, ISS, in Tokyo, Japan (February
21, 2011).
204
Id.
205
The Investor Responsibility Research Center was sold to Institutional Shareholder Services in 2006.
206
See Governance Vision’s Website, available at http://governancevisions.com/English/aboutus.html
(visited November 19, 2011).
207
Phone interview with Kuniaki Matsumoto, Chief Executive Officer, Governance Visions, in Fukuoka,
Japan (August 2, 2011).
208
Id.
209
Glass Lewis Establishes Alliance With Tokyo-Based Governance Visions, PRNewswire, August 27, 2009.
210
Japanese Proxy Governance Institute’s Website, available at http://www.j-pg.jp/eng/index.html (visited
November 19,2011).
211
Interview with Yoji Yoshioka, Executive Officer, Japan Proxy Governance Institute, in Japan,
Tokyo(February 22, 2011).
212
Id.
91
during the last decade. In France and Japan there has been an increase of foreign and
institutional shareholding in the capital of the companies. But while French mutual funds
are now facing a duty to vote, Japanese investors are still relatively passive. Proxy advisors
are still largely unknown to the general public while their recommendations can influence
the fate of our biggest corporations. 213 Their services are now fully integrated in the voting
process of all the most important institutional investors who would most likely be unable to
vote without them at a reasonable cost.
3. Influence and Regulation of Proxy Voting Advisors
The increasing influence of the proxy advisory activity has led issuers and regulators to
question their legitimacy and the lack of oversight.
3.1 The Increasing Influence of Proxy Advisors
There are multiple and non-exclusive factors explaining the influence of proxy advisors.
For Cotter et al., one reason is the recognition by mutual funds of the expertise of ISS in
identifying “value-producing voting choices.” 214 That is, ISS recommendations would be
the most cost effective decision. Another explanation is that ISS recommendations are
based on the same factors that institutional investors use so mutual funds would have voted
in the same sense anyway. 215 There can also be a herding behavior, i.e. by all following
ISS’ recommendations, fund managers can feel they respect their fiduciary duty and are
therefore protected. 216 Thus the former general counsel for corporate governance of
CalPERS declared: “An institution voting against the ISS recommendation better have a
pretty good reason.” 217
Due to those factors, proxy advisors not only influence the results of general meetings but
also the whole corporate governance system.
3.1.1 Proxy Advisors’ Influence on Shareholders’ Votes
3.1.1.1 The Influence of ISS in the United States
Speaking of the influence of ISS, Delaware’s Vice-Chancellor Leo Strine declared:
[P]owerful CEOs come on bended knee to Rockville, Maryland, where ISS resides,
to persuade the managers of ISS of the merits of their views about issues like
213
The merger of Hewlett and Compaq is said to have been accepted thanks to ISS favorable
recommendation. See Eleanor Laise, Is This The Most Influential Man on Wall Street?, SMARTMONEY,
October 1, 2002. See also Tom Johnson, HP, Compaq Merger Now in Hands of Shareholder Adviser,
Reuters, December 11, 2001, available at http://www.rediff.com/money/2001/dec/11hp.htm (visited
November 19, 2011).
214
James F. Cotter, Alan R. Palmiter, and Randall S. Thomas, ISS Recommendations and Mutual Fund
Voting on Proxy Proposals, 55 VILL. L. REV. 56 (2010).
215
Id. See also Stephen Choi, Jill Fisch, and Marcel Kahan, The Powers of Proxy Advisors: Myth or Reality,
59 EMORY L. J. 869 (2010).
216
Cotter,Palmiter and Thomas., supra note 214.
217
Laise, supra note 213.
92
proposed mergers, executive compensation, and poison pills. They do so because
the CEOs recognize that some institutional investors will simply follow ISS’s
advice rather than do any thinking of their own. 218
The influence of proxy advisors in the United States has been often criticized in the media.
Some commentators go as far as saying “Whatever ISS wants, ISS gets” 219 or that “ISS
wields extraordinary clout.” 220 ISS is an easy target for managers which probably regret
the times of shareholders apathy.
Academics have tried to verify the exact influence of proxy advisors, especially ISS, on
investors’ votes and the results of general meetings.
Gillan and Bethel examined the results of the 1998 general meetings and found out that
“against recommendations from ISS were associated with 13.63% to 20.56% fewer
affirmative votes for management proposals, depending on the specific proposal type.” 221
Choi, Fisch and Kahan have pushed the study further to take into account the factors on
which proxy advisors base their recommendations. Their study confirms that ISS is the
most influent proxy advisor, followed by Glass Lewis, and that ISS recommendations shift
from 6 to 10 percent of shareholders votes but this “is partially due to the fact that ISS (to a
greater extent than other advisors) bases its recommendations on factors that shareholders
consider important.” 222 Their results support the idea that proxy advisors’ influence has to
be put into perspective. Those firms are working as agents or intermediaries for the
investors, gathering and transmitting the information investors require and not as
independent power centers. 223
The recent reform from the New York Stock Exchange to eliminate discretionary broker
voting in case of uncontested director elections could give even more influence to proxy
advisors though. Indeed, brokers had the possibility to cast the votes of their clients
whenever the beneficiary shareholder did not give any instruction. They usually voted in
favor of the management’s candidates. 224 “These discretionary broker votes are estimated
to amount to about 19% of the votes cast at annual meetings.” 225
In response to the critiques ISS argues that it “does not control any percent of the votes, it’s
our clients who do.” 226 However, a previous CEO of ISS, John Connoly, admitted that up
to 20 percent of the clients were using the automatic vote service which means their proxy
218
Leo E. Strine, Jr., The Delaware Way: How We Do Corporate Law and Some of the New Challenges
We (and Europe) Face, 30 DEL. J. CORP. L. 688 (2005).
219
William J. Holstein, Is ISS Too Powerful? And Whose Interests Does It Serve?, CBSNEWS (February 7,
2008), available at http://blogs.bnet.com/ceo/?p=1100 (visited August 8, 2011).
220
Robert M. Krasne, ISS Wields Extraordinary Clout in Recommendations to Investors, Yet Also Serves
Corporations, PENSION & INVESTMENTS, May 31, 2004.
221
Stuart L. Gillan and Jennifer E. Bethel, The Impact of the Institutional and Regulatory Environment on
Shareholder Voting, 31 FIN. MGMT. 30 (2002).
222
Stephen Choi, Jill Fisch, and Marcel Kahan, The Powers of Proxy Advisors: Myth or Reality, 59 EMORY
L. J. 906 (2010).
223
Stephen Choi, Jill Fisch, and Marcel Kahan, Director Elections and the Role of Proxy Advisors, 82 S.
CAL. L. REV. 148-9 (2009).
224
Choi, Fisch, and Kahan, supra note222, at 874.
225
Id.
226
Interview of Martha L. Carter, ISS’s Director of Research, by Dean Starkman, A Proxy Adviser’s Two
Sides: Some Question Work of ISS for Companies It Scrutinizes, WASH. POST, January 23, 2006, at D1.
93
are automatically voting according to ISS’ recommendations. 227 Nevertheless those
recommendations are based on the voting policy chose by the clients and they still have the
possibility to override the automatic vote. 228
3.1.1.2 The Influence of ISS abroad
The European Commission has recognized the “substantial” influence of the proxy
advisors and ISS in particular on voting, especially on foreign markets with high
percentage of institutional investors. 229
In France executives facing more and more activism at their general meetings are quick to
point out ISS as the root of all evil. Thus a French newspaper commenting the last proxy
season declares that “large issuers [are at] the brink of nervous breakdown.” 230 The article
goes on by saying that the CAC 40’s companies do not bear anymore the American ISS’
incursion in the French corporate governance. This critique seems oblivion to the fact that
ISS’s research comes from French analysts based in France and according to a European
voting policy. On the other hand, it is probably true that most negative votes are cast by
their American-based shareholders but it is more risky to bite the hand that feeds.
According to the article the voting results follow closely the ISS’ recommendations. As
ISS is against cumulating the functions of CEO and Chairman of the board, which is still a
common practice in France, there have been recommendations against the election of some
CEO on the board of their companies, as in Société Générale or Alstom. Around 15
percent of the shareholders have voted against their reelections in conformity with ISS’
recommendation. The allocation of free shares also faced high opposition at Valéo this
year. 231 It makes sense that election and compensation are sensitive subjects for managers
and that they react strongly when suddenly confronted to some opposition. However, ISS
is not the only proxy advisor and some asset managers buy recommendations from
different sources to make their own opinion in the end. 232
There has not yet been any empirical research regarding the influence of proxy advisors’
recommendations on voting results in countries outside the United States. Given the
importance of foreign investors in France and Japan and the number of ISS’s client, it is
safe to assume that their influence is important and gradually increasing, especially on
foreign markets where investors are likely to rely on the opinion of a more knowledgeable
third-party.
Regarding France, HQB Partners, a proxy solicitation and corporate governance advisory
firm, studied the voting results of the CAC 40’s general meetings and concluded that
“resolutions subject to negative ISS recommendations [were] receiving an average of only
227
Id.
Id.
229
European Commission, Green Paper - the EU Corporate Governance Framework(2011), available at
http://ec.europa.eu/internal_market/company/docs/modern/com2011-164_en.pdf (visited November 19,
2011).
230
Votes en AG : les grands émetteurs aux bords de la crise de nerf [GM Proxy Voting : Large Issuers at the
Brink of Nervous Breakdown], LA LETTRE DE L’EXPANSION, July 11, 2011.
231
Id.
232
Id.
228
94
72.3% approval in 2010 compared to 78.8% in 2009.” 233 There is therefore a high risk of
rejection by the shareholders, especially for the special resolutions requiring a majority of
two-third to be approved. Nevertheless, the report notes that investors have more and more
sophisticated voting guidelines and do not simply follow ISS recommendations. 234 A
previous report also indicated that all resolutions rejected by the shareholders in 2008 had
received negative recommendations from ISS. 235
Regarding Japan, there are a growing number of Japanese issuers asking to meet ISS to
receive information concerning their policy guidelines, showing an awareness of their
influence. 236 ISS recognizes that their recommendations might have cause the rejection of
some resolutions on the Japanese market. 237 Issuers seem to be wary enough of their
recommendations to sometimes publish special releases when they learn the ISS has issued
against-recommendations. 238
3.1.2 Proxy Advisors’ Influence on Corporate Governance
With its voting guidelines on one hand and the voting recommendations in the other, ISS is
a powerful actor in the corporate world: soft-law maker and governance regulator. The
case of the adoption of poison pills in France makes a supportive argument. French law
was modified in 2005 239 to allow companies to issue warrants during takeovers in specific
circumstances. Corporations had to ask shareholders’ authorization for this issuance. In its
voting guidelines, ISS recommended to vote against those poison pills except if they
represented less than 25 percent of the issued capital, the company was not protected by
any other type of defensive measures, and finally the company had to respect some
disclosure requirements. 240 Those requirements were not included in the legal reform so
we are truly facing a soft-law creation, where companies have to comply with extra-legal
requirements. Apparently ISS was largely followed on that issue as in 2006 when the
French issuer Saint-Gobain submitted to the shareholders an authorization not in line with
ISS’ requirements, the resolutions received only 55 percent support. 241 This low support is
risky for companies when they are used to receiving voting results above 99 percent,
reminiscent of the Stalinist era. The following year Saint Gobain decided to comply with
ISS’ guidelines and received 81 percent support. 242 Veolia Environment, another listed
company, had to face the same situation with its non-complying authorization receiving
only 54 percent support in 2007 against 74 percent in 2008 for the complying resolution. 243
233
HQB Partners, An Overview of the CAC 40 2010 Annual General Meeting Season, (2011), available at
http://www.hqbpartners.com/content.php?itemID=33 (visited November 19, 2011).
234
Id.
235
HQB Partners, CAC 40 AGM Season – Trends and Observations, (2011), available at
http://www.hqbpartners.com/content.php?itemID=33 (visited November 19,2011).
236
Interview with Takeyuki Ishida, supra note 203
237
Id.
238
See Yokogawa Electronic Corp., Our Opinion on ISS Proxy Advisory Services’ Recommendation to Vote
Against Agenda Items 1 and 3 at 2011 Annual General Meeting of Shareholder , (June 17, 2011), available
at http://www.yokogawa.com/pr/ir/pdf/2011/20110617-en.pdf (visited August 2, 2011).
239
Act No. 2005-842 of July 26, 2005.
240
ISS, European Corporate Governance Policy – 2011 Updates (2010), available at
http://www.issgovernance.com/policy/2011/policy_information (visited July 24, 2011).
241
Alexandre Omaggio, Faut-il encadrer l'activité des agences de conseil en vote (proxy advisors)? [Should
We Regulate Proxy Advisors?], 46 LA SEMAINE JURIDIQUE ENTREPRISE ET AFFAIRES 13 (2009).
242
Id.
243
Id.
95
A similar description could be made regarding other subjects as the distribution of free
shares or severance payments to executives, with ISS adding new requirements from one
year to another. However, those policy updates are always made in agreement with ISS’
clients, based on each market’s specificities.
John C. Coffee gives another example of the rule-creation power of ISS in the United
States:
Although the Sarbanes-Oxley Act bars an accounting firm from providing a
limited number of consulting services to an audit client, the market appears
to be enforcing a considerably broader prohibition. […] [ISS] opposes
auditors receiving more in consulting fees from its corporate client than it
receives for audit and audit-related work. This norm has rapidly become
accepted. […] [The] percentage of firms failing this test fell from 60 percent
in 2002 to just 2 percent in 2003. 244
The companies legitimately fear that important resolutions will be rejected during general
meetings. A resolution rejected by the shareholders has a symbolic impact of the company:
it symbolizes that the management team has lost the support of shareholders. Therefore
they have strong incentives to follow ISS’ policy guidelines.
It is not sufficient that the resolutions submitted to the vote are lawful; they must also be
ISS compliant to ensure shareholder support. Companies with a large number of foreign
stockowners have the feeling that they have to comply with new rules every year from an
illegitimate source. Indeed, proxy advisors are not shareholders; they do not face any
economic risk so they are not entitled to have voting rights in the corporations. They are
not state agencies either so they lack democratic support.
As a consequence of outsourcing voting, each new regulation concerning proxy voting or
corporate governance is only increasing the influence of the proxy advisors. In fewer
words, the more we enfranchise the shareholders, the more power we give to proxy
advisors. It is hence in the interests of proxy advisors to lobby for corporate law reforms
and to modify corporate governance principles.
Once poison pills have been eliminated, classified boards must go; once classified
boards are gone, majority voting becomes a requirement, then the separation of the
CEO and the Chairman of the Board […], and so on. The never-ending cycle
creates a moving target for what these organizations consider ‘good’ corporate
governance, and every year places additional unproductive, non-business burdens
on boards. 245
244
JOHN C. COFFEE JR., GATEKEEPERS: THE PROFESSIONS AND CORPORATE GOVERNANCE 166-7 (1st ed.
2006).
245
Martin Lipton, Shareholder Activism and the “Eclipse of the Public Corporation”: Is the Current Wave of
Activism Causing Another Tectonic Shift in the American Corporate World?, Keynote Address, the 2008
Directors Forum of The University of Minnesota Law School(June 25, 2008), available at
http://blogs.law.harvard.edu/corpgov/files/2008/06/shareholder-activism-and-the-eclipse-of-the-publiccorporation-is-the-current-wave-of-activism-causing-another-tectonic-shift-in-the-american-corporateworld.pdf (visited November 25, 2011).
96
As corporate governance is the raison d’être of proxy advisors, it is in their interests of
being advocate of constant reforms. 246
Thus proxy advisors can be seen as an illegitimate actor influencing the votes of the most
important shareholders worldwide without bearing any financial risk. But we must
remember that the previous situation was shareholder apathy and managers having
absolute power of their general meetings. Proxy advisors have succeeded where
institutional investors have failed to do by themselves: to act coherently and cohesively to
put pressure on companies to improve their corporate governance.
But then what are the principles advanced by proxy advisors? The quest of ‘good’
corporate governance is not so unanimously supported anymore. 247 There is no doubt that,
to satisfy their clients, the principle of shareholder primacy is at the core of the corporate
governance principles defended by proxy advisors. Even if the proxy advisors say they
respect cultural differences and country specificities, they defend a view of corporate
governance based on the Anglo-American model. Thus, among their core principles lie for
example the introduction of independent directors among board members, the separation of
functions between the CEO and the chairman of the board, or the prohibition of poison
pills. Regarding the independence of the board in Japan, ISS recommends a vote against
“A top executive at a company that has a controlling shareholder, where the board after the
shareholder meeting does not include at least two independent directors based on ISS
independence criteria for Japan.” 248 Regarding the French market, all corporations need to
have at least 50 percent of independent board members (down to 33 percent for controlled
companies) according to ISS. 249 Originally the notion of independence was nowhere in
French and Japanese law but in both countries companies have been pressed to follow
those recommendations. However, the link between board independence and performance
of the company still needs to be proven as the different empirical researches gave
ambivalent evidence. 250 The need to remove poison pills might be less controversial since
empirical studies seem to agree that this entrenchment device is synonym of bad
performance. 251
246
Latham & Watkins LLP, Future of Institutional Share Voting: Three Paradigms 1, CORPORATE
GOVERNANCE COMMENTARY NEWSLETTER, July 2010.
247
Lucian A. Bebchuk and Assaf Hamdani, The Elusive Quest for Global Governance Standards, 157 U. PA.
L. REV. 1263 (2009).
248
ISS,
2011
Japan
Guidelines
Summary,
available
at
http://www.issgovernance.com/files/ISS2011JapanGuidelinesSummary20110131.pdf(visited August 10,
2011).
249
ISS, 2011 European Proxy Voting Guidelines Summary, available at
http://www.issgovernance.com/files/ISS2011EuropeanPolicySummary20110118.pdf(visited August 10,
2011).
250
See Benjamin E. Hermalin and Michael S. Weisbach, Boards of Directors as an Endogenously
Determined Institution: A Survey of the Economic Literature, April. 2003 FRBNY ECONOMIC POLICY
REVIEW 8 (“board composition, as measured by the insider-outsider ratio, is not correlated with firm
performance”). But see Lucian A. Bebchuk and Michael S. Weisbach, The State of Corporate Governance
Research, 23 REVIEW OF FINANCIAL STUDIES 939 (2010) (“there is a growing body of empirical research
indicating that director independence is associated with improved decisions with respect to some specific
types of decisions”).
251
See Lucian A. Bebchuk, Alma Cohen, and Allen Ferrell, What Matters in Corporate Governance?, 22
REVIEW OF FINANCIAL STUDIES 783 (2009) (“We have identified six entrenching provisions that are
negatively correlated with firm valuation, as measured by Tobin’s Q, as well as with stock returns during the
1990-2003 period.”). But see Jay Kesten, Managerial Entrenchment and Shareholder Wealth Revisited:
Theory and Evidence from a Recessionary Financial Market, 2010 BYU L. REV. 1609, founding that
97
3.2 The Regulation of Proxy Advisors
Choi et al. stressed the lack of oversight of proxy advisors:
This influence is troubling in light of the limited accountability of proxy
advisors. Proxy advisors do not have a financial stake in the companies
about which they provide voting advice; they owe no fiduciary duties to the
shareholders of these companies; and they are not subject to any meaningful
regulation. 252
In consideration of the growing influence of proxy advisors, the U.S. authorities have
begun to worry about the absence of regulation on this industry. In 2008 the SEC emitted a
Compliance Alert. 253 In July 2010 the SEC issued a concept release on Proxy Voting.254
Among other topics the concept release includes the need to inquire about the role and the
regulation of proxy advisors. The SEC’s decision will be of importance as ISS is under its
supervision as an institutional adviser and it will most probably influence future regulation
abroad. In 2009 the Millstein Centre for Corporate Governance and Performance of Yale
University published a report also on the theme of proxy voting with some proposals
regarding proxy advisory firms, including a possible Code of conducts for the corporate
governance industry. 255
In Europe the recent financial crisis has brought the proxy advisors under the regulators’
spotlight. Thus the OECD in its 2009 Report on the financial crisis or the European
Commission’s 2011 Green Paper on corporate governance 256 both have underlined some
problems regarding proxy advisors. Finally in March 2011 the AMF in France issued a set
of recommendations at the destination of proxy advisors. 257
The different national and supra-national authorities have identified the same set of issues
regarding proxy advisors: the risk of conflict of interests, the content of the
recommendations with the risk of a ‘one-size-fits-all’ approach, the disclosure and
entrenched firms performed better during the economic crisis of 2007-2008, available at
http://ssrn.com/abstract=1555856 (visited November 19, 2011).
252
Choi, Fisch and Kahan , supra note 222, at 872.
253
In this alert the SEC highlighted some deficiencies in the voting procedures of institutional investors,
including their lack of oversight of proxy advisors. SEC, Compliance Alert (July 2008), available at
http://www.sec.gov/about/offices/ocie/complialert0708.htm (visited November 19, 2011).
254
SEC, Concept Release on the U.S. Proxy System (July, 14, 2010), available at
http://www.sec.gov/news/press/2010/2010-122.htm (visited November 19, 2011) (hereinafter SEC Concept
Release).
255
The Millstein Center for Corporate Governance and Performance, Yale School of Management, Voting
Integrity – Practices for Investors and the Global Proxy Advisory Industry(2009), available at
http://millstein.som.yale.edu/Voting%20Integrity%20Policy%20Briefing%2002%2027%2009.pdf. (visited
November 19, 2011).
256
European Commission, Green Paper - the EU Corporate Governance Framework (2011), available at
http://ec.europa.eu/internal_market/company/docs/modern/com2011-164_en.pdf (visited November 19,
2011).
257
Autorité des Marchés Financiers, AMF Recommendation No. 2011-06 of 18 March 2011 on Proxy
Advisory Firms, available at http://www.amf-france.org/documents/general/9915_1.pdf (visited November
19, 2011) (hereinafter AMF Recommendation).
98
engagement with issuers. Before entering into the details of those regulations, we will
discuss if more regulations was in fact needed.
3.2.1 The Need of Oversight and Control of the Proxy Advisory Business
Extra-regulation concerning proxy advisors would not be required if the market is working
effectively. If the proxy advisors do not give accurate recommendations based on
trustworthy information, investors will seek the services of a more efficient competitor.
But the market can work only if some conditions are satisfied: clients must be able to move
to another proxy advisor at a reasonable price; other proxy advisors must provide an
interchangeable product. Do those conditions exist here? For many scholars the answer is
no. Choi et al. underlines the fact that
it is not clear that the proxy advisory industry is sufficiently competitive and
transparent to subject advisory firms—ISS in particular—to substantial
market discipline. Institutional investors (…) may lack sufficient interest in
voting to scrutinize advisors’ recommendations carefully. In addition, ISS
has, until recently, enjoyed a near-monopoly position and still remains the
dominant firm providing voting advice. 258
The OECD and the European Commission 259 have also stressed the lack of competition,
declaring that “a competitive market for advice needs to be encouraged.” 260
Tamara Belinfanti, Associate Professor at the New York Law School, has published a
thorough study of the proxy advisory industry. 261 In her article, she notes that the agency
theory applies to the relation between proxy advisors and institutional investors. Thus,
outsourcing proxy voting creates agency costs but, according to the author, there would not
be any effective mechanism to control those costs. 262 If usually the market should serve as
an efficient check on agency costs, it is unsuccessful here as mutual funds are apathetic and
do not closely monitor their votes and proxy advisors. 263 Indeed, funds’ performance will
not be judged on the quality of the voting.
Then intra-market competition could serve as another check on agency costs but ISS has a
dominant position and there are important barriers to entry. 264 ISS benefits from its first
mover advantage and any investor who would like to hire another proxy advisor would
face significant switching costs for the voting platform. Moreover to become a legitimate
competitor, one would need high investment to acquire the same level of technology and to
provide a better coverage of general meetings than ISS. 265 Thus the market seems
inefficient to regulate proxy advisors.
258
Choi, Fisch, and Kahan, supra note 222, at 872.
European Commission, supra note256, at 15.
260
OECD, supra note 135, at 11.
261
Tamara C. Belinfanti, The Proxy Advisory and Corporate Governance Industry: The Case for
Increased Oversight and Control, 14 STAN. J.L. BUS. & FIN. 384 (2009).
262
“From an agency theory perspective, ISS presents a lethal combination – significant power and virtually
no accountability.” Belinfanti, supra note 261, at 24.
263
Id., at 25-6.
264
Id., at 28.
265
Id., at 31-2.
259
99
In France, Alexandre Omaggio, a corporate lawyer specialist of securities law, has
underlined the difficulties a company would face to engage the responsibility of a proxy
advisor in case of an inaccurate voting recommendation. 266 Indeed, according to this
author, it would be extremely difficult for an issuer to prove the existence of a damage and
the causal link between the faulty recommendation and this damage. 267
It is interesting to note that the issuers, usually the most proponent of self-regulation
regarding corporate governance, have been the ones lobbying strongly for more oversight
of proxy advisors. 268 All the different authorities declared that they receive many call from
those actors. Thus in France, the Chairman of Proxinvest, the local proxy advisor, declared
about the recent recommendations issued by the AMF that: “It is the perfect illustration of
the absolute power of the issuers lobby versus the shareholders’ impotence. Instead of
protecting investors, the AMF takes care of protecting the CEOs.” 269 In the United States a
powerful advocator of more regulation is the Shareholder Communications Coalition. 270 A
misleading name as the Coalition includes the Business Roundtable 271 and the Society of
Corporate Secretaries & Governance Professionals, as well as investor relations
consultants. 272 We might doubt whether the shareholders’ interests are really at the heart of
this coalition, lobbying in the name of issuers and issuers’ consultants. The coalition
pressed the SEC to act and distributed a “discussion draft on proxy advisory services” on
April 2010 pointing out proxy advisors’ deficiencies and lack of regulation. 273
The issuers’ pressure seem to have been efficient as different regulators have decided to
launch proxy voting reforms or issued recommendations regarding proxy advisors to
provide a better transparency in the industry.
3.2.2 The Impartiality of Proxy Advisors
The most striking conflict of interest in the industry is the possibility for proxy advisors to
provide consulting services to issuers on how to improve their governance ratings or stock
266
Omaggio, supra note 241.
Belinfanti, supra note 261, at 32-9.
268
Steven M. Davidoff, Proxy Firms Need More Rules, Companies Say, DealBook –NYTimes.com (
November30, 2010), available at http://dealbook.nytimes.com/2010/11/30/in-one-area-companies-wantmore-regulation/ (visited August 8, 2011).
269
Mathieu Rosemain, Les cabinets de conseil de vote attirent l’attention des régulateurs [Proxy Voting
Advisors Under Regulators’ Spotlight], LES ECHOS, March. 31, 2011. (Translation by the author)
270
Their Website states that “The Shareholder Communications Coalition is an advocacy organization
dedicated to improving the ability of individual investors to vote their shares and communicate with the
publicly traded companies in which they invest. The Coalition also seeks to educate individual investors
about their rights as shareholders and the importance of participating in corporate elections.”, available at
http://www.shareholdercoalition.com/ ( visited July 31, 2011).
271
Business Roundtable is the most important association of CEOs of U.S. companies , available at
http://businessroundtable.org/about-us/ (visited November 19, 2011).
272
The
complete
member
list
is
available
on
their
Website,
available
at
http://www.shareholdercoalition.com/about.html (visited November 19, 2011).
273
The report concludes by saying that “We believe that proxy advisory services have an oversized impact on
the proxy process. Despite their large role, proxy advisory firms generally remain unregulated and
unsupervised and often are not transparent with regard to their standards, procedures, methodologies, and
conflicts of interest.” Society of corporate securities and Governance professionals, Proxy Advisory Services:
The Need for More Regulatory Oversight and Transparency (2010), available at
http://www.shareholdercoalition.com/SCSGP_NIRI_Discussion_Draft_on_Proxy_Advisory_Services_3-410.pdf (visited November 19, 2011).
267
100
plans while at the same time providing proxy voting recommendations to investors on the
same issues. 274 The GAO report had identified three other sources of potential conflicts:
1. Owners or executives of proxy advisory firms may have a significant
ownership interest in or serve on the board of directors of corporations that
have proposals on which the firms are offering vote recommendations.
2. Institutional investors may submit shareholder proposals to be voted on at
corporate shareholder meetings. This raises a concern that proxy advisory
firms will make favorable recommendations to other institutional investor
clients on such proposals in order to maintain the business of the investor
clients that submitted these proposals.
3. Several proxy advisory firms are owned by companies that offer other
financial services to various types of clients, as is common in the financial
services industry. 275
In answer to this issue, the OECD has declared that proxy advisors are subject to the
OECD Principles of Corporate Governance and therefore their analyses should be “free
from material conflicts of interest that might compromise the integrity of their analysis or
advice.” 276 On its side, the SEC declared that “As investment advisers, proxy advisory
firms owe fiduciary duties to their advisory clients.” 277 This statement has far-reaching
implications but it creates a discrepancy between the ISS and the other main proxy
advisors, Glass Lewis and Egan-Jones, who are not registered as investment advisers in the
SEC’s listing. 278 Mandatory registration in the future would be advisable to avoid different
levels of regulations between the actors.
ISS is the most often criticized and it is legitimate. Despite its leading role on the market, it
has maintained a governance consulting business at destination of issuers. This activity is
managed by ISS Corporate Services (hereinafter ICS, a separate subsidiary of ISS
separated by a ‘Chinese Wall’. ISS is informing his clients about the potential conflict of
interests in its voting recommendations but only in generic terms. 279 According to a
newspaper article published in 2002, around 200 companies a year buy ICS services to
check if their compensation plans and corporate governance guidelines will meet ISS
standards for a fee between “$15,000 a year for Web-based products to $33,000 for indepth consulting.” 280
274
SEC Concept Release, supra note 254, at 116.
Gov’t Accountability Office, Report to Congressional Requesters: Issues Relating to Firms That Advise
Institutional Investors on Proxy Voting (2007), available at http://www.gao.gov/new.items/d07765.pdf
(visited November 19, 2011) (hereinafter GAO Report).
276
OECD, supra note 135, at 25.
277
SEC Concept Release, supra note 254, at 110.
278
GAO Report, supra note 275, at 8.
279
The ISS research reports states that “This issuer may have purchased self-assessment tools and
publications from ISS Corporate Services, Inc. (hereinafter ICS), a wholly-owned subsidiary of Institutional
Shareholder Services Inc. (hereinafter ISS), or ICS may have provided advisory or analytical services to the
issuer in connection with the proxies described in this report. No employee of ICS played a role in the
preparation of this report. If you are an ISS institutional client, you may inquire about any issuer's use of
products and services from ICS by emailing disclosure@msci.com.”
280
Laise, supra note213.
275
101
The SEC is considering that a potential solution would be to reform the Exchange Act
Rule to require “that a person furnishing proxy voting advice to another person must
disclose to its client ‘any significant relationship’ it has with the issuer, its affiliates, or a
shareholder proponent of the matter on which advice is given.” 281
In France, the AMF has adopted quite similar recommendations on March 2011, asking
proxy advisors to adopt Charter of Ethics including rules to deal with those potential
conflicts of interests and to disclose those rules on their Websites.282 They also recommend
disclosing any “ties of interest” with the company or any shareholder. 283
The difficulty for ISS would be to provide this information to the clients without breaching
the internal firewall between ISS and ICS. It is true that this increased disclosure could
satisfy the investors. ISS has already replied that they are not going to change their policy
as investors already have the capacity to ask to ISS’s legal department the identities of
ICS’ clients. 284 This risk of conflict of interests is mostly limited to the United States as
ICS does not have offices in France or Japan. Other American proxy advisors do not
provide services to investors so they are not concerned by this regulation.
The Millstein Report is not so lenient and recommends a much stricter rule: “Governance
firms should endorse and comply with a first industry-wide Code of professional ethics,
including a general ban on a vote advisor performing consulting work for any company on
which it provides voting recommendations or ratings.” 285 The SEC is not totally opposed
to this solution though as it emits the possibility to prohibit such conflicts in its invitation
to comments. 286 It would seem the most reasonable solution in order to bring total
transparency to the business. This idea is supported even by one of the founding employees
of ISS 287 as well as by the European Corporate Governance Services, the partnership of
local proxy advisors. 288
Japanese regulators have not for the moment issued any special rule regarding proxy
advisors. Conflicts of interests could become a problem there too in the future for the two
Japanese proxy advisors, Governance Visions and Japan Proxy Governance. Indeed, Japan
Proxy Governance is not legally separated from Governance Visions, which sells investors
relations services to the issuers. There is no firewall between both services. 289 The issue is
of less importance for Governance Visions which does not sell any services to issuers but
does provide some data to investor relations consultants regarding proxy voting records of
foreign funds. 290
281
SEC Concept Release, supra note 254, at 120.
AMF Recommendations, supra note 257, at 3.
283
Id.
284
ISS, Response to AMF Recommendation No 2011-06 of 18 March 2011 in Respect of Proxy Voting
Agencies (2011), available at http://www.issgovernance.com/AMFStatement (visited November 19, 2011).
285
The Millstein Center, supra note 255, at 3.
286
SEC Concept Release, supra note 254, at 123.
287
Nell Minow, ISS May Be Under Fire, but Look How Far It - and Shareholder Rights - Have Come,
Bnet.com (March 16, 2011), available at http://www.bnet.com/blog/corporate-governance/iss-may-be-underfire-but-look-how-far-it-8212-and-shareholder-rights-8212-have-come/113 (visited July 30, 2011).
288
European Corporate Governance Service, ECGS responses to the E.C. Green paper on Corporate
Governance (2011), available at http://www.proxinvest.com/divers/greenpaper-ecgs.pdf (visited November
19, 2011).
289
Interview with Yoji Yoshioka, supra note 211.
290
Phone interview with Kuniaki Matsumoto, supra note 207.
282
102
3.2.3 The Accuracy of Proxy Advisors’ Recommendations
The critiques regarding proxy advisors’ recommendations concern on one side the content
of those recommendations with the risks of inaccuracy or a “one-size-fits-all” approach,
and on the other side the process of proxy advisors to issue their recommendations.
3.2.3.1 The inaccuracy of recommendations
Issuers sometimes complain that proxy advisors issue recommendation based on wrong
data and that there is a lack of transparency in how they formulate their recommendations.
The European Green Paper stated the fear of some investors and issuers that “the analytical
methodology fails to take into account firm-specific characteristics and/or characteristics of
national legislation and best practice on corporate governance.”
There have been recurring critiques that ISS’ analysts would be under-qualified without
any evidence of it though. 291 It is true that, due to the nature of the activity, proxy advisors
are bound to recruit seasonal employees. 292 Hopefully that does not imply they are not
qualified. The AMF has underlined the fact that proxy advisors need to “provide highquality” work but has not gone further. 293
To remedy those issues, the SEC suggests increasing the
disclosure regarding the extent of research involved with a particular
recommendation and the extent and/or effectiveness of its controls and
procedures in ensuring the accuracy of issuer data.” 294 “Proxy advisory
firms could also disclose policies and procedures for interacting with
issuers, informing issuers of recommendations, and handling appeals of
recommendations. We could also consider requiring proxy advisory firms to
file their voting recommendations with us as soliciting material, at least on a
delayed basis, to facilitate independent evaluation by market participants of
the quality of those recommendations. Proxy advisory firms that are
registered as investment advisers also are required to create and preserve
certain records that our examiners review when performing an inspection of
an adviser. 295
In France to avoid inaccuracy in the content of proxy advisors’ research, the importance of
the dialogue with issuers has been stressed. To ensure the quality of the information
contained in the proxy reports, the AMF recommends that proxy advisors communicate
with issuers and allow them to review the draft of the report. 296 They should have up to 24
hours to review the draft and indicate their comments, at the condition that the issuer had
also disclosure all the documents related to the general meeting at least 35 days before the
291
See Belinfanti, supra note 261, at 19 (ISS is “hiring relatively unskilled employees to conduct governance
analysis”). See also Rose, supra note 122, at 897 (“ISS…has been known to use relatively unskilled
temporary employees to conduct governance reviews.”)
292
Laise, supra note 213.
293
AMF Recommendation, supra note 257, at 1.
294
SEC Concept Release, supra note 254, at 122.
295
SEC Concept Release, supra note 254, at 114.
296
AMF Recommendation, supra note 257, at 3.
103
meeting. The AMF’s approach seems to be equitable, allowing the proxy advisor enough
time to write an informed analysis and ensuring a dialogue between issuers and proxy
advisors. The mandatory introduction of issuers’ comments in the proxy advisor’ research
seems rather invasive though. Corporations have already enough ways to communicate
with their shareholders, either directly through their usual channels or indirectly through
proxy solicitors. The information included in their comments must be already included in
other public documents to respect the market regulations so what is their added-value? If
all issuers decide to review the research and include comments, it represents a colossal
work for proxy advisors who already have very tight schedules to send their
recommendations on time. This creates important additional costs that investors will have
to bear in the end.
3.2.3.2 A one-size-fits-all governance approach
Except the risk of inaccuracy, issuers also complain that proxy advisors adopt a one-sizefits-all governance approach without taking into account firms’ specificities. 297 But to
comply with the different recommendations, proxy advisors are facing a dilemma: their
guidelines must be clear and precise to be predictable for issuers, but at the same time
general enough to be flexible and avoid a too strict approach. The new French proxy rules
allows even less flexibility as the issuer could ask the Court to cancel proxy votes which
are not in conformity of the proxy voting policy.
Thus a former employee of ISS makes this point: “ISS is often accused of being too rigid
and formulaic. There is some justification for this; it relies on formulas to demonstrate that
it is not swayed by conflicts from its consulting fees. But ISS is also criticized for
departing from its formula. This is absurd; no formula should take precedence over
concerns about performance.” 298
3.2.3.3 Ticking the box approach
In relation to the previous issue, commentators are afraid that investors and advisors have a
“ticking the box” approach in relation to proxy voting. Therefore they have stress the need
for investors to act independently when formulating their voting policy and casting their
votes. Thus the OECD declared that investors should not be “avoiding their
responsibilities.” 299
The French financial regulator, the AMF, has also recalled to asset managers their duty to
vote independently their shares “after careful examination of the resolutions. They should
not rely entirely on others, since this approach does not ensure compliance with the
principle that the shareholders’ interests must prevail.” 300
Here again, if the proxy advisors and investors are not allowed enough flexibility in their
voting guidelines, the risk of “ticking the box” approach can only increase.
297
SEC Concept Release, supra note 254, at 119.
Minow, supra note 287.
299
OECD, supra note 135, at 48.
300
Report Working Group AMF, supra note 2, at 23.
298
104
3.3 Conclusion
Proxy advisors’ influence is usually overstated but they nonetheless influence a substantial
number of investors. With the last financial crisis, the need for institutional investors to be
better watchdogs and to have independent corporate governance gatekeepers has been
amplified. As the market seems inefficient to regulate proxy advisors effectively, issuers
have pressed the SEC and the AMF to regulate while in Japan proxy advisors’ influence
might not be strong enough to make issuers’ react. The French regulation could serve as an
example of regulation but given the cross-border nature of the activity of proxy advising, it
would seem more efficient that the European Commission regulates at the European level.
4. Conclusion
The current financial and economic crisis has placed institutional investors in the spotlight
and revealed the lack of monitoring of the companies in which they invest. The rise of
quantitative managed funds has strengthened this lack of monitoring, as the managers of
those funds do not perform qualitative analysis of their stocks by definition. Moreover,
institutional investors as other shareholders are rationally apathetic; it makes more sense
for them to sell their stocks when a company is under-performing. Activism is costly and
brings uncertain results. Forcing institutional investors to use their voting rights at general
meetings to respect their fiduciary duty to their clients was supposed to improve the
situation. Its most salient result, however, was the boom of the proxy advisory industry.
Managers could not and did not want to analyze thousands of general meetings so they
took the economically rational decision to outsource proxy voting to those consulting
companies. It created a peculiar situation where each new reform regarding corporate
governance or proxy voting empowers even more proxy advisors.
The industry of proxy advisory services is dominated by Institutional Shareholder Services
which is said to sway 10 to 20 percent of the votes in the United States. French and
Japanese corporations, both facing a rise of foreign and institutional ownership, have
become aware of the influence of proxy advisors. They now engage with the proxy
advisors, ISS in particular, before general meetings and try to comply with their guidelines.
The issue is more significant in France where mutual funds have a duty to vote whereas
Japanese investors tend to be less active and follow management recommendations
regarding the vote at general meetings. Proxy advisors brought change to the corporate
governance world. The combined votes of institutional investors represent an important
pressure on corporations which thus have to respect the corporate governance principles
defended by those actors in order not to face shareholders’ rebuff. Proxy advisors have
become a convergence force towards the shareholder-model worldwide.
The lack of oversight and control of proxy advisors is now a major issue due to their
influence on the corporate world. The SEC has thus declared that proxy advisors have a
fiduciary duty towards their clients; therefore they have to provide accurate and
independent recommendations. But more importantly the OECD as well as the AMF in
France recalled to institutional investors that voting rights are their responsibility and using
proxy advisors’ services is not necessarily sufficient to respect their fiduciary duty. The
AMF has been the first to issue recommendations to proxy advisors, bringing more
transparency and ensuring communication with issuers. Those new norms should calm
105
issuers who have been very dissatisfied about ISS, seen as an illegitimate rule-maker
imposing foreign principles on them. However, the conflict of interests of ISS still remains
unregulated while the SEC and European Commission’s regulations are pending. Finally,
the legitimacy of the corporate governance principles championed by the proxy advisors is
an issue which would require a more profound examination in the future.
In the end, the beneficial roles played by proxy advisors must not be overlooked. We have
to remember that, in the original position, shareholders were not playing their roles of
watchdogs and institutional shareholders had a lot of trouble successfully cooperating.
Thanks to regulations and the proxy advisory services, investors are now voting in a
coordinated manner, pressuring companies to adopt corporate governance reforms when
needed. The “comply-or-explain” system adopted by many corporate governance codes
might be insufficient if institutional investors, through their agents the proxy advisors,
were not checking the actual compliance and disciplining the market.
With the globalization of the economy, cross-border transactions and voting have increased
exponentially. Proxy voting is now a whole and complex industry, including several layers
of intermediaries and involving advanced technology. Many new actors have emerged,
proxy advisors, proxy solicitors, proxy service providers, all unknown of the general public
but playing their part in the fight for corporate control. They are here to last.
106
CREATIVITY, COPYRIGHT, AND COMMUNITY: AN EXPLORATION OF THE
ISSUES SURROUNDING FAN-CREATED WORKS UNDER U.S. AND JAPANESE
COPYRIGHT LAW
Adrienne Lipoma
As the principle, please understand that the question is regarding a rather
delicate issue to which no one can perhaps identify a clear-cut criterion. Of
course, we cannot say that we can give tacit approval to any and all the
activities which threaten our intellectual properties. But on the other hand, it
would not be appropriate if we treated people who did something based on
affection for Nintendo, as criminals. 1
- Satoru Iwata, Nintendo President and CEO
1. Introduction
At its 70th annual shareholder meeting, the president of Nintendo was asked
what the company’s policy is towards fan activities that might infringe on
Nintendo’s copyrights such as “fan magazines, original short movies, music
bands, cosplay activities, websites, [and] orchestras.” 2 Sony and other video
game companies have been experiencing a series of distributed denial-ofservice attacks (DDoS attacks) in recent months. 3 These attacks occurred after
the hacker group Anonymous officially “declared war” 4 on Sony for Sony’s
decision to file suit against the person who cracked the security systems of the
PlayStation 3. When faced with its own hardware hack, Microsoft initially
threatened legal action 5 but has since changed its tune and is now “excited to
see that people are so inspired that it was less than a week after the Kinect
came out before they had started creating and thinking about what they could
do.” 6 The 10th annual Star Wars Fan Film contest winners were announced by
1
Nintendo, The 70th Annual General Meeting of Shareholders Q & A, available at
http://www.nintendo.co.jp/ir/en/stock/meeting/100629qa/05.html (visited June 29, 2010).
2
Id.
3
Keith Stuart, Why are Lulzsec and Anonymous hacking games companies?, THE GUARDIAN,
available at http://www.guardian.co.uk/technology/2011/jun/16/lulzsec-anonymous-hackinggames-companies?INTCMP=SRCH (visited June 16, 2011).
4
Annonymous,
Operation
Payback
brings
you
#OpSony,
available
at
http://anonnews.org/?p=press&a=item&i=787 (visited August 6, 2011).
5
Alex Hudson & Spencer Kelly, Microsoft Kinect 'Hack' Opens Up Possibilities, THE BBC
(Nov. 20, 2010), available at http://news.bbc.co.uk/2/hi/programmes/click_online/9210071.stm
(visited November 20, 2011).
6
Talk of the Nation, How The X-Box Kinect Tracks Your Moves (Nov. 19, 2010), available at
http://www.npr.org/2010/11/19/131447076/how-the-x-box-kinect-tracks-your-moves (visited
November 27, 2011).
107
George Lucas at last month’s Comic Con,7 but for the most part only parodies
and documentaries are allowed to participate in the contest. 8
What do the above anecdotes mean? They signal changes in the way fans and
the holders of intellectual property interact. We are moving more and more
from a “read-only” to a “read-write” society, to use Lawrence Lessig’s terms. 9
Consumers are no longer passively consuming. They take in protected
properties, but that is not where the action stops. As children, we all used to
make up stories and act them out with our favorite toys. Now, the act of
creating with the things we love no longer ceases when we graduate from the
sandbox. Technology, in no small part, drives this new (or arguably this return
to the old 10 ) read-write society. Everyday people have the tools to create
graphics and movies quickly and inexpensively. Online fan communities
spring up all the time. Sites like YouTube, deviantART, and Dreamwidth
Studios allow people to share their creative efforts instantly and with millions.
This “remix” culture, by its very nature, brushes up against intellectual
property law, particularly copyright law. This is particularly true for fan
communities. They gather to not only discuss beloved properties but also to
create and share their own visions of those properties. The new fan-created
works seem, fundamentally, to be in conflict with copyright law. There are, of
course, copyright exceptions, but do fan-created works fall within those safe
harbors? If they do not, is it worth a rights holder’s time and effort to pursue
claims against fans and risk a backlash from the people most likely to consume
the protected work? As fan communities increase in the United States, so too
do the opportunities for clashes between these communities and rights holders
of the protected works on which the communities’ new creations are based.
This environment of heightened conflict has, over the last decade or so, led to
both scholarly and grassroots efforts to address the issues around fan-created
works and copyright.
While the US has only recently begun addressing fandom and copyright issues,
Japan has had a thriving fan community – nay, industry – at apparent peace
with rights holders for decades. This industry centers around dōjinshi, or fancreated comics. 11 They are produced by individuals or by groups known as
7
Matt Enlow, Star Wars Fan Movie Challenge Winners Announced, The Atom Blog (July 22,
2011), available at http://www.atom.com/blog/2011/07/22/2011-star-wars-fan-moviechallenge-winners-announced/ (visited Novenber 15, 2011).
8
Amy Harmon, “Star Wars” Fan Films Come Tumbling Back to Earth, N.Y. TIMES, Apr. 28,
2002, available at http://www.nytimes.com/2002/04/28/movies/film-star-wars-fan-films-cometumbling-back-to-earth.html?scp=1&sq=star+wars+fan+films&st=nyt (visited November 15,
2011).
9
TED2007, Larry Lessig on Laws That Choke Creativity, Ted Talks (March 2007), available
at http://www.ted.com/talks/larry_lessig_says_the_law_is_strangling_creativity.html (visited
November 15, 2011).
10
Id.
11
The definition of dōjinshi given by the organizers of the largest dōjinshi market is
“magazines published as a cooperative effort by a group of individuals who share a common
ideology or goals with the aim of establishing a medium through which their works can be
presented.” What is the Comic Market, COMIC MARKET PREPARATION COMMITTEE 3 (Feb.
2008), available at http://www.comiket.co.jp/info-a/WhatIsEng080528.pdf (visited November
15, 2011).
108
“circles,” and they can be found online, in stores, and at various conventions
held throughout the year. How do these dōjinshi comics work within the
framework of the law? Do they actually operate within the law or is their
continued existence owed more to rights-holder tolerance than the legal
infrastructure? Answering these questions may help provide guidance for
American fan communities and rights holders moving forward. At the same
time an examination of the US situation may yield useful insights for Japan.
This paper seeks to explore the copyright systems, the fan communities, and
the interaction between fandom and law in the US and Japan and to see what
future changes, if any, might improve and strengthen the interests of all parties
involved. Part II looks at fan culture and the activities of its members. Part III
examines copyright statutes and relevant case law. Part IV highlights clashes
between law and fandom. Parts V and VI explore the implications of industryfan conflict and ways to address these issues. Part VII concludes.
2. Fandom in the US and Japan
The Oxford English Dictionary defines a “fan” as “[a] fanatic; in modern
English (orig. US): a keen and regular spectator of a (professional) sport, orig.
of baseball; a regular supporter of a (professional) sports team; hence, a keen
follower of a specified hobby or amusement, and gen. an enthusiast for a
particular person or thing.” 12 The fans discussed above are generally
enthusiasts of new media, particularly video games, fans of speculative fiction
genres – science fiction, fantasy, and horror – or both. They are enthusiasts of
creative intellectual properties. Thinking about the average sports fans, from
whence the modern usage of fan came, the activities of those fans include
watching games, discussing the games and players, and often playing the sport
as well. Fans of creative works do the same things. They read, or watch, or
play with the work itself, they discuss the characters and plots, and sometimes
they also “play the sport.” It is in this “playing” that problems arise. A quick
pick-up game of basketball does not require seeking permission from Mr.
Naismith or his estate 13 before hitting the court. A fan of a creative work who
wants to write a short story or make a video about the characters in that
creative work, however, comes squarely into the path of copyright law. Her
video or story may be a derivative work in the legal sense 14 or may be an
infringement of the creator’s moral rights. It is these fans, the ones whose
otherwise normal “fannish” activities reside in the shadow of intellectual
property law that are being addressed in this paper.
12
Fan definition, The Oxford English Dictionary [herinafter OED], available at
http://www.oed.com.ezproxy.sfpl.org/view/Entry/68000?rskey=juPBGm&result=2&isAdvanc
ed=false#eid4735564 (visited August 11, 2011).
13
History,
History
of
Basketball,
available
at
http://www.history-ofbasketball.com/history.htm (visited November 20, 2011).
14
All fan-created works are “derivative” in that they are derived from non-original source
material. Whether such a work falls within the legal definition of “derivative work” is a
different question. Throughout this paper references to derivative works will refer to the more
expansive derived sense rather than the legal one unless otherwise specified.
109
2.1 US Fandom
There are several genesis stories for modern fandom in the US, but most stories
trace fandom’s origins to the 1960s and in particular to Star Trek. 15 The first
Star Trek fanzine appeared the year after the show first aired. 16 These
magazines were circulated amongst small groups of fans by mail and at science
fiction conventions. 17 They contained fan fiction, or fanfic, stories written by
fans about characters in the show. 18 Since then, technology has allowed those
small groups to grow exponentially larger as they transitioned to digital life on
the Internet. 19 There are multiple archives of fan fiction on the web. 20 The
world of fan fiction is largely populated by women, and many of the stories
they write concern same-sex romantic or erotic relationships between their
favorite characters. 21 Such stories are called “slash” from the punctuation used
to denote character pairings. 22
Not all fan fiction is slash, and not all fan activities in the US are fan fiction.
There are music remixes and mash-ups, fan art, fan music (filk), 23 fanvids and
AMVs, 24 machinima, 25 cosplay, 26 video game remakes and mods, and more.
The relationship between fan activities and the original creators is varied.
Some have been encouraging, some have been hostile, and others have been
permissive or unaware of the activities. The responses of rights holders can
sometimes be predicted based on their identity. Original authors are more
likely to be permissive than institutional ones like publishers or game and
15
Lev Grossman, The Boy Who Lived Forever, TIME 2 (July 07, 2011), available at
http://www.time.com/time/arts/article/0,8599,2081784-1,00.html (visited November 15, 2011)
There are older, often much older, instances of fan fiction, but most modern histories begin
with the Star Trek fan activities.
16
Id.
17
Aaron Schwabach, The Harry Potter Lexicon and the World of Fandom: Fan Fiction,
Outsider Works, and Copyright, 70 U. PITT. L. REV. 387, 388-389 (2009).
18
The OED defines “fan fiction” as “fiction, usually fantasy or science fiction, written by a fan
rather than a professional author, esp. that based on already-existing characters from a
television series, book, film, etc.; (also) a piece of such writing.” OED, supra note 12. The first
recorded usage of fan fiction is 1944.
19
Schwabach , supra note 17, at 391.
20
See, e.g., Fanfiction.net, available at http://www.fanfiction.net/ (visited August 11, 2011)
and Archive of Our Own, available at http://archiveofourown.org/ (visited August 9, 2011).
21
Schwabach, supra note 17, at 390-391.
22
Id, at 391 (“the archetypal slash pairing Kirk/Spock”).
23
Melissa L. Tatum, Dr. Robert Spoo & Benjamin Pope, Does Gender Influence Attitudes
toward Copyright in the Filk Community?, 18 AM. U.J. GENDER SOC. POL'Y & L. 219, 220
(2010). The term filk, like many other modern culture and subculture terms, appears to have
come from a typo.
24
AMV are anime music videos.
25
Machinima
Definition,
OED,
available
at
http://www.oed.com.ezproxy.sfpl.org/view/Entry/276435?redirectedFrom=machinima#eid
(visited August 11, 2011). (“The practice or technique of producing animated films using the
graphics engine from a video game. Also: a film produced in this way; such films as a genre.”).
The word is a combination of “machine” and “cinema.”
26
PATRICK W. GALBRAITH, THE OTAKU ENCYCLOPEDIA: AN INSIDER’S GUIDE TO THE
SUBCULTURE OF COOL JAPAN 51 (2009). The activity came from people dressing up at science
fiction conventions in the US, but the term was coined in Japan: kosu-purei (costume + roleplay).
110
movie studios,27 though this is certainly not the case for all authors. 28 Nor are
institutional rights holders categorically opposed to the use of their products in
fan-created works. 29 In the case of Red vs. Blue, a machinima series made with
the game Halo, Microsoft not only allowed the fan creators to use the property
license-free, it hired them to produce advertisements for the game. 30
The Red vs. Blue example is unusual in that it led the fans to monetary rewards.
One aspect of American fan culture is that it is strongly anti-commercial.
Instead, fandom tends to be built around a social economy. 31 Fans often point
to this non-monetized aspect when they seek to justify their activities as fair
use. There are even anecdotal stories of fans “turning in” other fans to
copyright holders for seeking financial gain from their fan-created works. 32
This wall between official works for money and fan works for the joy of
creation appears solid in the US, but it is much more porous in the case of
Japan.
2.2 Japanese Fandom
The world of Japanese fandom is epitomized by “otaku.” Otaku can be
generally translated as “nerd,” “geek,” or “fanboy/fangirl.” 33 Like the US, the
modern otaku fandom also emerged in the 1970s and 80s. 34 The image of these
manga and anime obsessed fans has swung from one extreme to the other in
the intervening decades. In 1989, a child serial killer was branded the “otaku
murderer” by the media due to his large collection of anime. 35 The negative
connotation did not remain, however, and in 2005 otaku became a media
27
Schwabach, supra note 17, at 390 (Quoting Gene Roddenberry, the creator of Star Trek,
“[e]ventually we realized that there is no more profound way in which people could express
what Star Trek has meant to them than by creating their own personal Star Trek things . . . . It
was their Star Trek stories that especially gratified me. . . . Best of all, all of it was clearly done
with love.). A later rights holder of the same property did not feel the same way initially. Steve
Silberman, Paramount Locks Phasers on Trek Fan Sites, WIRED, Dec. 18, 1996 , available at
http://www.wired.com/culture/lifestyle/news/1996/12/1076 (visited November 20, 2011)
(reporting on Paramount’s sending of cease-and-desist letters to owners of Star Trek fan
websites).
28
See infra text accompanying note 159.
29
Clive Thompson, The Xbox Auteurs, N.Y. TIMES, Aug. 7, 2005, § 6 (Magazine), at 24,
available at http://www.nytimes.com/2005/08/07/magazine/07MACHINI.html (visited
November 20, 2011).
30
Id.
31
See Rebecca Tushnet, User-Generated Discontent: Transformation in Practice, 31 COLUM.
J.L. & ARTS 497, 514-513 (2008) (arguing that participants in a noncommercial activities
produce different works than those in commercial activities, meaning fan produced works
would not be infringing on the commercial market).
32
Casey Fiesler, Note, Everything I Need To Know I Learned from Fandom: How Existing
Social Norms Can Help Shape the Next Generation of User-Generated Content, 10 VAND. J.
ENT. & TECH. L. 729, 730-731. (2008).
33
Galbraith, supra note 26, at 171-179. In the US otaku are fans of anime and manga,
specifically. In Japan, an otaku can be someone obsessed with any kind of hobby (though
outside of anime, manga, video games, and idols, a descriptor might be necessary, e.g. a film
or train otaku).
34
ROLAND KELTS, JAPANAMERICA: HOW JAPANESE POP CULTURE HAS INVADED THE U.S.157
(2006).
35
Id.
111
sensation again due to the wild popularity of the book Densha Otoko (Train
Man) and the subsequent movie, TV show, manga, and anime. 36
Otaku engage in all the same activities as American fans, but the dōjinshi
phenomenon is something unique to Japan. To understand the world of
dōjinshi, it is first necessary to understand the manga industry in Japan. In the
US, comics have been historically confined to the superhero genre. 37 This trend
has changed in the last few decades, but Western comics and graphic novels
have mostly remained a fairly small genre. 38 Contrast this with Japan where
“manga are the dominant form in Japanese pop culture” and “virtually
everybody in Japan has had some exposure to manga, not only in childhood,
but in many stages of their adolescent and adult life.” 39 The subject matter of
manga is wide ranging, making it more of a medium than a genre. 40 And while
sales have fallen in recent years, annual sales still total billions of yen. 41
Manga is an integral part of the Ministry of Economic, Trade and Industry’s
“Cool Japan” program to promote Japanese cultural properties overseas. 42
Returning to dōjinshi, it is important to note that not all dōjinshi are necessarily
problematic with regard to copyright law. While many of them do feature
characters from protected works, many of them are wholly original in nature. 43
Just as manga is a medium and not a genre, so too is dōjinshi. 44 Tezuka Osamu,
36
Id., at 158-159.
See generally SHIRREL RHOADES, A COMPLETE HISTORY OF AMERICAN COMIC BOOKS
(2008) (chronicling the rise of the super hero comic in the 1930s to the modern evolution of
graphic novels).
38
Most Western comics can only be found in specialty stores. On the other hand, Englishlanguage versions of Japanese manga (and increasingly Korean as well) can be found in most
major bookstores. At its sales height in 2007, manga made up about two-thirds of all graphic
novels sales in the US. See, Calvin Reid, Fork in the Manga Road, PUBLISHERS WEEKLY, Jul.
29,
2011,
available
at
http://www.publishersweekly.com/pw/by-topic/booknews/comics/article/48190-fork-in-the-manga-road.html (visited November 20, 2011).
39
Susan Napier, Four Faces of the Young Female, in D.P. Martinez (ed.), THE WORLDS OF
JAPANESE POPULAR CULTURE: GENDER, SHIFTING BOUNDARIES AND GLOBAL CULTURES 92 (.
1998).
40
Frederik L. Schodt, DREAMLAND JAPAN: WRITINGS ON MODERN MANGA 28 (1996).
41
See Nihon no Shuppan Tōkei [Japan Publication Statistics], ZENKOKU SHUPPAN KYŌKAI
[The All Japan Magazine and Book Publisher's and Editor's Association], available at
http://www.ajpea.or.jp/statistics/index.html (visited November 20, 2011). The graph below
shows the manga sales (magazine in blue, books in red) in hundred millions of yen. Despite the
general decline, comic magazines and book sales still account for around ¥450 billion annually.
37
42
Ministry of Economy, Trade and Industry, Creative Industries (Cool Japan!), available at
http://www.meti.go.jp/english/policy/mono_info_service/creative_industries/creative_industrie
s.html (visited November 20, 2011).
43
Sharon Kinsella, Japanese Subculture in the 1990s: Otaku and the Amateur Manga
Movement, 24 J. JAP. STUD. 289, 300-301 (1998).
44
For example, in the call for entries for the 15th Japan Media Arts Festival held by the
Agency for Cultural Affairs, the guidelines for manga submission specifically mention dōjinshi
112
the “god of manga,” drew dōjinshi early in his career. 45 Other famous
professionals also got their start in the world of dōjinshi. 46 Many amateur
artists are women, 47 and many of their stories involve “slashing” their favorite
anime and manga characters. 48 There are many stores that sell dōjinshi, and it
is available online as well. 49
No discussion of dōjinshi would be complete without mentioning the Comic
Market or Comiket. 50 It began in 1975 and was held on a single day with just
700 attendees. 51 Now it is a biannual affair, lasting three days, and attracting
over 500,000 attendees. 52 As much as 5.75 billion yen can change hands in a
single day. 53 Even if one were to assume that the majority of dōjinshi sold at
Comiket were original, that would still leave a substantial number of comics
that could be potentially infringing.
Ignoring legal arguments for the moment, there are several other explanations
put forth as to why copyright litigation is not rampant. One reason often given,
regarding litigation generally, is that Japan is litigation-averse; however, this
proposition has been rebutted many times. 54 The mostly commonly offered
explanation for why there is no litigation over dōjinshi is that there is a “tacit
agreement” – anmoku no ryōkai – between the fans and industry. 55 Original
(“jishu seisaku/dōjinshi nado de happyō sareta manga”) [“manga ‘produced independently and
in small private magazines’”]. See Press Release, Bunkachō Medeia Geijutsu Matsuri Sakuhin
Boshū Gaiyō [Japan Media Arts Festival], [Entry Overview for Works of Art], available at
http://plaza.map-staff.jp/festival/2011/pdf/110708_fes.pdf (visited November 20, 2011) and in
English at http://plaza.map-staff.jp/festival/2011/pdf/110708_fes_EN.pdf (visited November
20, 2011).
45
Kelts, supra note 34, at 167.
46
Kinsella, supra note 43, at 298.
47
Kaoru Nagayama & Takashi Hiroma (eds.), 2007-2008 MANGA RONSŌ BOPPATSU [Manga
Controversy Outbreak] 65 (2008) (showing the percentage of participants and artists at
Comiket by gender).
48
Kinsella, supra note 43, at 301. There are multiple terms for slash in Japanese; yaoi is
perhaps the best known among English speakers and generally refers to works created by and
for women.
49
Mandarake is an example of a company that sells dōjinshi both online and in brick-andmortar stores. Mandarake, available at http://www.mandarake.co.jp/ (visited November 20,
2011).
50
Also sometimes written as “Komike” or “Komiketto.” See Schodt, supra note 40, at 40.
51
SHIMOTSUKI TAKANAKA, KOMIKKU MĀKETTO SŌSEIKI [GENESIS OF COMIC MARKET] 10
(2008).
52
Id.
53
AKASHI SUGIYAMA, KOMIKKU DŌJINSHI SOKUBAIKAI “KOMIKKU MĀKETTO” NO BUNKA
SHAKAGAKUTEKI KENKYŪ [A SOCIOLOGICAL STUDY OF THE CULTURE OF COMIC DOJINSHI
SALES EXHIBITION “COMIC MARKET”] 158 (2008).
54
See Salil Mehra, Copyright And Comics In Japan: Does Law Explain Why All The Cartoons
My Kid Watches Are Japanese Imports?, 55 RUTGERS L. REV. 155, 185 n.152 (2002)
(discussing idea of Japan as non-litigious).
55
The idea of a tacit agreement between industry and fans appears in writings on dōjinshi in
both English and Japanese. See generally Mehra, supra note 54, at 182-185 (discussing
incentives for rights holders not to litigate); Galbraith, supra note 26, at 29 (listing an entry for
“anmoku no ryōkai”); Kelts, supra note 34, at 69 (discussing the legality of dōjinshi with the
CEO of TokyoPop, an American publisher of manga); Daniel H. Pink, Japan, Ink: Inside the
(Oct.
22,
2007),
available
at
Manga
Industrial
Complex,
WIRED
http://www.wired.com/techbiz/media/magazine/15-11/ff_manga (visited November 20, 2011)
(advocating the exportation of “anmoku no ryōkai” to US business practices); Medeia Geijutsu
113
artists and publishers do not pursue copyright infringement claims against fans
because the existence of dōjinshi confers benefits to all parties involved. 56
Many artists continue to draw dōjinshi even after they become professional,
and new artists learn the craft through their fan activities.57 Publishers may not
like seeing hundreds of comics featuring their characters, but the mere
existence of those comics lets the publishers know which of their properties are
the most popular. 58 As long as this understanding holds, it would appear that
Japan has found a workable balance of competing interests.
3. Copyright Law in the US and Japan
There are many similarities between the copyright laws of Japan and those of
the US. Both countries are signatories to the Berne Convention. 59 Both
countries afford copyright protection to creative works 60 and not ideas 61 ,
though they express this restriction differently. Each country grants exclusive
rights of reproduction of the original work as well as rights to derivative works
to the original creator. 62 In addition, both Japan and the US have laws
protecting freedom of speech and expression. 63 Copyright, which by its very
nature grants monopolistic rights over expression, can often come into conflict
with the right of freedom of expression. Japan and the US have each tackled
the question of copyright versus free speech at the highest judicial level. 64 And
no Kokusaitekina no Kyoten no Seibi ni Kansuru Kentōkai (Dai Nikai) Gijiroku [Meeting
Notes of the Second Meeting of the Investigative Committee on Maintaining the International
Status of Media Arts], BUNKAICHŌ [Agency for Cultural Affairs], available at
http://www.bunka.go.jp/bunkashingikai/kondankaitou/madiageijutsu/02/gijiroku.html (visited
November 20, 2011) (discussing the existence of a tacit agreement regarding parody and
quotation and the need to study it); Naoto Misaki, Dōjinshi Sōken Repōto 2006- 5-27 [Dōjinshi
Research Report May 27, 2006], Doujinshi Research Institute, available at
http://www.st.rim.or.jp/~nmisaki/index.html (last modified January 7, 2011) (discussing an
alleged comment by the Agency of Cultural Affairs that the tacit understanding prevented
rights holders from exercising their rights).
56
For a good discussion of reasons why dōjinshi are permitted despite the existence of
copyright law, see Mehra, supra note 54, at 179-189 (discussing cultural arguments, tacit
agreement, and litigation norms).
57
Kelts, supra note 34, at 170.
58
Kaoru Nagayama & Takashi Hiroma (eds.), MANGA RONSŌ BOPPATSU 2 [MANGA
CONTROVERSY OUTBREAK 2] 28 (2009) (discussing dōjinshi as a sort of “price of fame”).
59
Berne Convention for the Protection of Literary and Artistic Works, Sept. 9, 1886, 828
U.N.T.S. 221.
60
Chosakuhō [Copyright Law], Law No. 418 of 1970, art. 2 (Japan), translated at
http://www.japaneselawtranslation.go.jp/law/detail/?ft=1&re=02&dn=1&co=01&x=0&y=0&k
y=copyright&page=19 (visited November 20, 2011) “‘Work’ means a production in which
thoughts or sentiments are expressed in a creative way and which falls within the literary,
scientific, artistic or musical domain.”
61
17 U.S.C. §102(b) (2009) (“In no case does protection under this chapter for a mask work
extend to any idea”).
62
Chosakuhō, supra note 60, art. 17-28, and 17 U.S.C. §106.
63
Nihonkoku Kenpō [Kenpō] [Constitution], art. 21, para. 1 (Japan), translated at
http://www.ndl.go.jp/constitution/e/etc/c02.html; and U.S. Const. amend. I.
64
Saikō Saibansho [Sup. Ct.] Mar. 28, 1980, Shō 51 (O) No. 923, SAIKŌ SAIBANSHO
SAIBANREI JŌHŌ HANREI KENSAKU SHISUTEMU [SAIBANREI JŌHŌ], 1, available at
http://www.courts.go.jp/ (visited November 20, 2011) (Japan) [hereinafter Montage
Photograph Case] and Campbell v. Acuff-Rose Music, Inc., 510 U.S. 569 (1994), respectively
(both cases address works satirizing/parodying copyrighted works).
114
each country’s high court has determined that the circumstances of the question
in controversy will dictate the outcome of that particular battle.
There are also differences between the two laws. The biggest difference that
comes immediately to mind is the issue of moral rights. Japan explicitly grants
moral rights to authors in Articles 18-20 of its copyright law. 65 The US
historically does not have moral rights, and there are many federal and state
judicial decisions that imply that the US does not recognize moral rights at
all. 66 Upon closer inspection, however, many of the rights granted under the
name “moral rights” are, in fact, present in the US: “The time-honored judicial
practice of distilling new wine in old bottles has resulted in an increasing
accretion of case law in some degree according the substance of moral rights,
either under copyright or under other conventional and respectable labels, such
as unfair competition, defamation, invasion of privacy or breach of contract.” 67
And to be scrupulously precise, there are federal statutory moral rights in the
US Congress passed the Visual Artists Rights Act of 1990, adding §106A to
the Copyright Act and brining US law into “greater harmony with laws of other
Berne countries.” 68 This addition of moral rights has little impact on the
comparison here, however, as the Act only relates to visual arts (per the
amendment’s name); even within this category, the qualification requirements
are very strict. 69 For argument’s sake, assume the US has no moral rights. This
difference will be important later in the discussion.
3.1 US Copyright Law and Cases
In the US, the Constitution is the foundation for copyright and patent
protection. 70 The law itself is contained in Title 17 of the United States Code.71
Chosakuhō, supra note 60, arts. 18-20.
4 MELVILLE B. NIMMER & DAVID NIMMER, NIMMER ON COPYRIGHT §8D.02 n.1 (2010)
(“Gilliam v. American Broadcasting Cos., 538 F.2d 14 (2d Cir. 1976) (‘American copyright
law, as presently written, does not recognize moral rights or provide a cause of action for their
violation, since the law seeks to vindicate the economic, rather than the personal, rights of
authors.’); Vargas v. Esquire, Inc., 164 F.2d 522 (7th Cir. 1947); Crimi v. Rutgers Presbyterian
Church, 194 Misc. 570, 89 N.Y.S.2d 813 (Sup. Ct. 1949). See Stevens v. National
Broadcasting Co., 148 U.S.P.Q. 755 (Cal. Super. Ct. 1966); Shostakovich v. Twentieth
Century-Fox Film Corp., 196 Misc. 67, 80 N.Y.S.2d 575 (Sup. Ct. 1948), aff'd, 275 A.D. 692,
87 N.Y.S.2d 430 (1949).”).
67
Id., at §8D.02(A).
68
Id., at §8D.02 n.5.
69
17 U.S.C. §101. “A ‘work of visual art’ is— (1) a painting, drawing, print or sculpture,
existing in a single copy, in a limited edition of 200 copies or fewer that are signed and
consecutively numbered by the author, or, in the case of a sculpture, in multiple cast, carved, or
fabricated sculptures of 200 or fewer that are consecutively numbered by the author and bear
the signature or other identifying mark of the author; or (2) a still photographic image produced
for exhibition purposes only, existing in a single copy that is signed by the author, or in a
limited edition of 200 copies or fewer that are signed and consecutively numbered by the
author.”
70
U.S. CONST. art. I, § 8, cl. 8. “To promote the progress of science and useful arts, by securing
for limited times to authors and inventors the exclusive right to their respective writings and
discoveries.”
71
17 U.S.C. §§101 et seq. (2009).
65
66
115
Copyright vests once a work is fixed in a tangible medium of expression. 72
Authors are given exclusive rights, subject to certain limitations, to reproduce
the copyrighted work, to prepare derivative works based upon the copyrighted
work, to distribute copies of the copyrighted work to the public by sale or other
transfer of ownership, and to perform, broadcast, and display works publicly. 73
Moral rights, as mentioned above, are effectively nonexistent.
Of particular importance to the discussion of fan-created works is the author’s
exclusive rights in derivative works. A derivative work is “a work based upon
one or more preexisting works, such as a translation, musical arrangement,
dramatization, fictionalization, motion picture version, sound recording, art
reproduction, abridgment, condensation, or any other form in which a work
may be recast, transformed, or adapted. A work consisting of editorial
revisions, annotations, elaborations, or other modifications, which, as a whole,
represent an original work of authorship, is a “derivative work.” 74 Fan-created
works, by their nature are based upon a preexisting work. Fans, though,
generally do not believe that their activities are (or should be) infringing on
copyrights. They are not copying or pirating movies, books, or video games.
They are interacting with them, and the fans believe that those interactions
should be okay. People often want the law to be what they think it should be,
but that does not mean that the law will magically become as they desire it. In
the case of fans in the US, though, their desire is not without some grounding
in reality. And that reality is the fair use provision of the US Copyright Act.75
Section 107 states:
Notwithstanding the provisions of sections 106 and 106A, the fair
use of a copyrighted work, including such use by reproduction in
copies or phonorecords or by any other means specified by that
section, for purposes such as criticism, comment, news reporting,
teaching (including multiple copies for classroom use), scholarship,
or research, is not an infringement of copyright. In determining
whether the use made of a work in any particular case is a fair use
the factors to be considered shall include—
1) the purpose and character of the use, including whether such use
is of a commercial nature or is for nonprofit educational purposes;
2) the nature of the copyrighted work;
3) the amount and substantiality of the portion used in relation to
the copyrighted work as a whole; and
4) the effect of the use upon the potential market for or value of the
copyrighted work.
The fact that a work is unpublished shall not itself bar a finding of fair use
if such finding is made upon consideration of all the above factors.
Use of copyrighted materials for “purposes such as criticism, comment, news
reporting, teaching (including multiple copies for classroom use), scholarship,
72
17 U.S.C. §102.
17 U.S.C. §106.
74
17 U.S.C. §101.
75
17 U.S.C. §107.
73
116
or research, is not an infringement of copyright” (emphasis added). It is worth
pointing out that fair use is not a right. It is merely a defense to a claim of
copyright infringement. 76 Because fair use is determined by a judicial
balancing test, it can be difficult to say in advance whether a work is infringing
or not. Disputes over what is considered fair use occur frequently, 77 courts are
left to balance the interests in contention, and users of copyrighted works are
left to decide for themselves (prior to litigation) whether they have strayed onto
dangerous ground. 78 One of these dangerous grounds is whether a given
instance of copying is for the purpose of satire or parody. Copying for the sake
of parody has been found to be a fair use of copyrighted material, 79 whereas
satire has not. 80 In Campbell, the Supreme Court explicitly drew a distinction
between parody and satire:
For the purposes of copyright law, the nub of the definitions, and the heart of
any parodist’s claim to quote from existing material, is the use of some
elements of a prior author’s composition to create a new one that, at least in
part, comments on that author’s works. If, on the contrary, the commentary has
no critical bearing on the substance or style of the original composition, which
the alleged infringer merely uses to get attention or to avoid the drudgery in
working up something fresh, the claim to fairness in borrowing from another's
work diminishes accordingly (if it does not vanish), and other factors, like the
extent of its commerciality, loom larger. Parody needs to mimic an original to
make its point, and so has some claim to use the creation of its victim’s (or
collective victims’) imagination, whereas satire can stand on its own two feet
and so requires justification for the very act of borrowing. 81
Campbell, however, did not address whether satire is outside the scope of fair
use. Nor have subsequent cases drawn a clear line as to what constitutes parody
versus satire. 82 Case law can offer some guidance as to how a court may apply
the various prongs of the balancing test, but it cannot offer the clear-cut
answers fans may want.
The lion’s share of fan activity revolves around using someone else’s
characters in the fans’ own works. If characters in and of themselves are not
76
See Eric Faden, A Fair(y) Use Tale, The Center for Internet and Society (Mar. 1, 2007),
available at http://cyberlaw.stanford.edu/documentary-film-program/film/a-fair-y-use-tale
(visited November 20, 2011) (a film using Disney cartoon clips to explain copyright). Cf. Lenz
v. Universal Music Corp., 572 F.Supp.2d 1150, 1154 (N.D.Cal.,2008.) (discussing whether or
not fair use is an excused infringement of a copyright or an authorized use of a copyright). But
see Bateman v. Mnemonics, Inc., 79 F.3d 1532, 1542 n.22 (11th Cir. 1996) (“Although the
traditional approach is to view ‘fair use’ as an affirmative defense, this writer, speaking only
for himself, is of the opinion that it is better viewed as a right granted by the Copyright Act of
1976.”).
77
The Digital Millennium Copyright Act (17 U.S.C. §512) provides for specific “takedown
rules” for dealing with allegedly infringing material on-line.
78
Several websites seek to educate lay persons who have received a takedown notice of their
rights (and copyright in general). See e.g., Chilling Effects Clearinghouse, available at
http://chillingeffects.org/ (visited March 31, 2011).
79
Campbell, supra note 64.
80
Nimmer, supra note 66, at §13.05(C)(3).
81
Campbell, supra note 64, at 580-581.
82
Nimmer, supra note 66.
117
copyrightable, then fans’ use of the characters should be non-infringing.
Characters are of two types: literary or graphic (think Sherlock Holmes and
Superman, respectively). Whether a literary or graphic character can be
copyrighted on its own, outside of its original work, has been addressed by US
courts on several occasions. 83 Over time, two different standards emerged.
Literary characters faced a more stringent “story being told” standard while
graphic characters were treated more leniently with an “especially distinctive”
standard. In Anderson v. Stallone a California district court addressed the
distinction between these two types of characters and stated that separate
standards for the literary and graphic characters were unnecessary. 84 The court,
however, proceeded to apply both standards and held that the characters of the
Rocky movies were so “highly developed” and “extensively delineated” that
they met both the “distinctive” standard and the “story being told” standard. 85
Whether a specific character is copyrightable can be open to debate, but as a
general rule, characters are copyrightable in themselves. For many fans, the
characters that they incorporate into their works will be extensively delineated
and highly developed. This is especially true of the wildly popular Harry
Potter series.
Despite the independently copyrightable nature of fictional characters, fans
should not despair. Even fan-created works featuring such characters can be
transformative. Warner Bros. Entertainment, Inc. v. RDR Books addressed just
this question of whether a fan-created work can be sufficiently transformative
to fall outside the original owner’s copyright. 86 Steven Vander Ark ran the fan
website “The Harry Potter Lexicon.” His purpose was to “create an
encyclopedia that collected and organized information from the Harry Potter
books in one central source for fans to use for reference.” 87 It was so
comprehensive that Rowling, Warner Brothers, and Electronic Arts all
referenced it while working on the Harry Potter books, movies, and video
games, respectively. 88 RDR contacted Vander Ark to see if he would be
interested in turning the website into a book. After assurances from RDR that
the book would not infringe on Rowling’s copyright, Vander Ark agreed to
publish the Lexicon. 89 J.K. Rowling and Warner Brothers then sued for
copyright infringement.
83
See generally, Nichols v. Universal Pictures, 45 F.2d 119 (2d Cir.1930) (discussing the
possibility that characters could be copyrighted: “it follows that the less developed the
characters, the less they can be copyrighted; that is the penalty an author must bear for marking
them too indistinctly.”); Warner Bros. Pictures, Inc. v. Columbia Broadcasting System, Inc.,
216 F.2d 945, 950 (9th Cir.1954) (arguing that the character of Sam Spade is not copyrightable
unless the character “constituted the story being told”); and Walt Disney Productions v. Air
Pirates, 581 F.2d 751, 755 (9th Cir.1978) (holding that comic characters are protected under
copyright).
84
Anderson v. Stallone, 1989 WL 206431 (C.D.Cal.1989) (“As a practical matter, a
graphically depicted character is much more likely than a literary character to be fleshed out in
sufficient detail so as to warrant copyright protection. But this fact does not warrant the
creation of separate analytical paradigms for protection of characters in the two mediums.”)
85
Id., at 7-8.
86
Warner Bros. Entertainment Inc. v. RDR Books, 575 F.Supp.2d 513 (S.D.N.Y. 2008).
87
Id., at 520.
88
Id., at 521.
89
Id., at 521-522. Vander Ark requested an indemnity clause in the contract in case litigation
ensued.
118
The court was charged with determining whether or not the Lexicon violated
the plaintiffs’ copyrights and whether the defendant’s affirmative defense of
fair use was valid. In applying the four-part test, the judge found that, with
regard to the Harry Potter fictional book series, the Lexicon was transformative.
The “facts” from which the Lexicon was contrived were all creative expression
and subject to copyright. 90 Nevertheless, the judge held that the Lexicon was
not derivative in its purpose as it “did not recast the material in another
medium to retell the story of Harry Potter, but instead [gave] the copyrighted
material another purpose.” 91 He also found the work to be transformative
because it served “reference purposes, rather than the entertainment or
aesthetic purposes of the original works.” 92 The Lexicon did not supplant the
objects of the Harry Potter work. 93 Additional facts ultimately tipped the
balance in favor of the plaintiffs, 94 but only just. Vander Ark and RDR Books
were able to make changes to the Lexicon such that it is now available for
purchase at local bookstores.
The holding in RDR Books does not actually clarify whether fan fiction is noninfringing, but it does provided some signposts in the wilderness of fair use. A
fan work in the same genre as the original work may still have a difficult time
meeting the fair-use defense, particularly if a fan’s goal is to do something
commercial with the work. If, on the other hand, the fan stays true to the
“social marketplace only” credo, then fan fiction’s legality may be on slightly
steadier legs.
3.2 Japanese Copyright Law and Cases
The first copyright law in Japan was enacted in 1899 to correspond with Japan
becoming a signatory to the Berne Convention. 95 That law was replaced in
1970 with a new law that extended copyright duration, expanded moral rights,
and included neighboring rights under the copyright umbrella. 96 Since then
amendments have been added, notably to extend copyright to databases and
computer programs. 97 Penalties for copyright infringement have also been
90
Id., at 536 (Quoting Castle Rock Entertainment Inc. v. Carol Publishing Group, Inc.: “[T]he
Second Circuit explained that such invented facts constitute creative expression protected by
copyright because ‘characters and events spring from the imagination of [the original]
authors.” 150 F.3d at 139; see also Paramount Pictures Corp. v. Carol Publ’g Group, 11
F.Supp.2d 329, 333 (S.D.N.Y.1998) (stating that ‘[t]he characters, plots and dramatic episodes’
that comprise the story of the ‘fictitious history of Star Trek’ are the story’s “original
elements,” protected by copyright’)”).
91
Id., at 539.
92
Id., at 541.
93
Id.
94
The Lexicon quoted extensively from two semi-reference works of Rowling’s, diminishing
its transformative nature.
95
HIROSHI ODA, JAPANESE LAW 345 (2nd ed. 1999).
96
Id.
97
Id.
119
increased over the last decade, but exceptions to copyright have been added as
well, carving out a small “fair use” space. 98
The law seeks to provide and secure the rights of authors in their works and
thereby contribute to the development of culture. 99 A copyrightable work is
one in which “thoughts or sentiments are expressed in a creative way and
which falls within the literary, scientific, artistic or musical domain.” 100 Article
10 provides specific examples of works that qualify for protection. 101 There is
no requirement for works to be “fixed in a tangible medium” like in the US; 102
instead, the three main criteria for a work to be copyrightable are (1) the work
must express thought or sentiment, (2) that thought or sentiment must be
expressed in a creative way, and (3) the work must fall into one of the four
domains listed in Article 2.
Like the US, authors have an exclusive right over derivative works. A
“derivative work” is a work created by translating, arranging musically, or
transforming, or dramatizing, cinematizing or otherwise adapting a pre-existing
work. 103 Unlike the US, Japan grants moral rights in all copyrightable works.
Moral rights are inalienable. 104 These rights include the right to make a work
public, 105 the right to identification, 106 and the right to preserve the integrity of
the work. 107 Moral rights also play a key role in most of the relevant litigation
as will be seen below. In addition, Japanese copyright law does not have a
specific fair use provision. Instead, it enumerates specific limitations to the
98
History of Copyright Systems in Japan, Copyright Research and Information Center,
available at http://www.cric.or.jp/cric_e/csj/csj.html (visited November 20, 2011). Many of the
limitation expansions have been in the area of increased accessibility for people with hearing
and vision impairments. An update in 2009 performed necessary housekeeping with regard to
the Internet and what constitutes permissible non-authorized copying (e.g., reproduction to
implement Internet searches or publication of images as part of online sales).
99
Chosakuhō, supra note 60, at art 1, para. 1 (“The purpose of this Act is to provide for, and to
secure protection of, the rights of authors, etc. and the rights neighboring thereto with respect
[to] [copyrightable] works as well as performances, phonograms, broadcasts and wirebroadcasts, while giving due regard to the fair exploitation of these cultural products, and by
doing so, to contribute to the development of culture.”).
100
Id., at art 2, para. 1.
101
Id., at art 10. “examples of ‘works’ include, in particular, the following:
(i) novels, [play/film] scripts, dissertations, lectures and other literary works;
(ii) musical works;
(iii) choreographic works and pantomimes;
(iv) paintings, engravings, sculptures and other artistic works;
(v) architectural works;
(vi) maps as well as diagrammatical works of a scientific nature, such as drawings, charts,
and models;
(vii) cinematographic works;
(viii)
photographic works;
(ix) computer program works.
102
Dennis S. Karjala & Keiji Sugiyama, Fundamental Concepts in Japanese and American
Copyright Law, 36 AM. J. COMP. L. 613, 617 (1988) (pointing out that lectures are included
amongst the enumerated works).
103
Chosakuhō, supra note 60, at art 2, para. 11.
104
Karjala & Sugiyama, supra note 102, at 618.
105
Chosakuhō, supra note 60, at art 18.
106
Id., at art 19.
107
Id., at art 20.
120
author’s rights. 108 Many of those limitations map to US fair-use principles. For
example Article 32(1) allows for quotations: “It shall be permissible to make
quotations from a work already made public, provided that their making is
compatible with fair practice and their extent does not exceed that justified by
purposes such as news reporting, criticism or research.” 109 This provision
leaves open the question of what is “fair practice” and what will exceed a
justifiable quotation. There is case law on this issue, but it ties back into moral
rights, yielding very different results in cases that would seem to be similar to
US fair-use analyses (what is fair practice, how much is too much). Even if
Japan did have a US-style fair use provision, the usefulness of such a provision,
from a fan’s perspective, would be lost. The language of the moral rights
provisions does not allow for modifications or transformations of the protected
work; therefore, the justification of non-infringement by fan-created works in
the US – they are transformative – would be useless in the Japanese context.
Japan does not have the extensive amount of case law the US does, but it does
have some cases that address copyright issues relevant to fan-created derivative
works. As a civil-law country, Japan does not have a system of binding
precedent the way the US does, though Japanese law does develop through
statutory interpretation. 110 Lower courts generally follow the rulings of higher
courts (so as not to be overruled), and the Supreme Court has a “strong de facto
binding power” over all. 111 Courts rarely cite other cases as precedent, and the
distinction between holdings and dicta, crucial in US legal analysis, is not so
clearly defined. 112 As a result, “dictum in well known cases can be as
important, even more important, than the holding of the case on its facts.”113
Courts throughout the world generally do what they have done before, so even
if the result of a Japanese court decision is not binding the same way it would
be in the US, those decisions are still instructive as to how future cases might
play out.
The issues addressed by litigation in the US discussed above, the ability of
characters to have independent copyright and general fair-use principles, do not
cleanly map to the Japanese situation. Because there is no fair-use provision in
the Japanese Copyright Act, other rationales have been put forward to justify
fan-created work. The two primary justifications for the legality of dōjinshi are
parody and quotation. 114 Before addressing those, however, we begin with
question of whether characters are copyrightable independent of the work they
appear in as there are a few cases that address this issue directly.
The first case to address the question of whether a character can have
independent copyright was the Sazae-san Case in 1976. 115 Sazae-san is the
Chosakuhō, supra note 60, at arts. 30-50.
Id.
110
Karjala & Sugiyama, supra note 102, at 614.
111
Id.
112
Id.
113
Id.
114
See generally Yoshihiro Yonezawa, MANGA TO CHŌSAKUKEN: PARODEI TO INYŌ TO
DŌJINSHI TO [Manga and Copyright: Parody, Quotation and Dōjinshi] (2001).
115
Hasegawa v. Tachikawa Bus K.K., I Chosakuken Hanreishu 721 (Tokyo District
Court, May 26, 1976) [hereinafter Sazae-san Case].
108
109
121
main character in a long-running and very well-known comic strip. 116 A tour
bus company had placed the faces of three of the characters from the comic
strip on its buses without the author’s consent. The author sued for copyright
infringement. The defendant countered, arguing that the use of the characters’
faces had nothing to do with the plot or the content of the comics and that they
were not being used to express such content. 117
The court rejected the defendant’s argument and set forth a test for how to
determine whether there is infringement of a copyrighted character: “if a
person were to look at the defendant’s buses and in his/her mind immediately
connect those figures on the bus with the plaintiff's copyrighted figures, that
would sufficiently establish a copyright infringement.” 118 The infringement
was not of an independent copyright in the characters, however; the court held
that the defendant “infringed each one of the plaintiff’s copyrights for each
day's comic strip.” 119 The court’s reasoning was that the characters had
established their own identities over time – instead of the author adapting the
characters to the plots of the daily comic strips, she adopted the plots of the
strips to the characters. 120 The court also included, as an additional justification,
popularity as a factor to use in determining copyright, but it did not clarify to
what extent popularity should be considered.
After the Sazae-san case came a series of cases concerning the character
Popeye appearing on various articles of clothing. 121 In the Popeye Scarf Case,
the Osaka High Court held that a fictional character was not copyrightable
outside of its original work. 122 Once detached from the work, a character
became an abstract idea and was thus not eligible for copyright. 123 If the
jurisprudence stopped here, dōjinshi artists would have the legality of their
works assured. Instead, the Popeye Scarf Case moved on the Supreme
Court. 124 There, the Court held “that the plaintiff’s expression of the cartoon
character Popeye could properly form the subject of copyright, even though . . .
the idea of Popeye alone separate from the cartoons in which he appears could
not receive protection.” 125 The court also stated that subsequent comics sharing
116
Kenneth L. Port, Copyright Protection of Fictional Characters in Japan: The Popeye Case It's Not Just a Mick[e]y Mouse Affair, 7 WIS. INT’L L.J. 205, 215 n.79 (1988). An English
translation of the Sazae-san Case can be found at the end of the article.
117
Id., at 215.
118
Id.
119
Id., at 216.
120
Id. “[T]he expression of permanent characters in a certain role with certain looks and shape
exceeds the mere facial expressions, movements, or emotions of the specific characters in
specific scenes within the comic strip.”
121
For a very good explanation of the Popeye Undershirt Cases preceding the Scarf Case, see
id., at 218-219.
122
Id., at 220.
123
Id.
124
Saikō Saibansho [Sup. Ct.] Jul. 17, 1997, Hei 4 (O) No. 1443, SAIKŌ SAIBANSHO SAIBANREI
JŌHŌ HANREI KENSAKU SHISUTEMU [SAIBANREI JŌHŌ], 1, available at http://www.courts.go.jp/
(visited November 20, 2011) (Japan) [hereinafter Popeye Supreme Court Case].
125
Mehra, supra note 54, at 173 (“‘togai tojyo jinbutsu ga kakareta kakkai no manga sore zore
ga chosakukenbutsu ni atari, gutaiteki na manga wo hanare, migi tojyo jinbutsu no iwayuru
kyarakutaa o motte chosakubutsu to iu koto ha dekinai’ [said personage’s each appearance as
drawn in a manga suffices as the subject of a copyright, but if you separated it from manga,
said appearing personage could not be said to be a so-called copyrightable character]”).
122
the same basic setting, idea, appearance, and personality of the main figures
would be considered derivative works. 126
As for the issues of parody and quotation, there is again Supreme Court
precedent, but the usefulness of its guidance is questionable. The copyright law
does not contain a provision on parody (like in the US). The one case
addressing parody, the Photo Montage Case, does not in fact squarely address
parody but rather deals more with quotation.127 Article 32 allows for quotations
of copyrighted work, so long as such quotations are “compatible with fair
practice” and are only as extensive as the purpose of the quotation would
justify. 128
In the Montage Photograph Case, a well-known parodist created a photo
montage when he combined the plaintiff’s photo of alpine skiers on a mountain
slope with an image of car tires in order to criticize the current state of
vehicular pollution. 129 The plaintiff sued for infringement of his copyright and
moral rights. 130 While the High Court held that the use was permissible, the
Supreme Court overturned the ruling, stating that while “it is not impermissible
to use another person’s work as material in creating one’s own work,” such use
is “limited to cases where it is used in a manner which does not enable direct
perception of the essential characteristics per se of the form of expression of
[another] person’s work.” 131 In other words, the use of the photograph was not
a lawful quotation, and quotations that infringe moral rights are not allowed
under the moral rights provision. 132 The Court treated the case like any other
sort of quotation and did not attempt to construct a logical analysis appropriate
to parody and the special relation between the original work and the parody. 133
Popeye Supreme Court Case, supra note 124, at 4 (“kono yōna baai ni ha, kōzoku no manga
ha, senkō suru manga o hon’an shita mono toiu koto ga dekirukara, senkō suru manga wo
gencho sakumotsu to suru ni-ji-teki chosakubutsu to kaesareru” [In this case, the subsequent
comic, because it can be said that it is an adaptation of the preceding comic, can be understood
to be a derivative work of the original work.]).
127
Keiji Sugiyama, The First Parody Case In Japan, 9 EUR. INTEL. PROP. REV. 285, 288
(1987).
128
Chosakuhō, supra note 60, at art. 32. “It shall be permissible to quote from and thereby
exploit a work already made public, provided that such quotation is compatible with fair
practice and to the extent justified by the purpose of the quotation, such as news reporting,
critique or research.”
129
Montage Photograph Case, supra note 64. For a summary of the facts and holdings in
English see Tranparency of Japanese Law Project, Modification of a Photograph in a Parody
available
at
http://www.tomeika.jur.kyushu‘Montage’,
u.ac.jp/result.php?s=142a5d3e6252d96ee82db15395f05c0e&c=4222494e3505e7b67cae31328
7c7c3f2 (visited November 20, 2011).
130
Transparency of Japanese Law Project, Modification of a Photograph in a Parody
‘Montage’.
131
Montage Photograph Case, supra note 64.
132
Sugiyama, supra note 127, at 287-288.
133
Id at 288. Sugiyama goes on to analyze parody and divides the topic into “identifiable” and
“unidentifiable” parody and argues that the Court’s logic would prevent some instances of the
first kind of parody and all instances of the second.
126
123
A more recent case involving quotation, commentary, and moral rights is the
Declaration of Arrogance Debunked Case. 134 In this case, the defendant copied
parts of the plaintiff’s comic book in order to critique the plaintiff’s work. The
plaintiff sued for infringement of his right to make copies and for violation of
his moral rights. The Intellectual Property High Court held that the quotation
was permissible and did not infringe on of the plaintiff’s right of reproduction.
The plaintiff made his arguments in a comic format; in order to critique those
arguments, the defendant was justified in quoting not just the words but also
the images, as those images are an indispensable part of the comic. 135
Regarding moral rights, the court found that some of the modifications were
acceptable under Article 20 136 – the addition of eye masks were “unavoidable”
to protect the honor of those depicted – but the change in panel layout was an
infringement as it was not “unavoidable” and was an “unjustly insulting
treatment of [the plaintiff]’s expression . . . by unduly emphasizing the
arranging of the layout of the [defendant’s] book. 137
As the above two cases illustrate, moral rights can play a decisive role in the
outcome of copyright-infringement cases. Another important copyright case
that hinged on moral rights is the Tokimeki Memorial Case.138 The video game
maker Konami brought suit against an importer of memory cards that could be
used to modify game data in the game Tokimeki Memorial. The game itself is
a high school dating simulator, the goal of which is to have one of the female
characters declare her love for the main character at graduation. This is
accomplished by raising the scores of certain character parameters as the game
progresses. The levels are preset at the beginning of the game, and the story
unfolds and new characters appear as the player “levels up” his stats. The
memory card allowed users to begin the game with higher values in the
character parameters or to skip right to the end of the game. Because the story
unfolds in accordance with the values of the player’s various character
parameters, using the memory card changes the game’s story. The Supreme
Chiteki Zaisan Kōtō Saibansho [Intellectual Prop. High Ct.] Apr. 25, 2000, Hei 11 (Ne) No.
4783, SAIKŌ SAIBANSHO SAIBANREI JŌHŌ HANREI KENSAKU SHISUTEMU [SAIBANREI JŌHŌ], 1,
available at http://www.courts.go.jp/ (visited November 20, 2011) (Japan) [hereinafter
Declaration of Arrogance Debunked Case]. For a summary of the facts and holdings in English
see Tranparency of Japanese Law Project,‘Declaration of Arrogance Debunked’ Case,
available
at
http://www.tomeika.jur.kyushuu.ac.jp/result.php?s=ed7031a15de4508aaa1dbee8c1c4809e&c=34f104e5e70b66f3ecf127c278f
9388e (visited November 20, 2011).
135
Transparency of Japanese Law Project, ‘Declaration of Arrogance Debunked’ Case.
“Manga are works in which pictures and words form an indivisible whole. Since [the plaintiff]
has used such manga to set out his arguments, then obviously if the pictures themselves are the
target of criticism, and also if [the plaintiff]’s arguments are the target of criticism, not only the
words of those manga but also the pictures need to be quoted, in order to accurately indicate
what is being criticized.”
136
Chosakuhō, supra note 60, at art. 20, para. 2 (the provisions of paragraph 1 do not apply to
“modifications that are considered unavoidable in light of the nature of a work as well as the
purpose of and the manner of its exploitation.”).
137
Transparency of Japanese Law Project, ‘Declaration of Arrogance Debunked’ Case, supra
note 134.
138
Saikō Saibansho [Sup. Ct.] Feb. 13, 2001, Hei 11 (ju) No. 955, SAIKŌ SAIBANSHO
SAIBANREI JŌHŌ HANREI KENSAKU SHISUTEMU [SAIBANREI JŌHŌ], 1, available at
http://www.courts.go.jp/ (visited November 20, 2011) (Japan) [hereinafter Tokimeki Memorial
Case].
134
124
Court agreed with Konami’s argument that the change in the story constituted
an infringement of Konami’s right of identity in the work. The holding has
been criticized for limiting the autonomy of private users. 139
To underscore the two key differences between Japanese and US law, the
existence of moral rights and the lack of fair use, let us look briefly at a case
with similar fact to the Tokimeki Memorial Case that was tried in the US In
1992, Nintendo sued the makes of the Game Genie. 140 The Game Genie, like
the memory card in the Tokimeki Memorial Case, allowed users to alter
features of Nintendo’s copyrighted games. 141 The court held that the Game
Genie did not create derivative works because nothing it expressed was “fixed”
in a tangible medium. 142 It also held that even if it did create derivative works,
such works were protected under fair use. The Game Genie did not supplant
Nintendo’s market (consumer still needed to buy games in order to play them),
and the use was private and thus non-commercial. 143 If either case were
transplanted to the other country, the verdicts would probably flip. The Game
Genie would infringe on Nintendo’s moral rights, and the infringing memory
card of the Tokimeki Memorial Case would be fair use. The video game
jurisprudence does realign when it comes to add-ons that allow users to play
“backup copies” of games (i.e. illegal downloads or copies). In 2009, Nintendo
was granted injunctions against the makers of the R4 Revolution DS/Majikon
in both the US and Japan. 144 The legal rationales were different, but the results
were the same. 145
Finally Article 30, the right of reproduction for private use, bears special
mention. First, the grant is explicit. Second, a user may reproduce a
copyrighted work for “his personal use or family use or other equivalent uses
within a limited scope.” 146 Interpretations of what constitutes “limited scope”
play a role in some of the clashes between Japanese rights holders and dōjinshi
artists.
4. Conflicts between Rights Holders and Fans
4.1 Conflicts in the US
139
See Nobuko Kawashima, The Rise of ‘User Creativity’: Web 2.0 and a New Challenge for
Copyright Law and Cultural Policy, 16 INT’L J. OF CULT. POL’Y 337 (2010).
140
Lewis Galoob Toys, Inc. v. Nintendo of America, Inc., 964 F.2d 965 (9th Cir. 1992).
141
Id. at 967 (“The Game Genie functions by blocking the value for a single data byte sent by
the game cartridge to the central processing unit in the Nintendo Entertainment System and
replacing it with a new value.”).
142
Id., at 968.
143
Id., at 970-2.
144
See Nintendo of America Inc. v. Chan, No. CV 09-4203 JFW, 2009 WL 2190186 (C.D.Cal.
July 10, 2009); and Tōkyō Chihō Saibansho [Tokyo Dist. Ct.] Feb. 27, 2009, Hei 20 (Wa) No.
20886, SAIKŌ SAIBANSHO SAIBANREI JŌHŌ HANREI KENSAKU SHISUTEMU [SAIBANREI JŌHŌ], 1,
available at http://www.courts.go.jp/ (visited November 20, 2011) (Japan).
145
Unfair competition in Japan and circumvention of copyright protection systems in the US
146
Chosakuhō, supra note 60, at art. 30.
125
For all the current scholarship 147 on fan fiction in legal circles, the number of
cases of out-and-out conflict between rights holders and fans remains fairly
low. This is not to say that there are no clashes. Mostly, there are cease-anddesist letters. 148 YouTube has a system to automatically take down potentially
infringing material, 149 and other ISPs will generally comply with takedown
notices to maintain the safe-harbor protections granted by the Digital
Millennium Copyright Act. 150 Rights holders are required to consider fair use
before issuing DMCA takedown notices, 151 but even if a rights holder does
make a good faith effort in assessing fair use before issuing a takedown notice,
the creator of the potentially infringing work probably will not fight the
claim. 152 The time, effort, and legal fees are too great for the average person to
challenge a takedown notice. 153
One of the most storied incidents of author versus fans is the case of Marion
Zimmer Bradley. Bradley was the author of several very popular fantasy
novels set in the fictional world of Darkover. She was an avid supporter of fan
activities, holding contests for fan-created works set in the Darkover universe
and even publishing twelve anthologies of fan-written stories. 154 She even
147
See generally Legal Analysis, Fanlore, available at http://fanlore.org/wiki/Legal_Analysis
(visited November 20, 2011) (chronologically cataloging law review articles on fan fiction).
148
See generally Chilling Effects Clearinghouse, available at http://www.chillingeffects.org/
(visited November 20, 2011). Chilling Effects maintains a searchable database of cease-anddesist letters organized by type (DMCA, fan fiction, fair use, etc.)
149
Content ID, infra note 257.
150
Digital Millennium Copyright Act of 1998 17 U.S.C. §512 (2009). See also Frequently
Asked Questions (and Answers) about DMCA Safe Harbor, Chilling Effects Clearinghouse,
available at http://chillingeffects.org/dmca512/faq.cgi#QID125 (visited November 20, 2011).
(“Once notice is given to the service provider, or in circumstances where the service provider
discovers the infringing material itself, it is required to expeditiously remove, or disable access
to, the material. The safe harbor provisions do not require the service provider to notify the
individual responsible for the allegedly infringing material before it has been removed, but
they do require notification after the material is removed.”).
151
See generally Lenz v. Universal Music, supra note 76.
152
E.g., the creators of the comic strip Penny Arcade chose not to fight a cease-and-desist letter
from American Greetings regarding a parody of Strawberry Shortcake. See Tart as a Double
Entendre, Penny Arcade (Apr. 14, 2003), available at http://www.pennyarcade.com/comic/2003/04/14/ (visited November 20, 2011) (announcing the removal of the
comic from their archive and directing questions to American Greetings). For an image of the
comic and a discussion about whether it is fair use see John Scalzi, Strawberry Shortcake and
Penny
Arcade,
Whatever
(Apr.
25,
2003),
available
at
http://whatever.scalzi.com/2003/04/25/strawberry-shortcake-and-penny-arcade/
(visited
November 20, 2011).
153
JC Fletcher, Square Enix Pulls the Trigger on Chrono Trigger Fan Projects, Joystiq (May
12, 2009), available at http://www.joystiq.com/2009/05/12/square-enix-pulls-the-trigger-onchrono-trigger-fan-projects/ (visited November 20, 2011) (quoting a response by a recipient of
a takedown notice: “We do not accept the validity of Square Enix's claims, nor the legal
rationale underpinning their position. Nonetheless, we are complying with their demands so as
to avoid the expenses and burdens of litigation, because, frankly, they can afford a frivolous
lawsuit more than we can.”).
154
Catherine Coker, The Contraband Incident: The strange case of Marion Zimmer Bradley, 6
WORKS
AND
CULTURES
1,
1.1
(2011),
available
at
TRANSFORMATIVE
http://journal.transformativeworks.org/index.php/twc/article/view/236/191 (visited November
20, 2011).
126
acknowledged some of the fan stories as canon. 155 The friendly relationship
and collaboration that lasted two decades came to sudden and acrimonious end
over a dispute with a fan. Legal action was threatened by the fan regarding
authorship rights in Bradley’s forthcoming novel Contraband, and Bradley’s
publisher ultimately dropped her contract. The book was never published, and
Bradley dissolved her fan communities. 156 It is argued that many authors’
attitudes towards fan fiction and fan interaction have been shaped by this
incident. 157 It is possible that as more professional authors emerge from the
ranks of amateur fandom, those authors will take a more nuanced approach,
“see[ing] fan works as a phenomenon that simply exists, neither good nor
evil.” 158 Even still, individual authors will react differently depending on how
they feel about their own works.
For many authors, the idea of fan fiction is deeply troubling because they see
their characters as analogous to their children. 159 For these authors, it is not a
question of loss of profits but loss of control over their creations. Were moral
rights truly part of US copyright law, these authors would be able to assert
control with legal backing. As it stands, assuming fan fiction is not infringing,
they best they can do is implore fans to “leave their characters alone.”
Depending on the content of the fan fiction, authors might have an argument
that a particular work is obscene, 160 but personal distaste of a fanfic’s contents
is not grounds for copyright infringement. 161 This did not stop science fiction
155
Id. “Canon” is the “official” version of events and characters in a fictional universe (i.e.,
what the original author wrote). “Fanon” is the official version of events and characters as
drawn from fan-created works. See Brooke Gladstone, The Tao of “Star Trek”?, All Things
(Sept.
8,
2006),
available
at
Considered
http://www.npr.org/templates/story/story.php?storyId=5953255 (visited November 20, 2011).
156
Coker, supra note 154, at 1.2. For a full discussion of what happened see id., at 3.
157
Id., at 4.9 (“In 2008 the unpublished draft of Stephenie Meyer's work in progress, Midnight
Sun, was leaked and placed online by fans. In retaliation, Meyer announced that she was
killing the book and posted a copy of the text on her own Web site. In 2010, Diana Gabaldon
posted (and subsequently deleted) a lengthy blog entry decrying fan fic and asking fans not to
write or publish it.”).
158
Id.
159
Grossman, supra note 15, at 5. “George R.R. Martin, author of A Game of Thrones, writes
on his website, ‘My characters are my children ... I don’t want people making off with them,
thank you. Even people who say they love my children.’ Ursula K. Le Guin, another giant of
the fantasy canon, writes, ‘To me, it’s not sharing but an invasion, literally — strangers coming
in and taking over the country I live in, my heartland.’” See also Elizabeth F. Judge,
Kidnapped and Counterfeit Characters: Eighteenth-Century Fan Fiction, Copyright Law, and
the Custody of Fictional Characters, in ORIGINALITY AND INTELLECTUAL PROPERTY IN THE
FRENCH AND ENGLISH ENLIGHTENMENT 22, 22 (Reginald McGinnis ed., 2009) (quoting
cartoonist Gary Larson “Those cartoons are my ‘children’ of sorts, and like a parent I’m
concerned about where they go at night without telling me. And seeing them at someone’s web
site is like getting the call at 2:00 a.m. that goes, “Uh, Dad, you’re not going to like this much,
but guess where I am.”).
160
A finding of obscenity, though, requires meeting a judicial standard, not just the author’s
“squick” level. See Miller v. California, 413 U.S. 15, 24 (1972) (setting out the test for
obscenity: “A state offense must also be limited to works which, taken as a whole, appeal to
the prurient interest in sex, which portray sexual conduct in a patently offensive way, and
which, taken as a whole, do not have serious literary, artistic, political, or scientific value.”).
Litigation regarding obscenity has also moved outside the realm of copyright.
161
But see Brian Link, Note, Drawing A Line In Alternate Universes: Exposing The
Inadequacies Of The Current Four-Factor Fair Use Test Through Chanslash, 33 T. JEFFERSON
127
author Larry Niven from sending a cease-and desist letter to a fan for writing a
slash story involving Niven’s characters the kzinti. 162 Like Bradley, Niven had
been on good terms with his fans, 163 but he still ended up policing the
“playground” to keep out works he objected to. 164 Technically, Niven and
other authors cannot keep people out of their playgrounds, but threats of
lawsuits are often sufficient to quash fans whose works the original author
finds distasteful.
Fan activities related to video games, AMV, and machinima are closer to the
line of infringement than fan fiction, and companies’ attitudes towards these
activities have been much more unwelcoming. These fan-created works
employ the actual original media in the re-workings, often without adding
original art or music, making arguments for transformativeness much harder. 165
Square Enix has gone after multiple fan versions of its game Chrono Trigger.
In 2004, it sent a cease-and-desist letter to the people behind the Chrono
Resurrection project, a group of fans attempting to remake Chrono Trigger for
a new platform. 166 It also shut down a fan produced sequel, five years in the
making, days before its scheduled release date in 2009. 167 Fans remain
undaunted, however, as there are still Chrono Trigger several projects in the
works. 168 The makers of the King’s Quest series fan sequel “The Silver
Lining” were shut down twice in their eight year quest to create the game.169
L. REV. 139 (2010) (arguing that there should be a “fifth factor” of moral rights in the fair use
balancing test).
162
Schwabach, supra note 17 ,at 403. The kzinti are an alien species from Niven’s work that
are “large and tiger-like in appearance and, to some extent, behavior.”
163
Id. at 404 (“Ringworld is ten years old; and I have never stopped getting letters about it.
People have been commenting on the assumptions, overt and hidden, and the mathematics and
the ecology and the philosophical implications, precisely as if the Ringworld were a proposed
engineering project and they were being paid for the work. You who did all that work and
wrote all those letters: be warned that this book would not exist without your unsolicited help. I
hadn't the slightest intention of writing a sequel to Ringworld. I dedicate this book to you.”).
164
Id. (“I hereby refuse you permission to use the kzinti in any literary property. The last guy
who did that involved the kzinti in a sadomasochistic homosexual gangbang, badly, and
published it on a computer network. A friend alerted me, and we spoke the magic word and
frightened him away. (Lawsuit.) I'm still a little twitchy on the subject, so don't take any of this
too personally. . . It would have been fun to see what [the fan] might do with it; but I'm going
to refuse him anyway. I don't want the playground getting too crowded.”).
165
Id., at 400.
166
Jess Ragan, Singin the Brews: The History & Philosophy of Homebrew Game Development,
1Up
Games
(Mar.
20,
2006),
available
at
http://www.1up.com/do/feature?pager.offset=6&cId=3148820 (visited November 20, 2011).
167
Earnest Cavalli, Square Enix Kills Near Complete Chrono Trigger Fan Project, WIRED
,May 11, 2009, available at http://www.wired.com/gamelife/2009/05/square-enix-kills-nearcomplete-chrono-trigger-fan-project/ (visited November 20, 2011).
168
Fan
Projects,
Chrono
Compendium,
available
at
http://www.chronocompendium.com/Term/Fan_Projects.html (visited November 20, 2011)
(cataloguing fan projects completed, canceled, or in progress).
169
Ragan, supra note 166 (“Vivendi Universal planned to stop the game's development with
legal action but relented when thousands of angry King's Quest fans -- having been denied a
legitimate sequel for years -- promised retribution in the form of boycotts.”); Xav de Matos,
Activision Shuts Down Fan-Made King's Quest Sequel, Joystiq (Feb. 28, 2010), available at
http://www.joystiq.com/2010/02/28/activision-shuts-down-fan-made-kings-quest-sequel/
(visited November 20, 2011) (“The original deal would see the game's authorized release as
part of a non-commercial fan license; however, current King's Quest IP holder Activision has
decided (after ‘talks and negotiations’) it is not interested in entering a similar agreement with
128
The overall pattern here seems to be that individual creators are more accepting
of fan-created works unless and until they get hurt (economically or
psychologically) by fan activities. Institutional rights holders tend to crack
down on fan-created works to protect against potential economic harm but
then pull back if fan pushback is too severe, resulting in threatened or actual
economic harm. The uncertainty in how parties will respond can raise
transaction costs needlessly, and such costs need to be addressed to start
untangling the creator-consumer knot.
4.2 Conflicts in Japan
The “shadow” world of fan-created works in Japan may appear to be in
harmony with the law-abiding world, but all is not as tranquil as it seems.
Issues related to expression and censorship, 170 taxes, 171 and copyright have
been springing up over the last several years. More than two-thirds of the entry
for dōjinshi on the Japanese version of Wikipedia is devoted to issues facing
dōjinshi and of that two-thirds, more than half addresses copyright issues.172
Regarding copyright, most issues are resolved at the cease-and-desist stage,
though there are a few notable incidents that went much further. And for all
that litigation has remained sparse, incidents of rights holders asserting their
rights have been increasing. A key trigger for the current awareness and debate
can be traced back to 1999 and the Pokemon Dōjinshi Incident. 173
In the fall of 1998, an amateur artist released a Pokemon-themed dōjinshi
staring Pikachu in erotic situations.174 When Nintendo heard about the comic,
it contacted the Kyoto police, and the artist was arrested and jailed for violating
copyright law. 175 Other members of the fan community were also contacted by
the police under suspicion of abetting copyright infringement, and fierce debate
as well as calls for protests and boycotts of Nintendo products broke out
the indie team.”); King’s Quest Fans See the Silver Lining Starting This Saturday,
Geekadelphia (Jul. 6, 2010), available at http://geekadelphia.com/2010/07/06/kings-questfans-see-the-silver-lining-starting-this-saturday/ (visited November 20, 2011) (“Phoenix Online
and Activision have made an agreement to release the project as a free, downloadable series
[that] will be released this Saturday, July 10th, with several more installments coming
throughout 2010.”).
170
Asahi Shimbun, Regulations on manga, Japanese Law Blog (Dec. 5, 2010), available at
http://japaneselaw.blogspot.com (visited November 20, 2011).
171
Doujinshi Manga Artist Prosecuted for Tax Evasion, Comipress (Feb. 21, 2007), available
at http://comipress.com/news/2007/02/21/1535 (visited November 20, 2011).
172
Dōjinshi,
Wikipedia,
available
at
http://ja.wikipedia.org/wiki/%E5%90%8C%E4%BA%BA%E8%AA%8C (visited November
20, 2011).
173
Not to be confused with the “Pokemon Shock” seizure incident in 1997.
174
Naoto Misaki, Pokemon Dōjinshi Chosakuken Mondai Kanren [Pokemon Dōjinshi
Copyright Problem Related (information)], Doujinshi Research Institute, available at
http://www.st.rim.or.jp/~nmisaki/topics/pokemon.html (visited November 20, 2011).
175
Id. The total incarcerated time was 22 days. It would be more correct to call it detention
time as Japanese law provides for up to 23 days of pre-indictment detention. See generally
Daniel H. Foote, The Benevolent Paternalism of Japanese Criminal Justice, 80 CALIF. L. REV.
317, 333 (1992) (discussing the Japanese criminal law system and procedure). Ultimately, the
author paid a fine of ¥100,000.
129
online. 176 The story was not limited to online debate; it was headline news
throughout the country. 177 A few months after the arrest, Nintendo released a
comment (published in special features in both the Asahi and Kyoto
Newspapers 178) to the effect that personal use of characters is allowable, but
sale or display to large groups of people at stores or events exceeds personal
use under copyright law. 179 While there have been no similarly severe incidents
since, the mere fact that a fan artist was arrested sent shockwaves through the
fan communities that continue to resonate today.
It was one of those shockwaves that spurred the founder of Comiket, Yoshihiro
Yonezawa, to begin formally examining the relationship between fan activities
and copyright. 180 He organized an “Emergency Symposium” at Comiket the
following year to consider expression and copyright. 181 A second follow-up
symposium was organized in November of the same year and included legal
experts on the panel. 182 No definitive defense was ever devised, but parody and
quotation are still the shields of choice, even though these arguments remain
admittedly insubstantial. 183
Another notable incident involving dōjinshi and copyright is the Doraemon
Final Episode Incident. The creator of Doraemon passed away before the
completion of the manga series. 184 In 2005 a fan began selling a “final
episode” dōjinshi on-line and in stores that sold around 13,000 copies. 185 When
the publisher Shogakukan and the creator’s agency Fujio F. Fujiko Production
learned of the comic’s existence, they sent a cease-and-desist warning. Their
176
2007-2008 MANGA RONSŌ BOPPATSU, supra note 47, at 74-75.
Mehra, supra note 54, at 190-191. For a breakdown of which newspapers carried what
information and when, see Naoto Misaki, Pokemon Dōjinshi Chosakuken Mondai Kanren
Shiryō [Pokemon Dōjinshi Copyright Problem Related Materials], Doujinshi Research
Institute, available at http://www.st.rim.or.jp/~nmisaki/topics/pokemon2.html (visited
November 20, 2011).
178
Misaki, supra note 174.
179
Nintendō no Komento, [Nintendo’s Comment], Nichiyou Shuppan (Apr. 8, 1999), available
at
http://web.archive.org/web/20010215212927/http://www.nitiyo.com/zine/poke/poke19990408.
htm (visited November 20, 2011) (accessed by searching for www.nitiyo.com/zine/poke/ in the
Internet Archive index). The comment goes on to say that developers do not like to see their
work depicted in disturbing ways, and showing such disturbing images to young fans is
unforgivable.
180
Atsushi Ohara, Shinmiri Shiteru Baai Janai Yo [This Isn’t an Occasion to be Solemn]
SHIMBUN,
June
7,
2010,
available
at
ASAHI
http://www.asahi.com/showbiz/column/animagedon/TKY201006060099.html
(visited
November 20, 2011).
181
Kinkyū Shinpojiumu: Hyōgen to Chosakuken wo Kangaeru [Emergency Symposium:
Thinking About Expression and Copyright], Comiket (Feb. 6, 2000), available at
http://www.comiket.co.jp/inc/2000/symposium000206.html (visited November 20, 2011).
182
Shinpojiumu Dai Ni Kai: Chosakuken ni Kansuru Shinpojiumu [Second Symposium:
Symposium Related to Copyright], Comiket (Nov. 18, 2000), available at
http://www.comiket.co.jp/inc/2000/symposium2.html (visited November 20, 2011).
183
See 2007-2008 MANGA RONSŌ BOPPATSU, supra note 47, at 72-92.
184
“Doraemon” Saishū-Wa 、 Katteni Shuppan Shita Dansei Ga Shazai [Publisher of
“Doraemon” Final Episode Voluntarily Apologizes], ASAHI SHIMBUN, May 29, 2007, available
at
http://www.asahi.com/culture/news_entertainment/TKY200705290047.html
(visited
November 20, 2011).
185
Id.
177
130
chief complaint was that the “final episode” was too much like the real thing.
Shogakukan’s head of intellectual property stated that “his fanzine’s binding is
so similar to the original one that some people mistakenly thought it was
genuine.” 186 And while the publisher was not categorically opposed to dōjinshi,
the number of volumes sold in this case was excessive. 187 After receipt of the
warning, the fan artist offered a formal apology to the publisher and production
company and also turned over a part of the proceeds from the sale of his
dōjinshi.
Responses to the incident varied. One social critic stated that “if publishers
basically approve of the existence of [such] fanzines, the creation of a [new]
rule should be studied, which would require fanzines selling more than a
certain number of copies to pay part of their profits to copyright holders.”188
Another implied that the fan artist should have known better than to make his
dōjinshi so similar to the legitimate product. 189 Others focused on the issue of
how much copying is permissible and where homage fits within copyright.190
New artists start by copying what came before, and one reason to allow
dōjinshi is to grow talent for future “legitimate” comics. Where to draw the
line between what is permissible and what is not is difficult for permissive
rights holders. 191
In contrast to fan-created comics with their two incidents of note to date, fancreated software has had many more brushes with the law. There have been
other cases like the Tokimeki Memorial Case, holding that devices modifying
games are a violation of moral rights, 192 but there have also been several
incidents of cease-and-desist letters sent to fans creating derivative games. The
most “shocking” case involving a cease-and-desist letter happened in 2005. A
dōjin circle called Aqua Style created a series of parody fighting games called
Malignant Variation, which were modeled after the Banpresto Super Robot
Wars games. 193 The games featured characters and music from a wide range of
properties. 194 Just before the release of the fourth installment, Aqua Style
186
Makoto Fukuda, “Doraemon” Fanzine Ignites Copyright Alarms, THE DAILY YOMIURI,
June 17, 2007, at 22, available at 2007 WLNR 11316898.
187
Id.
188
Id.
189
Id.
190
Mohō, Dokomade Yurusareru Doraemon “Saishū-Wa” [To What Extent Is Copying
Permitted – Doraemon “Final Episode”], ASAHI SHIMBUN (June 9, 2007), available at
http://www.asahi.com/culture/news_culture/TKY200706090089.html (visited November 20,
2011).
191
Id. When the article’s author asked the president of the production what he would have done
if the “Final Episode” had sold fewer copies, the president answered “that’s difficult…”
(“‘moshi “saishū-wa” ga korehodo ōku urareteinakattara?’ to tou to, ‘ūn, muzukashii desu ne’
to iu kotae ga kaette kita”).
192
Nobuo Matsumura & Shunji Miyama (eds.), CHITEKI SHOYŪKEN MONDAI KENKYŪKAI
[INTELLECTUAL PROPERTY RIGHTS ISSUES RESEARCH SOCIETY], SAISHIN SHOSAKUKEN
KANKEI HANREI TO JITSUMU [NEW COPYRIGHT PRECEDENT AND PRACTICE] 72 (2006)
(discussing the “Dead or Alive 2” case involving the sale of a CD that would let users remove
the costumes from the characters and have them fight in the nude).
193
SŪPĀ ROBOTTO TAISEN [Super Robot Wars], available at http://www.suparobo.jp/index.php
(visited November 20, 2011).
194
Comike ni Shōgeki!? Parodei Sakuhin ni Keikoku de Hanbai Chūshi! [Comiket Shock!?
Sales of Parody Goods Stopped by Warning!], Tantei File (Dec. 30, 2005), available at
131
received an infringement notice from a rights holder. 195 The rights holder was
never specified nor was the nature of the infringement notice indicated, but
Aqua Style complied and destroyed the 40,000 copies it had prepared to sell at
Comiket. 196 Roughly two years later, a final video and music CD, but no game,
were released with official permission from JASRAC. 197
Other instances of fan software being pulled from the market after an
infringement notice from the rights holder have had mixed results. In 2003,
Sunrise ordered the dōjin circle Project YNP to cease selling a racing game
based on Sunrise’s property Future GPX Cyber Formula. 198 It was pulled from
the market, but Project YNP was able to obtain permission from Sunrise to put
the fan game back on sale. 199 That particular happy ending is underscored by
the fact that Project YNP will release its third game based on Sunrise’s
property sometime this year. 200 Another fan game featuring characters from the
Melancholy of Haruhi Suzumiya was also pulled from the market in 2008 after
receiving a warning from the publisher of the original work. 201 And in
February of this year, Konami sent an infringement warning to the dōjin circle
Alo Marron requesting that the fan game not be distributed, any server activity
be suspended, the game’s website be deleted, and the group to cease making
derivative works of Konami’s property. 202 Given that Konami has litigated all
the way to the Supreme Court over its rights in the past, this is one fan game
that probably will not receive a second chance.
http://www.tanteifile.com/tamashii/scoop_2005/12/30_01/index.html (visited November 20,
2011).
195
Ebifly, Malignant Variation Final Hanbai Chūshi de Daienjōchū no Ken Nitsuite
[Concerning the Large Conflagration Over the Sales Stoppage of Malignant Variation Final],
Ebinavi (Dec. 31, 2005), available at http://ebi-navi.net/2005/12/31/424/ (visited November
20, 2011) (quoting Aqua Style’s announcement to terminate sales after notice from a copyright
holder).
196
Comike ni Shōgeki!? Parodei Sakuhin ni Keikoku de Hanbai Chūshi!, supra note 194. The
game featured characters from Anpanman, Doraemon, Kiteretsu, et al.
197
Final of Final, Aqua Style available at http://www.aquastyle.org/fof_shop.html (visited
November 20, 2011). The site requests that people please refrain from uploading the video to
the Internet as it is only for paying customers (“nao, go-riyōha kōnyūsha nomi de, nētto he no
appurōdo ha go-entyo kudasai”). JASRAC is Japan’s oldest and largest musical copyright
administration society. See generally http://www.jasrac.or.jp/ejhp/index.htm.
198
Kushima Shūjirō, Dōjin Gēmu “Suzumiya Haruhi no Gekitō” ga Keikoku wo Uke Haifu
Teishi [Fan Game “Fierce Fighting of Haruhi Suzumiya” Sales Stopped After Receipt of
Warning],
Temple
Knights
(Feb.
20,
2008),
available
at
http://templeknights.com/archives/2008/02/post_879.html (visited November 20, 2011).
199
Available at http://www.project-ynp.com/product/product.html (visited November 20, 2011)
(“sanraizu-sama no go-kyōryoku & hanbai kyokawo ete kibōno rirīsu! Yume wo jigen suru
tame ni…”) [“The long-awaited release with Sunrise’s cooperation and sales permission! In
order to realize the dream…” ].
200
Id.
201
Darkhorse_logc, Dōjin Gēmu “Suzumiya Haruhi no Gekitō” Kadokawa Shoten kara no
Renraku wo Ukete Haifu Teishi ni [Fan Game “Fierce Fighting of Haruhi Suzumiya” Sales
Ceased After Receipt of Correspondence from Kadokawa Shoten], Gigazine (Feb. 21, 2008),
available
at
http://gigazine.net/news/20080221
(visited
November
20,
2011)_haruhi_gekitou_kadokawa/ (a screen capture of the circle’s apology and compliance
with the publisher’s request can be found here).
202
Karinharp, MQMA3 Kōkai Teishi Nituite [Concerning the Release Stoppage of MQMA3],
(Feb.
4,
2011),
available
at
CHIRUNO TO FLASH TO DŌJIN GĒMU
http://pixiv.cc/karinharp/archives/2158981.html (visited November 20, 2011).
132
At the end of the day, Japan has a very permissive stance towards fan-created
works. The tacit agreement, anmoku no ryōkai, is the best explanation for how
dōjinshi are allowed to thrive. At the same time, because the nuances of the
legal system leave fans almost completely in a grey zone, clashes between
rights holders and fans, when they happen, are much more severe than in the
US
Finally, with regard to both countries, there seems to be a difference in
tolerance between dōjinshi/fanfic and video games. The former is largely
tolerated, but the latter is not. One explanation for the difference could be
works for hire. The two main reasons to reject a fan-created work are economic
impact and infringement of moral rights. Moral rights, in general, will be a
concern of authors, the ones who see their works as their “children.” Economic
impact will be a primary concern of intermediaries, “media” who are in the
industry not to create “art for art’s sake” but to make money. The vesting of
rights in a company instead of in a person will change the motivations for
exercising those rights. Companies have better resources to go after perceived
infringers, and they have more to lose. So while Konami may or may not have
felt emotionally invested in the storyline infringed upon by the memory card in
the Tokimeki Memorial Case, it did feel economically invested in protecting its
intellectual property.
Another reason could just be the nature of the two kinds of properties. Comics
and stories are more “disposable” than games. A single fan fiction or comic
volume will not monopolize a consumer’s time. He or she will read it and then
move on to the next story or comic. They are short 203 and are thus consumed in
larger quantities. Video games, on the other hand, particularly role-playing
games, can take an average of 50 to100 hours to complete. 204 Consumer will,
on this theory, buy fewer games because they do not have enough hours in the
day to play multiple games. Rereading and replaying reinforce this: rereading a
favorite comic or story multiple times will still not match the time consumed in
replaying a 70-hour game. Yet another reason could be that fan-made games
are inherently less transformative. They are generally remakes or sequels, both
categories firmly within derivative work rights given to authors. Those rights,
vested in companies loath to miss any chance at monetization, will be more
fiercely protected.
203
Generally speaking, there are many epic fanfics like the thirty-five chapter Lord of the
Rings/Mary
Sue
fan
fic
parody
Game
of
the
Gods,
available
at
http://www.fanfiction.net/s/1518794/1/The_Game_of_the_Gods Of the 40,706 entries for Lord
of the Rings on fanfiction.net, only 365 are over 100,000 words. See Lord of the Rings,
Fanfiction.net, available at http://www.fanfiction.net/book/Lord_of_the_Rings/ (visited
November 20, 2011).
204
A distinction should be made between traditional console/computer games and the newer
casual games of the iPhone and Facebook. Consumers may well spend 100 hours playing
Farmville, but they do it in 5 minute bursts over several months while playing other casual
games. Traditional console games often cannot be finished in less than 20-30 hours; full
“completion” can easily move that to 100 or 150 hours. See, e.g., Shin Megami Tensei:
Persona 3 Average Play Time?, Gamefaqs (June 4, 2009), available at
http://www.gamefaqs.com/boards/932312-shin-megami-tensei-persona-3/49807420
(visited
November 20, 2011).
133
5. Why Conflicts Are Problematic
So why does all this matter? Fan-created works seem to be getting by under the
current legal regime in both the US and Japan. The lack of clear-cut legal
protection or acceptance has not stopped the continued proliferation of works
on either side of the Pacific. Comiket and its kin still bring in billions of yen
each year, despite the handful of cease-and-desist orders. In the US, the Harry
Potter Lexicon case remains more or less alone in litigated fan-created works
(none of the cases subsequently referencing it have been concerned with
anything resembling fan-created works 205). There is a hiccup here and there,
but the status quo by and large works just fine.
But the status quo is not working just fine. Original creators see their works
seemingly infringed with impunity, while the members of the “remix”
culture 206 are stifled by uncertainty regarding whether or not they will face
legal action for their activities. Intellectual property is, at its core, an optional
regime. Rights are reserved for creators, but it is the choice of each creator
whether or not to exercise those rights. Business can benefit from turning a
blind eye to infringing activities, but leaving unspoken what are and are not
acceptable uses raise the transaction costs for everyone involved. 207
Confronting these legal and economic tensions will also address other
underlying tensions formed by the current copyright regime.
Firstly, fan-created works are nothing new. Arguments can be made for the
existence of fan-created works going as far back as the 15th century in Western
culture. 208 The practice of creating derivative works was certainly alive and
well during the 18th century in opera 209 and in the abundance of unauthorized
205
Salinger v. Colting, 607 F.3d 68 (2nd Cir. 2010) (finding copyright infringement due to
substantial similarity between two novels); Cariou v. Prince, 2011 U.S. Dist. LEXIS 29070
(S.D.N.Y. March 18, 2011) (use of photos in artist’s gallery show infringing); WPIX, Inc. v.
ivi, Inc., 765 F. Supp. 2d 594 (S.D.N.Y. 2011) (streaming copyrighted television programs
over the Internet); Pearson Educ., Inc. v. Vergara, 2010 U.S. Dist. LEXIS 101597 (S.D.N.Y.
Sept. 27, 2010) (involving sales of instructor solutions manuals online); Microsoft Corp. v.
AGA Solutions, Inc., 2010 U.S. Dist. LEXIS 26756 (E.D.N.Y. March 22, 2010) (sale of
infringing software); Pearson Educ., Inc. v. Nugroho, 2009 U.S. Dist. LEXIS 101600 (S.D.N.Y.
Oct. 27, 2009) (sale of instructors' solutions manuals online); Salinger v. Colting, 641 F. Supp.
2d 250 (S.D.N.Y. 2009) (preliminary injunction against potentially derivative novel);
SimplexGrinnell LP v. Integrated Sys. & Power, Inc., 642 F. Supp. 2d 167 (S.D.N.Y. 2009)
(bankruptcy related dispute). Only Cariou and Salinger come close to embodying facts that
might make them similar to the typical fan-created work, but they are still far cries from the
typical fan art or fanfic.
206
LAWRENCE LESSIG, REMIX: MAKING ART AND COMMERCE THRIVE IN THE HYBRID
ECONOMY (2008).
207
See generally Tim Wu, Tolerated Use, 31 COLUM. J.L. & ARTS 617 (2008) (discussing
benefits of certain copyright infringement and ways to formalize such use).
208
Lessig, supra note 206, at 305, pointing out that some have argues that the “Siege of
Thebes” was the first fanfic. See also, John Lydgate's Prologue to the Siege of Thebes:
Introduction, 1992 THE CANTERBURY TALES: FIFTEENTH-CENTURY CONTINUATIONS AND
ADDITIONS 12 (discussing how the poem “attempts to revive and extend the frame-narrative of
The Canterbury Tales”).
209
See, e.g., Donald Jay Grout & Hermine Weigel Williams, A SHORT HISTORY OF OPERA 184
(4th ed. 2003) (discussing Handel’s borrowing of music from other composers for his operas).
134
sequels to works like Robinson Crusoe. 210 Many well-known and even Pulitzer
Prize winning works could be considered fan fiction. 211 Ran is an AU 212
version of King Lear, Rent is an AU version of La Boheme, and A Thousand
Acres is another King Lear AU retelling. Would the world be better off without
these works because they are based on or rework existing properties? And
while those examples are all of works drawing from public domain sources,
there are examples, particularly in movies, where the inspirational source
material was still under copyright. 213 Storytelling and creativity are natural
parts of being human – from cave paintings to pop culture. As long as we have
been human, we have been creating. People find meaning in being creative, 214
and as modern life leads to more existential angst, creative outlets will be even
more indispensable. If fan-created works are a problem, increasing copyright
protection and enforcement will, in all likelihood, not solve it. Law can change
some human behavior, but others are too ingrained to be successfully curtailed
by legislation. Finding a way to balance the creative impulses on the one hand
with financial incentives for intermediaries 215 on the other is essential.
Secondly, an argument can be made that fan-created works serve as an outlet
for otherwise under- or non-represented societal groups. This may be truer of
the US than it is in Japan, given the overall smaller audience and the crosspollination of professional and amateur works in Japan. 216 US creators do
solicit input from fans 217 and sometimes even invite derivative works, 218 but
these sorts of activities do not address underlying representational disparities.
Looking at just the speculative fiction category in the US, women make up
between thirty and forty percent of published authors. 219 People of color make
210
Judge, supra note 159, at 23.
Cory Doctorow, Pulitzer-Winning Fanfic: A Non-Exhaustive List, Boingboing (May 27,
2010), available at http://boingboing.net/2010/05/27/pulitzer-winning-fan.html (visited
November 20, 2011).
212
“Alternate Universe”
213
Desperado is a reworking of A Fistfull of Dollars, which itself is a reimagining of Yojimbo.
Pretty Woman was a retelling of My Fair Lady, an adaptation of the play Pygmalion. The
musical’s lyricist in a note in the libretto stated “I have omitted the sequel because in it Shaw
explains how Eliza ends not with Higgins but with Freddy and – Shaw and Heaven forgive me!
– I am not certain he is right.” FREDERICK LOWE, MY FAIR LADY: A MUSICAL PLAY IN TWO
ACTS 7 (1956).
214
See e.g., Viktor Frankel’s logotherapy and its emphasis on meaning through creative values.
WILLIAM STEWART, AN A-Z OF COUNSELLING THEORY AND PRACTICE 291 (4th ed. 2005) (“A
major source of meaning is through the value of all that we create, achieve and accomplish.”).
215
See generally RICHARD E. CAVES, CREATIVE INDUSTRIES: CONTRACTS BETWEEN ART AND
COMMERCE 21-72 (2000) (discussing “gatekeepers” and what motivates them).
216
Kelts, supra note 34, at 170.
217
First-Ever 'Fanisode' Successfully Scripted by Fans of 'THE L WORD (R), PR NEWSWIRE,
available
at
http://www.prnewswire.com/news-releases/first-ever-fanisode-successfullyscripted-by-fans-of-the-l-wordr-56434892.html (visited November 20, 2011) (describing a
contest where fans will write and vore on scripts which Showtime will make into an actual TV
episode).
218
Lawrence Sonntag, Blizzard Issues We Care Statement Re World of Starcraft, MACHINIMA
(Jan. 21, 2011), available at http://blog.machinima.com/insidegaming/2011/01/21/blizzardissues-we-care-statement-re-world-of-starcraft/ (visited November 20, 2011) (discussing
Blizzard’s statement encouraging the Starcraft II mod community).
219
Broad Universe, Statistics, available at http://broaduniverse.org/statistics/statistics (visited
November 20, 2011). The statistics are more balanced for short stories, but the short story
market is mostly on-line and not in bookstores.
211
135
up an even smaller percentage. 220 Within the speculative fiction community,
amongst both fans and published authors, a discussion over racism and the
portrayal of characters of color exploded into a months-long online fight
referred to as RaceFail ’09. 221 Among other things, this particular Internet
conflagration highlighted a market segment that is currently not being served.
While steps are being taken to remedy this, 222 fan-created works can fill the
immediate gap until market or infrastructural change leads to the publishing of
more works that serve this underrepresented community.
Thirdly, looking to manga’s cousin anime for a moment, we can see the
evolution of a relationship between fans and rights holders who reaped major
benefits by refraining from enforcement. In the US fansubs – anime with
English subtitles added by fans – helped create the commercial anime
market. 223 Fansubs are by definition derivative; 224 they do not even enter into
the derivative versus transformative debate. Despite this, companies
historically had a practice of turning a blind eye to unauthorized videos
provided they were strictly noncommercial. 225 In return, fans would cease their
subtitling activities once a company announced that an officially licensed
version would be available commercially. 226 Interest in anime grew through the
distribution of fansubs, and as interest grew, companies found it worth their
time and effort to start bringing products onto the market. 227 Due to the
technology in use at the time (video tapes), fans had an incentive to buy
legitimate copies because fansubs were often of very poor quality. 228
Anime distributors and fans had a mutually beneficial unspoken understanding
for a long time until technology upset this balance. The move from analog to
digital technology eliminated the quality degradation that had driven fans away
220
See e.g., The Carl Brandon Society, available at http://www.carlbrandon.org/index.html
(visited November 20, 2011). While it does not have a statistical breakdown of authors, the list
of known authors of color is short enough that the overall percentage of PoC within the
published speculative fiction community must be low.
221
The debate, oftentimes very acrimonious, ranged over journals and blogs for roughly five
months. There is no definitive capturing the debate (nor is there a definitive explanation for
how the debate started), but several sites have aggregated links for those seeking to trace the
events. See, e.g., RaceFail '09, Fanlore (last modified July 10, 2011), available at
http://fanlore.org/wiki/RaceFail_%2709 (visited December 3, 2011).
222
E.g., the founding of Verb Noire, “a small press for the talented and underrepresented.”
Verb Noire, available at http://verb-noire.livejournal.com/profile (last modified Oct. 28, 2009).
223
See Sean Leonard, Celebrating Two Decades of Unlawful Progress: Fan Distribution,
Proselytization Commons, and the Explosive Growth of Japanese Animation, 12 UCLA ENT.
L. REV. 189 (2005).
224
Translations are considered derivative works under both US and Japanese copyright law.
See Chosakuhō supra, note 60, at art 2, para. 11; and 17 U.S.C. §101.
225
FRED PATTEN, WATCHING ANIME AND READING MANGA: 25 YEARS OF ESSAYS AND
REVIEWS, 120 (2004)
226
Id.
227
Leonard, supra note 223, at 198 (describing the history of American fansubbing).
228
Patten, supra note 225 (noting that the act of subtitling itself degraded the video quality).
Each time a fansub was copied, the video quality became more degraded to the point where it
would be almost impossible to make out anything but the subtitles. A personal anecdote
regarding fansub quality: when the movie X was released in theaters in the US, the story was
heavily modified from the original Japanese. As the theater full of anime fans watched these
changes in horrified silence, someone yelled out “Look at all the colors that weren’t in your
fansub!”
136
from the fansubs of questionable quality and towards the guaranteed high
quality commercial products. And as fans turned to free on-line content,
companies turned to cease-and-desist letters. Balance in the anime world is
being reestablished as once illegal on-line providers enter into official licensing
agreements, 229 but just as one problem seems to be under control a new one
pops up. 230 Scanlations, digital scans of manga with the original Japanese
replaced with English, have all the legal problems of fansubs, and while, like
fansubs, they once played a beneficial market role, this is no longer the case. 231
Companies are returning to the cease-and-desist letters.
In all of these instances, the tacit agreement broke down, mainly because of
changing technology. The author of the Doraemon “Final Episode” reached as
many buyers as he did because he sold online. Fansubs went digital and online.
Scanlations are possible because of high-quality, inexpensive scanners and
image editing software. Fans want what they want, when they want it. Industry
can keep them happy by turning a blind eye but only so long as the bottom line
is preserved. The anmoku no ryōkai works only if all players respect the
unspoken rules, placing the worlds of fandom and industry in a prisoners’
dilemma. 232 If steps can be taken to diminish needless uncertainty, and by
extension needless strife, all parties involved will be better served.
Following from the above and abusing a well-known koan, if a person holds
monopoly rights in a creative property but there is no one around to buy the
product, are those rights worth anything? Rights holders are faced with a
dilemma – enforce their rights and alienate their fans or forego enforcement
and lose revenue opportunities that they are entitled to. This is not a theoretical
question; fans can be wildly fickle and they often feel entitled to their
derivative works. When companies began going after professional anime video
pirates in the mid-1990s, fans thought the companies were going after them
229
ICV2,
Crunchyroll
Goes
Legit
(Nov.
18,
2008),
available
at
http://www.icv2.com/articles/news/13770.html (visited November 20, 2011). “This move
continues the trend toward online distribution of anime in the US on a nearly simultaneous
basis with the broadcast of new episodes in Japan. As Crunchyroll CEO Kun Gao put it, “By
providing more viewing options to fans and closing the release gap with domestic broadcast in
Japan, Crunchyroll helps fans satisfy their craving for the latest anime while supporting rights
holders’ efforts to monetize their content.”
230
Calvin Reid, Japanese, U.S. Manga Publishers Unite to Fight Scanlations, PUBLISHERS
WEEKLY (June 8, 2010), available at http://www.publishersweekly.com/pw/bytopic/digital/copyright/article/43437-japanese-u-s-manga-publishers-unite-to-fightscanlations.html (visited November 20, 2011). “Scanlations” is a combination of “scan” plus
“translation.”
231
Id. “[E]arly fan-driven scanlation sites were aimed at making manga available overseas at a
time when English translations of manga were rare. Indeed these fan scanlators would remove
their online translations when the books were licensed for the English-language market. That’s
no longer the case, said [Kurt] Hassler. ‘These sites are run as businesses and include direct
scans of licensed English-language manga editions. Some even include our copyright notices.
We don’t want to have to do this but publishers are now focused on this problem.’”
232
Daniel H. Pink, Japan, Ink: Inside the Manga Industrial Complex, WIRED (Oct. 22, 2007),
available
at
http://www.wired.com/techbiz/media/magazine/15-11/ff_manga
(visited
November 20, 2011) (“If they cooperate — that is, if they honor the terms of anmoku no ryōkai
— they both gain. But if one overreaches — if publishers crack down aggressively or if
dōjinshi creators go too far — they both suffer.”).
137
and their amateur fansubs. 233 Attempts by companies to explain their activities
quickly devolved into arguments between hostile fans and defensive
representatives; even now, fans remember this as an attempt by “selfimportant” executives to try to bully them. 234 Recently, Minori, a Japanese
maker of adult video games, shut down a fan translation site for copyright
infringement. 235 Like fansubs, the translation site falls clearly within derivative
works, but the negative fan reaction to the takedown is illustrative of the
entitlement that fans feel towards properties they have invested time in. Again,
fans want what they want, and copyright law (or any other law) is not going to
stand in their way. 236
The above underscore one of the problems with relying on social norms is
picking the particular social norm to rely upon. Advocates of following fandom
norms point to the non-economic nature of their activities, 237 emphasizing that
by their nature they are not in competition with the rights holders’ original
works. And this is, to a certain extent, true. No fan work would exist without
the original work to build from. On the other hand, even noncommercial works
have the potential to cut into the money-making opportunities for the legitimate
rights holder. Every fan video game remake or sequel may be a labor of love,
born out of devotion to the underlying original and often frustration that there
is no new product for the fans to purchase, but it is also directly stepping into
the realm of rights reserved to the original creator. In this case, rights holders
may have themselves to blame – fans would not need to be making their own
versions of the games if the rights holders were providing them with a
legitimate commercial version to engage with. This market failure may be why
some fan games have eventually been officially sanctioned by rights holders. 238
233
Patten, supra note 225, at 119.
Id.
235
Zalas, Eden* Edit War with Minori, Encubed (Apr. 23, 2010), available at
http://novelnews.net/2010/04/23/eden-edit-war-with-minori/ (detailing the back-and-forth
between the company and fans).
236
Zalas, Minori Continues Chatting, Encubed (Apr. 24, 2010), available at
http://novelnews.net/2010/04/24/minori-continues-chatting/ (further detailing the back-andforth between the company and fans). One fan’s comment neatly encapsulates the essence of
the uphill battle rights holders face when exercising those rights: “Please at least understand
one thing about the Internet. That is, the Internet is an entity that surpasses international law; in
other words, you cannot apply archaic rules and rights to the Internet. Even if you stop one
project through a complaint or raiding, someone somewhere will definitely continue. Rather,
these types of actions end up giving said work more exposure and usually end up having the
reverse intended effect. It's probably too late for this game, but in the future, if there's some
content you don't want the world to see, it's best to shut up and do nothing. It's impossible to
crush the will of the people on the net; they'll come back no matter what!”
237
Steven A. Hetcher, Using Social Norms to Regulate Fan Fiction and Remix Culture, 157 U.
PA. L. REV. 1869, 1884-1887 (2009). See also Rebecca Tushnet, User-Generated Discontent:
Transformation in Practice, 31 COLUM. J.L. & ARTS 497, 514-513 (2008) (arguing that
participants in a noncommercial activities produce different works than those in commercial
activities, meaning fan produced works would not be infringing on the commercial market).
238
Geekadelphia, supra note 169. See also AGD Interactive, available at
http://www.agdinteractive.com/games/games.html (visited November 20, 2011) (amateur
studio that remade several Sierra properties; now a professional studio that has ceased
producing remakes).
234
138
Another problem with relying on social norms is that the sense of entitlement
and ownership of the original properties by the fans can tip the balance from
respect for the creator to contempt. One of the reasons for the Darkover
problem was that the fan who threatened to sue over her fan-created novel felt
that she needed to “save” her favorite fictional character from the creator. 239
The takedown of the English translation wiki by Minori was met with anger,
profanity, and a vow that the fans would not be stopped. 240 Many of the articles
reporting on cease-and-desist letters aimed towards fan-created games imply
that the rights holder is in the wrong because they (1) are not giving the fans
anything new and (2) are interfering with the fans’ attempts to fill the market
gap. 241 While trying to show that fan communities are categorically different
from file sharers, one academic advocate points out that “creators of fan fiction
and remix feel as if they have a right to such uses. One [interviewed] fanfiction writer . . . states that ‘the text already belongs to us; we are not taking
anything other than our own fantasies, so therefore we are not stealing anything
at all.’” 242 It is this sense of entitlement and ownership that prompts the
backlash against rights holders exercising their rights. The entitlement is all the
stronger in the cases of perceived failure by the rights holders to cater to fan
desires. Going back to the fan-created games one more time, rights holders’
market silence has helped foster a category of games referred to as
“abandonware.” These are games that are technologically out of date, no longer
on the market, and not currently being exploited in some other capacity by
rights holders. They are the games targeted for remakes by fans 243 or available
for download on various abandonware sites. These are also the games that are
beginning to be given new life in places like Nintendo’s Virtual Console, XBox Live, and Steam. In the time between “abandonment” and repackaging,
however, many users become accustomed to getting those games for free and
are not inclined to pay for something they had appropriated in the rights
holders’ absence. 244
These practices and other Internet norms need to be taken into account by those
advocating community self-governance as a solution to the creator-user
conflict. Coupling the sense of entitlement to the pure piracy element of
Internet society can lead to a “try and (maybe) buy” culture. In other words,
users will “try” illegal software and then (possibly) buy the legitimate version
once they have had a chance to evaluate it. Giving things out for free on the
239
Coker, supra note 154, at 1.2 (The fan was “‘convinced Marion wasn't paying enough
attention to Danvan. And it was like he was a real character, a person’ whom she had to rescue
from the author in order to ‘do right by him.’”).
240
Zalas, Minori Continues Chatting, supra note 236.
241
Cavalli, supra note 167 (“I fully understand Square Enix’s desire to protect its properties,
but that doesn’t make this any less depressing. The game looked quite good (if obviously
derivative) from what little had been shown to the public, and it’s not like Square Enix is
offering fans of the series any sort of viable extension of the tale.”).
242
Hetcher, supra note 237, at 1881.
243
AGD Interactive, supra note 238.
244
Fletcher, supra note 153. From a comment by RKN, posted May 13, 2009 12:45AM (“I got
to play it years ago on my PC thanks to a PC emulator. If it wasn't illegal then, I'm sure its [sic]
illegal now thanks to it no longer being abandonware because of Nintendo's Virtual Console.
But I wouldn't want to purchase a Wii just to play it.”).
139
Internet can still result in sales, 245 but that practice seems best suited to music
or other properties that can capitalize on reaching a wider audience with a free
product and then make money through some other channel like live
performances or merchandizing.
Those who would argue that try-and-buy is not harmful to rights holders might
point out that companies have a greater chance of earning more revenue as
such a scheme promotes purchases the companies otherwise would not have
received from consumers hesitant to spend their money on an unknown
quantity. When a consumer does purchase a legitimate version of a creative
good, that consumer signals that he appreciates the efforts of the producer. In
turn the sales earned by the producer would be more meaningful because they
will implicitly signal what the market wants. On the other hand, if the social
norms do not encourage this monetary feedback loop and consumers default to
merely taking instead of buying, then technologies like the R4 Revolution are
an even greater threat to producers’ exclusive rights.
6. Possible Solutions
So what is to be done? There is always the option of doing nothing. Fan
activities have been living in the shadows of intellectual property for a very
long time. The main proponents of bringing fan-created works into the legal
sunlight are the believers in remix culture. 246 If copyright is the means of
dealing with the economic positive externalities associated with producing
creative goods, and those goods would not be produced without the incentive,
then the status quo should be fine. Proponents of remix culture would then
direct the economic skeptics to all of the blogs, videos, collaborative projects,
open source software movements, and other free things on the Internet as proof
that creativity does not need economic incentive to thrive. 247 The more people
there are creating, the greater the innovation and the more creative “public
works” for all. Would we prefer to have the existing market of Hollywood
provide us with 40 hours of film a year or would we rather have the future
market of YouTube and its successors give us 29 hours of video a minute? 248
And even for those who do not share the belief that remix is the way to greater
peace, love, and creativity, the activities and the tools to facilitate them are here
to stay. Every new technology has been decried as piracy before it is accepted
as progress. 249 Changes in social norms are no different. Change is scary, but it
comes to all things. Creators and consumers are in closer dialogue than ever,
and the creator/consumer divide is blurring. Rights holders can either recognize
245
Greg Sandoval, Study: Free beats fee for Radiohead's 'In Rainbows', Cnet News (Nov. 5,
2007), available at http://news.cnet.com/8301-10784_3-9811013-7.html (visited November 20,
2011) (discussing the revenue figures for Radiohead’s free album).
246
Lessig, supra note 206.
247
Id. at 289-91.
248
Oliver Laughland & Christian Bennett, Cory Doctorow on Copyright and Piracy: ‘Every
Pirate Wants To Be an Admiral’, THE GUARDIAN, May 30, 2011, available at
http://www.guardian.co.uk/commentisfree/video/2011/may/30/internet-piracy-cory-doctorow
(visited November 20, 2011).
249
Id.
140
that the legal regime protecting them was written with the printing press and
arms-length transactions in mind, or they can acknowledge these normative
changes and at worst not be hurt by them and at best flourish under them.
The first possible recommendation for addressing the new reality is a new law
to reflect it. The copyright law in the US could be amended to explicitly allow
fan-created works as transformative. 250 Japanese law could be amended to
allow for broad fair use, 251 the moral right of integrity could be modified to
allow for transformative works, or Article 30 could be amended to clarify how
far the scope of “private use” extends. Other schemes could be devised, but
they all require the modification of existing law. Companies who are invested
in the current copyright system would lobby hard against changes that might
divest them of rights, and there would also be the need to ensure that any
changes to the law do not interfere with international treaty obligations. From a
purely practical standpoint, the legal will to make changes is probably lacking.
Instead of going with hard law, a more soft law approach could be taken. One
approach that has been gaining traction is the commons licensing or copyleft
movement. 252 The primary licensing organization for this approach is Creative
Commons, “a nonprofit organization that develops, supports, and stewards
legal and technical infrastructure that maximizes digital creativity, sharing, and
innovation.” 253 What it does is provide ready-made licenses, in multiple
languages, specifying what a user is allowed to do with a creative work. The
organization has six different licenses, ranging from the most permissive,
requiring mere attribution, to the most restrictive, allowing only sharing with
credit and no commercial or derivative uses allowed. 254 Creative Commons
licenses do not supplant copyright law. Rather, they sit on top of the underlying
law, which assumes all rights reserved, and provide a simple, uniform licensing
scheme to encourage creativity by cutting down on transaction costs. If a fan is
looking for a song to use with her new machinima video, she can search for
music based on the license of her choice. 255 Licensing schemes can be an
incredibly powerful tool for protecting rights and empowering users, but their
utility is only as great as their adoption. Competing schemes may also add
confusion instead of clarity. Various groups like NicoNicoDōga (for video) and
250
Patrick McKay, Culture of the Future: Adapting Copyright Law to Accommodate FanMade Derivative Works in the Twenty-First Century, 24 REGENT U.L. REV. (forthcoming
2011) (arguing for an amendment to the Copyright Act to “explicitly clarify that
noncommercial, transformative works are fair use, ban the use of the DMCA takedown process
and automated copyright filters to block this type of content, and provide real penalties to deter
copyright owners from abusing copyright law to suppress legitimate follow-on creativity.”).
251
But see Keiko Tominaga, Does Japanese Copyright Law Need Fair Use?, 16 CASRIP 3
available
at
(2009),
http://www.law.washington.edu/Casrip/Newsletter/default.aspx?year=2009&article=newsv16i
3JapanFairUse (visited November 20, 2011) (arguing against the introduction of fair use in
Japan).
252
The GNU General Public License is the most cited “copyleft” license. See The Gnu General
Public License (last modified July 13, 2011), available at http://www.gnu.org/licenses/gpl.html
253
Creative Commons , available at http://creativecommons.org/ (visited November 20, 2011)
254
Creative Commons, Licenses, available at http://creativecommons.org/licenses/ (visited
November 20, 2011).
255
UNCTAD 179, CREATIVE ECONOMY REPORT 2010,(describing Creative Commons and
listing several tools related to maximizing licensing utility).
141
Piapro (for VOCALOID characters) have instituted their own “commons”
licensing systems. 256 Licensing systems are still relatively new, so it remains to
be seen how widespread their use will be outside of users already invested in
the free culture/remix movement.
The best of all possible worlds is the one in which fans are happy because they
are free to interact with beloved creative works and the rights holders are
happy because they make money. How can we have 40 Hollywood movies a
year and 29 hours of YouTube a minute instead of either/or? One way to
obtain this balance is by trying to find ways to monetize fan activities on behalf
of the rights holders. The very technology facilitating the derivative works can
also be turned to the benefit of companies. YouTube is home to copyrighted
material running the gamut from pure copying to innovative mash-ups. There
is now a system called Content ID that scans user-uploaded content; when it
finds potentially infringing content, YouTube will leave the videos up, take
them down, or add advertising to them. 257 Once a rights holder has given its
preference, the system will work automatically. 258 YouTube promotes the
system as a way to make money, interact with fans, reduce infringement, and
gather market data. 259 Companies are increasingly turning away from blocking
content and choosing instead to put advertising on it. 260 Even Sony, who
originally saw Content ID a means to stop infringement, has come around after
seeing how the free advertising can lead to sales: “Generally, we're trying to be
as liberal as we possibly can in allowing users to do their thing, but also allow
us to monetize our content.” 261 There are problems with Content ID, 262 but it is
a step in the right direction. And the revenue from YouTube can be significant.
Kadokawa Group created a Kadokawa channel on YouTube in the beginning
of 2008. 263 By the end of the year, Kadokawa had reportedly earned over
¥10,000,000 a month from Content ID’s inVideo advertising. 264 Using
technology instead of fighting it may be one of the paths to Web 2.0 harmony.
256
See Niconico Commons, available at http://www.niconicommons.jp/ (visited November 20,
2011); Piapro , available at http://piapro.jp/ (visited November 20, 2011).
257
Content ID, Youtube, available at http://www.youtube.com/t/contentid (visited November
20, 2011).
258
Id.
259
Id. “Turn your fans into marketers and distributors of your content—while letting them
interact with their favorite content.”
260
Sean Cole, Copyrighted Material Staying Up On YouTube, Marketplace Money (May 27,
2011),
available
at
http://marketplace.publicradio.org/display/web/2011/05/27/mmcopyrighted-material-staying-up-on-youtube/ (visited November 20, 2011). “[T]he number of
entertainment companies going for the ads tripled between the second and third quarter of last
year.”
261
Id.
262
Id. It still takes down content that may be fair use, and it can also possibly lead to the
erosion of understanding regarding fair use: “what we don't want to have the price of that be is
a situation where everybody assumes that just because music exists in a video that you should
have to get permission for it or you should have to pay, for it because in many instances you
don't have to.”
263
Kadokawa
Anime
Channel,
available
at
http://www.youtube.com/user/KADOKAWAanime?gl=JP&hl=ja (visited November 20, 2011).
264
Animeanime, Kadokawa Gurūpu YouTube kara no Gekkan Kōkokushūnyū 1000 Manenchō
wo Tassei [Kadokawa Group You Tube Monthly Advertising Revenue Exceeds ¥100,000,000]
(Jan. 3, 2009), available at http://animeanime.jp/biz/archives/2009/01/_youtube1000.html
(visited November 20, 2011).
142
And businesses and rights holders would be wise to turn their attention to
finding such paths. The world of fans and fan-created works is moving more
and more out of the shadows on its own. Meiji University in Tokyo will be
opening a new Tokyo International Manga Library in 2014 “to house and
preserve manga, anime, and video games, as well as related materials, and to
academically and culturally manage and utilize these resources.” 265 The
already open forerunning facility is the Yoshihiro Yonezawa Memorial Library
of Manga and Subculture, which houses thousands of volumes of manga, many
of which are dōjinshi. 266 On the other side of the Pacific, the University of
California at Riverside is home to the Eaton Collection of Science Fiction,
Fantasy, Horror, and Utopian Literature. 267 Within that collection can be found
tens of thousands of fanzines and related documents. 268 The Organization for
Transformative Work opened its doors in 2008 in order to “to serve the
interests of fans by providing access to and preserving the history of fanworks
and fan culture in its myriad forms.” 269 They host a vast fan fiction archive and
also have an academic journal to promote scholarship in fanworks and
practices. 270 Last year, National Public Radio covered the rise of fan-centered
activism, where fans use their wide networks to promote real world causes like
marriage equality, Haiti earthquake relief, and literacy. 271 Just this summer,
Time magazine ran an extended article on fan fiction. 272 It did not quite make it
to the cover story, but it was one of the cover teasers. Fan culture and fan
activities, particularly the copyright-questionable ones, may still be relatively
unknown, but they will not remain so for much longer. 273 The authors of
copyrighted works that make their way into the collective psyche should not be
surprised when they find their characters showing up in unexpected places. To
take the example in current Western culture, Harry Potter shows up in medical
studies 274 and as the subject of college courses 275. Most of the medical studies
265
Meiji University, Overview of the Facility and Planned Location, available a
http://www.meiji.ac.jp/manga/english/outline/ (visited November 20, 2011).
266
Meiji
University,
Message,
available
at
http://www.meiji.ac.jp/manga/english/yonezawa_lib/message/ (visited November 20, 2011).
267
UC Riverside, About the Eaton Collection, available at http://eaton-collection.ucr.edu/
(visited November 20, 2011).
268
UC Riverside, Fanzines and Fan Criticism in the Eaton Collection, available at
http://eaton-collection.ucr.edu/fanac/Index.htm (visited November 20, 2011).
269
Organization
for
Transformative
Works,
available
at
http://transformativeworks.org/about/believe (visited November 20, 2011).
270
Organization
for
Transformative
Works,
available
at
http://transformativeworks.org/projects (visited November 20, 2011).
271
Neda Ulaby, Harry Potter: Boy Wizard ... And Real-World Activist?, Monkey See (Nov. 18,
2010), available at http://www.npr.org/blogs/monkeysee/2010/11/17/131395444/harry-potterboy-wizard-and-real-world-activist (visited November 20, 2011).
272
Grossman, supra note 15.
273
Id. “Right now fan fiction is still the cultural equivalent of dark matter: it's largely invisible
to the mainstream, but at the same time, it's unbelievably massive.”
274
William Weir & Hartford Courant, J.K. Rowling's Characters Turn Up in Medical
ANGELES TIMES (July
16,
2011),
available
at
Literature,
Too,
LOS
http://www.latimes.com/health/la-he-harry-potter-medical-research-20110716,0,5574115.story
(visited November 20, 2011). PubMed lists 30 different Harry Potter related medical studies.
275
Alysha Love, “Deathly Hallows” Not the End for True Potter Fans, REUTERS (July 5,
2011),
available
at
http://www.reuters.com/article/2011/07/05/us-potter-fansidUSTRE7642SF20110705 (visited November 20, 2011).
143
employ the books as a research tool, but one study was based entirely within
the world of the books, analyzing what might be the cause of Harry’s
headaches. Legal academics are just as taken with Harry Potter. A search for
“Harry Potter” in the title of law review articles yields twenty and twenty-five
hits in Lexis and Westlaw, respectively. 276 And like the medical studies, some
of the articles keep their analyses strictly within the confines of the fictional
world. 277
There may be other solutions to the dissolving creator/consumer dichotomy.
New opportunities may present themselves as steps are taken to address the
change. Japan’s Ministry of Internal Affairs and Communications has proposed
setting up a special “cyber district” with commons-style copyright. 278 Special
copyright-free zones could be created like the Mizuki Shigeru Road in
Sakaiminato City. 279 Fans and rights holders will need to work together to
confront the changing social and technological landscapes. Doing so might
even lead to greater “promotion of the arts and sciences” and lead to the
increased “development of culture.”
7. Conclusion
This paper began with the premise that the US might have something to learn
from Japan, but there are lessons to be learned for everyone concerned. For
those seeking change in Japan, the fair use/transformative works doctrine will
not be useful, at least not without a major overhaul of the copyright system. As
long as moral rights can quash any attempt at transformativeness, Japan will
need to look to other solutions to resolve tensions between fans and rights
holders. The US could import the “tacit agreement” system that has been in
place with regard to dōjinshi, but the nature of the US market will exacerbate
the weak points of such an arrangement. The fan bases are too diverse, the
interactions historically too arms-length for tacit agreements to be effective.
The status quo has changed. The Pandora’s (or Urashima Taro’s) Remix Box
has been opened, and there will be no going back to the read-only culture of
the last several decades. The conflicts between fans and right holders over the
fate of copyrighted works will continue to grow. Rights holders who cling to
the old way of business will find themselves increasingly at odds with the
276
Search performed Aug. 10, 2011. Searches for “Harry Potter” generally in Lexis and
Westlaw yielded over 500 and 700 articles, respectively.
277
See generally Aaron Schwabach, Harry Potter and the Unforgivable Curses: Normformation, Inconsistency, and the Rule of Law in the Wizarding World, 11 ROGER WILLIAMS U.
L. REV. 309 (2206) (discussing the rule of law within the Harry Potter universe); Scott
Hershovitz, Harry Potter and the Trouble with Tort Theory, 63 STAN. L. REV. 67 (2010)
(analyzing tort law theory via imagined scenarios of Harry Potter as a law student).
278
Saibā Tokku no Kasōkūkan Purojeikuto, Sanka Kurīetā nado wo Boshūchū [Cyber District
Virtual Space Project Looking for Developer Participants], Second Times (Nov. 10, 2009),
available at http://www.secondtimes.net/news/japan/20091110_cyber.html (visited November
20, 2011).
279
Mizuki
Shigeru
Road
&
Mizuki
Shigeru
Museum,
available
at
http://www.sakaiminato.net/foreign/en/mizuki.html (visited November 20, 2011). The citizens
of the town do not need to pay royalties to use the characters from Gegege no Kitarō.
144
people they rely on for their livelihoods. At the same time, fans’ growing sense
of entitlement can alienate rights holders and potentially drive them from the
market or to serve other users. The relationships here are reciprocal. Both sides
would do well to remember not to bite the hand that feeds them.
The way to balance these interests will not be through legal change. Law
reform is a long and tedious project, and where technology is concerned, laws
have a tendency to be a few years out of date from the moment they are passed.
Instead, rights holders need to make judicious use of the rights they already
have. Intellectual property is an elective scheme. Rights holders have the
option to exercise their rights or not exercise them. By delineating the
boundaries of what fan uses they will permit ex ante, needlessly high
transaction costs and conflict can be avoided. Whether industry chooses to do
this through licensing schemes, formally stated policy, structured play spaces,
or some other means is up to them. It may not be at a shareholders meeting, but
rights holders should expect to soon enter into dialogue with fans about the
boundaries of permissive use, and they need to have answers to fans’ questions
at the ready.
145
INVESTOR-STATE DISPUTE SETTLEMENT UNDER THE ICSID CONVENTION –
A COMFORTABLE ROOM FOR VIETNAM?
Dang Tran Anh Tuan
1. Introduction
Foreign investment has been considered one of the key factors for the economic growth in
Vietnam. It has played a vital role in supplementing capital, accelerating export, promoting
the transfer of technology, human resource development and job placement. Thanks to its
legislative efforts and commitments by means of the enactment of domestic laws and
regulations - the 2005 Investment Law, the 2005 Law on Enterprises, the 2005 Law on
Environmental Protection and etc., and the conclusion of a large number of international
legal instruments on investment and trade, both bi-lateral and multi-lateral, Vietnam has
become an attractive destination for foreign investment. Currently, it ranks 12th in Foreign
Direct Investment Index 2010 1, and 11th in Ease of Doing Business. 2
Besides these achievements, there still remain certain shortcomings and lacunae in
Vietnamese laws and regulations of foreign investments, such as licensing procedures,
post-admission treatment, incompatibility between domestic law and international treaties
and etc. that would trigger a possibility of investment disputes between foreign investors
and Vietnam/state agencies, which will be normally settled by the domestic courts of
Vietnam, or through international arbitrations. 3 Foreign investors’ choice of the latter is
obvious. From the perspectives of foreign investors, they do not want to have their
investment disputes settled by the domestic courts of host countries since they are afraid of,
to name a few, unfair trials or prolonged legal proceedings, in which they could be placed
in a weak position. Instead, they want to choose international arbitration that is perceived
as speedy, neutral, cost-effective, confidential and etc. to do this job.
Such desire from foreign investors, not only those doing business in Vietnam but also
others worldwide, gave birth to the establishment of international arbitrations in settlement
of investment disputes between investors and host countries, such as the International
Centre for Settlement of Investment Disputes (ICSID), ICSID Additional Facility,
arbitration under UNCITRAL Rules, or ad-hoc arbitration. To give effect to such
arbitrations, countries have concluded multi-lateral and bi-lateral agreements on
investment promotion and protection that contain dispute settlement clauses invoking such
international arbitrations, or specific agreement to bring existing disputes to international
arbitrations.
So, here arises the question of which international arbitration option foreign investors
prefer? Let’s take a look at the world to find the answer. According to UNCITRAL Latest
1
A.T. Kearney、Global Management Consultants Report 2010, available at
http://www.atkearney.com/index.php/Publications/foreign-direct-investment-confidence-index.html
2
World Bank, Doing Business Report 2010, available at http://www.doingbusiness.org/rankings.
3
As provided for in paragraph 4, Article 12 of the 2005 Law on Investment of Vietnam, “Disputes between
foreign investors and Vietnamese state management agencies relating to investment activities in the
Vietnamese territory shall be settled by a Vietnamese arbitration body or court, unless otherwise provided
for in contracts between representatives of competent state agencies and foreign investors or in treaties to
which the Socialist Republic of Vietnam is a contracting party.” Most of BITs with Vietnam have invoked
international arbitration for the settlement of such disputes.
146
Developments in Investor-State Dispute Settlement, a majority of investor-state disputes
were settled under ICSID or ICSID Additional Facility Rules for a 1987-2010 period. In
2010, there are 25 known treaty-based investor-state dispute settlement cases filed under
international investment agreements. Of the 25 cases, 18 were filed with ICSID or ICSID
Additional Facility, 4 with arbitration under UNCITRAL Rules and 1 with the Stockholm
Chamber of Commerce (SCC). For the remaining 2 cases, the applicable arbitration rules
are unknown (Figure 1). 4
Moreover, according to the ICSID 2010 Annual Report, the caseload of ICSID has
increased from a single case in 1972 to an average of slightly over 23 cases per year in
2000-2009. This trend was seen in 2010 with 27 cases. 5 The majority (19) of these cases
asserted ICSID jurisdiction on the basis of BITs (figure 2). This represents a 12 percent
increase from 2009 and indicates that ICSID continues to play a key and leadership role in
institutional investor-state dispute settlement. Issues addressed in ICSID cases became
more diverse, ranging from availability of provisional measures, the proper role of third
non-disputing parties, the meaning of substantive obligations, and the application of
customary international law.
4
5
UNCTAD , available at http://unctad.org/diae.
This figure is slightly different from UNCITRAL statistics, which stated only 25 cases.
Figure 2
Source: ICSID
With such statistics above, it is no doubt that among the aforesaid international arbitrations,
foreign investors have preferred ICSID or ICSID Additional Facility to non-ICSID
arbitration in the settlement of their investment disputes with host states. In that sense, the
settlement of investment disputes between foreign investors and Vietnam under ICSID or
ICSID Additional Facility Rules in the time to come, though such disputes are not
expected, is not an exception. However, Vietnam hasn’t been - until now - a member of the
ICSID Convention. Meanwhile, Vietnam has concluded a large number of bi-lateral
investment treaties 6 (BITs), and multi-lateral agreements, e.g. the WTO Agreements, the
Agreement on the Common Effective Preferential Tariff Scheme for the ASEAN Free
Trade Area. Most of those agreements have required Vietnam to refer investor-state
disputes to ICSID arbitration. So, what benefits would Vietnam get if it became a
Contracting State to the ICSID Convention?
Bearing the aforesaid background in mind, and recognizing the importance of investorstate dispute settlement in the context of globalization and international integration, I
would like to conduct my study of the investor-state dispute settlement under the ICISD
Convention to examine the fitness of this mechanism to Vietnam, and whether accession to
this Convention is a smart choice for Vietnam.
This article is structured as follows: following this Introduction, Section 2 will be an
overview of the ICSID Convention that covers its background of establishment, objectives
and major contents. Section 3 will examine the dispute settlement mechanism under the
ICSID Convention and analyze how ICSID arbitration functions under BITs. In addition,
Section 3 will also give us a comparison between ICSID Arbitration Rules and
UNCITRAL Arbitration Rules, and between the ICSID Convention and the 1958 New
York Convention on Recognition and Enforcement of Foreign Arbitral Awards. Section 4
will evaluate the pros and cons in the dispute settlement under the ICSID Convention from
6
Until June 1, 2011, Vietnam has concluded 58 BITs. see UNCTAD, Total Number of Bilateral Investment
Treaties Concluded, 1 June 2011
available at http://www.unctad.org/sections/dite_pcbb/docs/bits_vietnam.pdf.
Vietnam’s perspective to judge whether this settlement mechanism is really effective for
Vietnam, and whether Vietnam’s accession to the ICSID Convention is a necessity.
Section 5 will represent a number of “internal” challenges Vietnam has to cope with if
becoming a Contracting State to the ICSID Convention. The final part is the conclusion
found in Section 6.
2. Overview of the ICSID Convention
2.1 Background
The Washington Convention on the Settlement of Investment Disputes between States and
Nationals of Other States is a multi-lateral treaty that was formulated by the Executive
Directors of the International Bank for Reconstruction and Development (it has been
renamed as the World Bank). It was open for signature on March 18, 1965, and came into
force on October 14 1966, when it had been ratified by 20 countries. As of May 5, 2011,
there have been 157 States that are signatory to the ICSID Convention. Of these, 147
States are ICSID Contracting States by means of their ratification, acceptance or approval
of the ICSID Convention (Figure 3 and Annex).
Figure 3
“The ICSID Convention sought to remove major impediments to the free international
flows of private investment posed by non-commercial risks and the absence of specialized
international methods for investment dispute settlement” 7. It has also paved the ways for
the settlement of investment disputes between host states and foreign investors. In
accordance with the provisions of the ICSID Convention, the Centre is established “to
provide facilities for conciliation and arbitration of investment disputes between
Contracting States and nationals of other Contracting States” 8 through its Regulations and
Rules, which were last amended on September 29, 2002 and entered into force on January
1, 2003. For the first time, a system at international level was instituted that allows nonstate entities, i.e. individuals and corporations, to directly sue states; that restricts state
Source:
ICSID
immunity to a certain extent; that excludes the operation of national remedy
rules;
that
gives room to international law in governing relationships between foreign investors and
host states; and that direct enforcement of international tribunal awards is permissible 9.
7
“About ICSID”, available at
http://icsid.worldbank.org/ICSID/FrontServlet?requestType=CasesRH&actionVal=ShowHome&pageName=
AboutICSID_Home.
8
9
Art. 1, para 2, the ICSID Convention.
CHRISTOPH H. SCHREUER, THE ICSID CONVENTION: A CONTEMPORARY XI (2005) .
In the late 1970s, the Centre began to expand its scope with the advent of ICSID
Additional Facility Rules 10 (hereinafter, the AFR) that was adopted by the Administrative
Council of the Centre in 1978. The AFR, with its own rules and regulations, is designed to
provide a settlement mechanism for investor-state disputes where only one of the States
concerned, either the host State or the home State is a Contracting State to the ICSID
Convention; and where such disputes do not directly arise out of investment, which is a
requirement for invocation of ICSID arbitration. It is may also be used for fact-finding
proceedings. However, it is noted that none of the provisions of the ICSID Convention
shall be applicable to the AFR 11. The latest amendments to the AFR came into effect on
April 10, 2006.
2.2 Objectives
The ICSID Convention is mainly designed to :
Promote economic development through the creation of favorable
investment climate and the facilitation of private international investment, which is
clearly expressed in its Preamble: “Considering the need for international
cooperation of economic development, and the role of private international
investment.”
Create an effective and efficient settlement mechanism for investment
disputes that is considered a backbone factor for the promotion and protection of
investment. With its own standard clauses and rules of procedures as well as
institutional capability, this mechanism avoids any frustration of proceedings and
assures the recognition and enforcement of arbitral awards.
Serve the interests of both investors and host states in the ways that it helps
host states to attract more foreign investment, to guard against diplomatic
protection from home states, and to protect them from other foreign or international
litigations. From investor’s perspective, they can get a direct access to an effective
international settlement mechanism if they have investment disputes with the host
states. This balance of interests has been affirmed in the Report of the Executive
Directors on the ICSID Convention. Paragraph 13 of the Report states that “the
provisions of the ICSID Convention maintain a careful balance between the
interests of investors and those of host states. Moreover, the ICSID Convention
permits the institution of proceedings by host states as well as investors...” 12
2.3 Contents
The ICSID Convention consists of 10 chapters and 75 articles, together with the
Administrative and Financial Regulations (the Regulations), the Rules of Procedures for
the Institution of Conciliation and Arbitration Proceedings (Institution Rules), the Rules of
10
Name in full: Rules Governing the Additional Facility for the Administration of Proceedings by the
Secretariat of the International Centre for Settlement of Investment Disputes.
11
AFR, Art. 3. Further noted that certain provisions of the Administrative and Financial Regulations of
ICSID apply mutatis mutandis in respect of the proceedings under the Additional Facility.
12
Report of the Executive Directors on the Convention, , para. 13.
Procedures for Conciliation Proceedings (Conciliation Rules) and the rules of Procedures
for Arbitration Proceedings (Arbitration Rules), stipulating
Establishment and organization of the International Centre for Settlement of
Investment Disputes (“the Centre” or “ICSID”) (Chapter I). The Centre has an
Administrative Council which is composed of one representative from each
Contracting State and headed by the President of the World Bank as ex officio
Chairman; a Secretariat composed of a Secretary General, one or more Deputy
Secretary General and staff; a Panel of Arbitrators and a Panel of Conciliators, each
consisting of qualified persons designated by Contracting States. The Centre has
legal personality and enjoys immunities and privileges 13.
Jurisdiction of the Centre that is in Chapter II: including ratione personae
jurisdiction and ratione materiae jurisdiction 14.
Conciliation (Chapter III): Request for conciliation, constitution of the
conciliation commission and conciliation proceedings 15.
Arbitration proceedings (Chapter IV): Request for arbitration, constitution
of the tribunal, functions and powers of the tribunal, the arbitral award,
interpretation, revision and annulment of the arbitral award, recognition and
enforcement of the award 16
Replacement and disqualification of conciliators and arbitrators (Chapter
17
V) .
-
Cost of proceedings (Chapter VI) 18.
-
Place of proceedings (Chapter VII) 19.
-
Disputes between Contracting States (Chapter VIII) 20.
-
Amendment to the ICSID Convention (Chapter IX) 21.
-
Final provisions (Chapter X) 22.
With its objectives and institutional support feature, the ICSID Convention has become
one of the international treaties that have a large number of member States and other
signatories, and – consequently – has emerged as an effective tool for the promotion of
international investment. The most important factor contributing to the fame of the ICSID
Convention is its dispute settlement mechanism. Section 3 will make an analytical
diagnosis of this mechanism to see how it functions, with a focus on ICSID arbitration.
13
For details, see the ICSID Convention, Art. 1- 24; the Regulations.
For details, see the ICSID Convention, Art. 25- 27.
15
For details, see the ICSID Convention, Art. 28- 35; the Institution Rules; the Conciliation Rules.
16
For details, see the ICSID Convention, Art. 36- 55; the Institution Rules, the Arbitration Rules.
17
For details, see the ICSID Convention, Art. 56- 58, the Arbitration Rules.
18
For details, see the ICSID Convention, Art. 59- 61; the Regulations, Regu. 14-19; the Arbitration Rules.
19
For details, see the ICSID Convention, Art. 62- 63; the Arbitration Rules.
20
For details, see the ICSID Convention, Art. 64.
21
For details, see the ICSID Convention, Art. 65 - 66.
22
For details, see the ICSID Convention, Art. 67 – 75.
14
Four fundamental issues relating to this settlement mechanism, they are scope of
application; choice of law; arbitral tribunal and arbitration proceedings; and arbitral awards
and their recognition and enforcement, will be examined. In addition, difference between
ICSID arbitration and arbitration under UNCITRAL rules, and the relationship between
ICSID arbitration and BITs – a key bi-lateral treaty, based on which ICSID arbitration
proceedings are instituted by investor against the host state - will be also analyzed in
Section 3.
3. Dispute Settlement Mechanism under the ICSID Convention
3.1 Scope of Application
Under the ICSID Convention, only a limited number of investor-state disputes can be
brought for settlement under the ICSID arbitration rules. In other words, the Centre shall,
as provided for in Article 25 of the ICSID Convention 23, have the jurisdiction over any
dispute that meets the following requirements:
(1) The dispute must be legal dispute arising directly out of an investment;
(2) The dispute is between a Contracting State (or any constituent subdivision or
agency of a Contracting State that has been designated to the Centre by that State)
and a national of another Contracting State; and
(3) The parties to the dispute consented in writing to submit to the Centre, that are
discussed below:
23
ICSID Convention, Art. 25.
“(1) The jurisdiction of the Centre shall extend to any legal dispute arising directly out of an
investment, between a Contracting State (or any constituent subdivision or agency of a Contracting
State designated to the Centre by that State) and a national of another Contracting State, which the
parties to the dispute consent in writing to submit to the Centre. When the parties have given their
consent, no party may withdraw its consent unilaterally.
(2) "National of another Contracting State" means
(a) any natural person who had the nationality of a Contracting State other than the State
party to the dispute on the date on which the parties consented to submit such dispute to
conciliation or arbitration as well as on the date on which the request was registered
pursuant to paragraph (3) of Article 28 or paragraph (3) of Article 36, but does not include
any person who on either date also had the nationality of the Contracting State party to the
dispute; and
(b) any juridical person which had the nationality of a Contracting State other than the
State party to the dispute on the date on which the parties consented to submit such dispute
to conciliation or arbitration and any juridical person which had the nationality of the
Contracting State party to the dispute on that date and which, because of foreign control,
the parties have agreed should be treated as a national of another Contracting State for the
purposes of this Convention.
(3) Consent by a constituent subdivision or agency of a Contracting State shall require the approval
of that State unless that State notifies the Centre that no such approval is required.
(4) Any Contracting State may, at the time of ratification, acceptance or approval of this Convention
or at any time thereafter, notify the Centre of the class or classes of disputes which it would or
would not consider submitting to the jurisdiction of the Centre. The Secretary-General shall
forthwith transmit such notification to all Contracting States. Such notification shall not constitute
the consent required by paragraph (1) ”
3.1.1
Any Legal Dispute Arising Directly out of an Investment
3.1.1.1 Any Legal Dispute
“Any legal dispute”, as the first element of the dispute, means that the claimant has to
make a concrete legal claim based on specific legal rights. Factual disputes or conflicts of
interests are not under the jurisdiction of the ICSID Convention. The drafting history of the
ICSID Convention reflects that “the expression "legal disputes" has been used to make
clear that while conflicts of rights are within the jurisdiction of the Centre, more conflicts
of interests are not. The dispute must concern the existence or scope of a legal right or
obligation, or the nature or extent of the reparation to be made for breach of a legal
obligation". 24 For example, disputes over ordinary sales contracts shall be excluded from
the ICSID jurisdiction. Therefore, the legal nature of a dispute submitted to ICSID
arbitration must be found. ICSID’s jurisdiction will not be invoked if it is not a legal
dispute even the parties have agreed to submit the dispute or agreed that “ex aequo et
bono” principle 25 will be applied to decide the dispute. However, in practice such a
requirement hasn’t caused any difficulty to arbitral tribunals.
3.1.1.2 Arising Directly out of Investment
As mentioned in above, any dispute not arising directly of investment shall not fall under
ICSID’s jurisdiction. It is unfortunate that the term “investment” is not defined in the
ICSID Convention and it is decided on a case-by-case basis by ICSID tribunals. The
reason why the ICSID Convention omitted such definition came from the fear that
jurisdiction discussions could prolong even the parties already gave their consent to ICSID
jurisdiction. It is further emphasized in the Report of the Executive Directors of the World
Bank: “No attempt was made to define the term “investment” given the essential
requirement of consent by the parties, and the mechanism through which Contracting
States can make known in advance, if they so desire, the classes of disputes that they would
or would not consider submitting to the Centre (Article 25(4)).” 26 In that sense, this has
allowed the parties to characterize their transaction as an investment at their own discretion.
But, the parties’ freedom in this respect is within limitation. Article 42 of the ICSID
Convention gives room to the tribunal to decide whether a dispute falls under ICSID
jurisdiction. However, it is noted that this competence of the tribunal gives inconsistent
decisions on jurisdictions that may restrict further acceptance of ICSID arbitration by new
countries, may result in certain problems in enforcement of ICSID awards and may
prolong the arbitration proceedings. To deal with this situation, many ICSID tribunals have
relied on so-called “Salini test” in ICSID case No. ARB/00/4: Salini Costruttori S.P.A. and
Italstrade S.P.A. v. Kingdom of Morocco 27 to define “investment”. According to the test,
the following elements identify “investment” for the purpose of invocation of ICSID
jurisdiction, they are: (i) a contribution; (ii) a certain duration over which the project is
implemented; (iii) a sharing of operational risks; and (iv) a contribution to the host state’s
development. For example, this test was stated in ICSID case No. ARB/03/29: Bayindir
Insaat Turizm Ticaret Ve Sarayi A.S. v. Islamic Republic of Pakistan hat reads: “Both
parties relied upon previous decisions by ICSID Tribunals to define the notion of
24
Report of the Executive Directors on the ICSID Convention, 1 ICSID Reports 28
ICSID Convention, Art. 42(3).
26
Report of the Executive Directors of the World Bank, para. 27
27
ICSID case No. ARB/00/4, available at http://italaw.com/documents/Salini-English.pdf.
25
investment under Article 52 of the ICSID Convention, in particular upon the decision in
Salini v. Morocco.” 28
In addition, directness (“arising directly out of”) is also a requirement of institution of
ICSID arbitration proceedings. It means that the dispute must be reasonably closely
connected to the investment transaction. But, the investment need not be a foreign direct
investment. It may cover portfolio (indirect) investment. Therefore, the term “investment”
defined in many BITs cover both, e.g. Japan-Vietnam BIT. 29
3.1.2 Characters of the Parties
3.1.2.1 Contracting State or Its Constituent Subdivision or Agency
Under the ICSID Convention, one of the parties must be a Contracting Party or any
constituent subdivision or agency of a Contracting State that has been designated to the
Centre by that State. A State may engage in foreign investment through its central agencies
or designated authorities. If there is an investment agreement concluded between an
investor of a Contracting State and a province of another Contracting State, the investor
cannot bring his claim against the State but that province. It appears more complicated in a
case where a constituent subdivision or agency of a Contracting State is a party to the
dispute for number of reasons. First, that constituent subdivision or agency must be
designated by the Contracting Party. Second, the approval of the Contracting State over
consent of the constituent subdivision or agency is still required even though it has been
designated by that Contracting State (so-called “double-layer” of consent) 30 . Accordingly,
ICSID shall not have jurisdiction over a dispute where a constituent subdivision or agency
of a Contracting State is a party if the constituent subdivision or agency is not designated
by the Contracting State or there is no approval from that Contracting State over the
consent of the constituent subdivision or agency.
3.1.2.2 National of a Contracting State
3.1.2.2.1 National as Natural Person
As for the disputant who is an investor, the ICSID Convention covers both natural persons
and juridical persons, they are: (i) “any natural person who had the nationality of a
Contracting State other than the State party to the dispute; (ii) a juridical person having
the nationality of a Contracting State other than the State party to the dispute; and (iii) a
juridical person which had the nationality of the Contracting State party...because of
foreign control, the parties have agreed should be treated as a national of another
Contracting State for the purposes of the ICSID Convention” 31 . The requirement of
nationality is interpreted in two ways: positive requirement and negative requirement. To
meet the positive requirement, investors must be nationals of a Contracting State while, in
the negative requirement, investors must not hold the nationality of the host State.
Accordingly, individual investors of a non-Contracting State are not eligible to submit the
28
ICSID case No. ARB/00/4, available at http://italaw.com/documents/Bayandiraward.pdf, para. 130.
Japan-Vietnam BIT, Art. 1(2): “the term “investment” means every kind of asset owned or controlled,
directly or indirectly, by an investor, including (a)...; (b) shares, stocks or other forms of equity participation
in an enterprise, including rights derived therefrom.”
30
ICSID Convention, Art. 25, para (3).
31
The ICSID Convention, Art. 25, para. (2).
29
dispute to the Centre. This requirement can be further interpreted that dual nationals
(holding both the nationality of the home state and that of the host state) are also not
allowed to bring the dispute to ICSID because the Centre is not instituted to permit a
national to arbitrate with his/her own government. In addition to this nationality
requirement, individual investors have to satisfy the “date” requirement, according to
which they have to be nationals of a Contracting State on the date the parties consented to
submit to ICSID’s jurisdiction and also on the date the request for conciliation or
arbitration is registered by ICSID. For example, in ICSID case No. ARB/02/7: Hussein
Nuaman Soufraki v. United Arab Emirates 32 , the request for ICSID arbitration of Mr.
Soufraki (the claimant) who had lost his Italian nationality by obtaining Canadian
nationality was rejected by the tribunal under the Italy-UEA BIT because that the claimant
did not have Italian nationality. However, there is an exception that allows a dual national
to institute ICSID arbitration proceedings. It would be the case where the host state
naturalized an individual investor intentionally for the purpose of escaping ICSID’s
jurisdiction 33.
3.1.2.2.2 National as Juridical Person
Corporate investors will qualify as nationals of a Contracting State if their nationality is
determined through their place of incorporation (the Contracting State where corporate
investors are incorporated) or seat of business (the Contracting State where the
headquarters or the centre of corporate investors are established). This elaboration is not
seen in the ICSID Convention. However, such traditional criteria for determining the
nationality of a corporation under international law and domestic law have been
consistently adopted by ICSID tribunals. 34 If a corporate investor holds the nationality of a
non-Contracting State, it cannot institute ICSID arbitral proceedings. Moreover, the “date”
requirement must be also satisfied by corporate investors, that is to say on the date the
parties consented to submit to ICSID’s jurisdiction. However, under special circumstances,
a corporate investor of the host state can invoke ICSID’s jurisdiction if there has been an
agreement between the host state and the home state that treated, because of foreign
control, the corporate investor as a national of the home state.
3.1.3. Multiple Parties
Another matter of concern is whether it is possible to have multiple parties in ICSID
arbitration? There have been cases involving multiple claimants and a few involving the
States together with a government agency. For example, in Tidewater Inc. and others v. the
Bolivarian Republic of Venezuela ICSID Case No ARB/10/5 where there are 8 claimants,
namely Tidewater Inc.; Tidewater Investment SRL; Tidewater Caribe, C.A.; Twenty Grant
Offshore, L.L.C.; Point Marine, L.L.C.; Twenty Grant Marine Service, L.L.C.; Jackson
Marine, L.L.C; Zapata Gulf Marine Operators, L.L.C. In Repsol YPF Ecuador, S.A. and
others v. the Republic of Ecuador and PetroEcuador ICSID Case No. ARB/08/10, the
respondents are the Republic of Ecuador and Empresa Estatal Petróleos del Ecuador.
Those have suggested that multiple parties are possible if ICSID's particular jurisdiction
requirements have been met.
32
ICSID case No. ARB/02/7, available at
http://icsid.worldbank.org/ICSID/FrontServlet?requestType=CasesRH&actionVal=showDoc&docId=DC155
3_En&caseId=C213
33
Christoph H. Schreuer, supra, at
34
Christoph H. Schreuer, supra, at
3.1.4 Parties’ Consent
Under Article 25(2) of the ICSID Convention, the consent of the parties to the dispute must
be made in writing and submitted to the Centre. Additionally, neither party may withdraw
its consent unilaterally once they have given their consent. There are traditionally a number
of ways of giving consent, they are:
3.1.4.1 Under Contracts
There is often an arbitration clause in a contract that refers the dispute to ICSID for
settlement. Given that only certain investor-state disputes can be submitted to ICSID due to
ICSID’s jurisdictional limitations and special characteristics, the Secretariat of ICSID has
offered the ICSID Model Clauses that are available at its website 35. The Clauses cover
place of proceedings, choice of law, methods of constituting the tribunal, provisional
measures, etc. 36 Such Model Clauses will make it easy for the parties, especially the
investor, to invoke ICSID jurisdiction over their dispute.
3.1.4.2 Under Treaty or National Law
Today, a common way for investor to refer their disputes with a state or its agency to
ICSID arbitration is the investor’s acceptance of the offer by the state set forth in the
national law of the state or under multi-lateral or bi-lateral agreements on investment and
trade. For instance, as stipulated in Article 1112 “Consent to Arbitration” of the North
American Free Trade Agreement (NAFTA):
“1. Each Party consents to the submission of a claim to arbitration in accordance
with the procedures set out in this Agreement.
2. The consent given by paragraph 1 and the submission by a disputing investor of
a claim to arbitration shall satisfy the requirement of:
(a) Chapter II of the ICSID Convention (Jurisdiction of the Centre) and the
Additional Facility Rules for written consent of the parties;
(b) Article II of the New York Convention for an agreement in writing; and
(c) Article I of the InterAmerican Convention for an agreement.”
However, certain observations should be noted:
A potential claimant (investor) does not necessarily have any contractual
relationship the with host state to submit the invest-host state dispute to ICSID
arbitration because of international investment agreements. This sometimes
surprises the state since they simply think that the absence of a contract means no
obligation.
35
ICSID Model Clauses, available at http://icsid.worldbank.org/ICSID/StaticFiles/model-clauses-en/maineng.htm.
36
ICSID Model Clauses: special clause relating to subject-matter of the dispute “the consent to the
jurisdiction of the Centre recorded in citation of basic clause above shall [only]/[not] extend to disputes
relating to the following matters:...”.
Even in a case where a host state gives its consent under an international
investment agreement, ICSID’s jurisdiction could be excluded because all
requirements to institute ICSID arbitration are not sufficiently met. For example,
under a BIT between country A (home state) and country B (host state) that allows
investors bring their disputes with the host state to ICSID. However, country B is
not a Contracting State to the ICSID Convention, or the dispute is not a dispute
arising directly out of investment, etc.
3.1.4.3 Agreements to Submit an Existing Dispute
In principle, it is possible for the parties to agree to submit their dispute to ICSID
arbitration. However, it is not a common way to do so since a state party is very reluctant
or unwilling to agree to invoke ICSID arbitration over the existing dispute. In fact, there
are some cases where the parties agreed to submit their existing disputes to ICSID. 37 For
example, in Compania del Desarrollo de Santa Elena S.A. v. Republic of Costa Rica 38, the
Government of Costa Rica agreed to refer their existing dispute with the Santa Elena
Development Company to ICSID arbitration in order to enjoy a $175 million economic
development loan from the Inter-American Development Bank.
3.1.4.4 Limitation on Consent
However, the ICSID Convention shall not automatically obligate a Contracting State, upon
its ratification, acceptance or approval, to bring all their disputes with foreign investors of
another Contracting State before the Centre for settlement. As stated in the Preamble of the
ICSID Convention, "no Contracting State shall by the mere fact of its ratification,
acceptance or approval of this Convention and without its consent be deemed to be under
any obligation to submit and particular dispute to conciliation or arbitration". If a State is
not a Contracting State to the ICSID Convention at the time of a request for ICSID
arbitration, such State shall not be subject to ICSID’s jurisdiction even it has given its
consent to the jurisdiction.
The ICSID Convention allows Contracting States parties to notify ICSID of types of
disputes they would not consider submitting to the ICSID arbitration. 39 Furthermore, a
Contracting State may exclude the territories for which the Contracting State is responsible
from the application of the ICSID Convention by written notice to the depositary of this
Convention upon its ratification, acceptance or approval, or subsequently. 40
3.2
Choice of Law
Choice of law turns out to be one of the issues both claimants (investors) and respondents
(Contracting States) have to challenge. Article 45 41 of the ICSID Convention provides for
37
Abby Cohen Smutny, Arbitration before the International Centre for Settlement of Investment Disputes,
IBA Arb. & ADR News. LEXIS 29 (2002).
38
See Compania del Desarrollo de Santa Elena S.A. v. Republic of Costa Rica, ICSID Case No. ARB/96/1,
Award (February 2000), 15 ICSID Rev-FILJ 169 (2000).
39
ICSID Convention, Art. 25(4).
40
ICSID Convention, Art. 70.
41
It reads as follows:
law applicable to the subject-matter of disputes. Accordingly, the tribunal shall apply law
as agreed by the parties to the dispute. There is no time limitation on the parties’ agreement
on the law applicable. Thus, the parties may agree to choose the law applicable to the
dispute in the course of the arbitration proceedings 42. There are different ways to for the
parties to exercise choice of law in ICSID arbitration:
Under a specific agreement: The parties may agree on the law applicable to
their dispute under ICSID arbitration before or even after the institution of the
proceedings. In most cases, there is a choice of law clause in such agreement. The
ICSID Model Clauses has been developed to offer an example on a choice of law
clause: “Any Arbitral Tribunal constituted pursuant to this agreement shall
apply specification of system of law [subject to the following modifications:...].” 43
-
Under national legislation, e.g. the 2005 Law on Investment of Vietnam. 44
Under international treaty, mainly BITs, e.g. Article 10 of ArgentinaNetherlands BIT reads “7. The arbitration tribunal addressed in accordance with
paragraph (5) of this Article shall decide on the basis of the law of the Contracting
Party which is a party to the dispute (including its rules on the conflict of law), the
provisions of the present Agreement, special Agreement concluded in relation to
the investment concerned as well as such rules of international law as may be
applicable.” 45
In the absence of such agreement, the law applicable to the dispute shall be the law of the
Contracting State (including its rules on conflict of laws) and such rules of international
law as may be applicable. In most ICSID cases, the law applicable of the Contracting State
party to the dispute is often the law of the host country. The ICSID Convention gives
priority to the law of the host state as the law applicable to investor-state disputes under
ICSID arbitration. For example, in ICSID case No. ARB/87/2: Mobil Oil Corporation and
others v. New Zealand 46, the arbitral tribunal applied the law of New Zealand as the host
country. However, there are very few ICSID cases where the law applicable is the law of
the investor’s state. For instance, in ICSID case ARB/84/2 Colt Ind. Operation Corporation,
Firearms Div. v. Government of the Republic of Korea, the tribunal determined the law of
the home country as the law applicable to the dispute because the subject-matter of the
contract were agreements on technical and license issues that are in close connection with
that law.
"(1) The Tribunal shall decide a dispute in accordance with such rules of law as may be agreed by
the parties. In the absence of such agreement, the Tribunal shall apply the law of the Contracting
State party to the dispute (including its rules on the conflict of laws) and such rules of international
law as may be applicable.
(2) The Tribunal may not bring in a finding of non liquet on the ground of silence or obscurity of the
law.
(3) The provisions of paragraphs (1) and (2) shall not prejudice the power of the Tribunal to decide
ex aequo et bono if the parties so agree.”
42
Kresimir Sajko, “Selected Issues: Washington Convention on Settlement of Investment Disputes between
States and Nationals of Other States”, 6 Croat. Arbit. Yearb. 129 (1999),
43
ICSID Model Clauses, available at http://icsid.worldbank.org/ICSID/StaticFiles/model-clauses-en/maineng.htm.
44
See footnote 3 supra.
45
Argentina-Netherlands BIT, available at
http://www.unctad.org/sections/dite/iia/docs/bits/netherlands_argentina.pdf.
46
Attorney-General v. Mobil Oil NZ Ltd., New Zealand, High Court, 4 ICSID Reports 123.
In regard to the application of international law to investor-state disputes, international law
often plays two roles: complementary role and corrective role. In case of a legal vacuum in
the law applicable of the Contracting State Party, international law plays its
complementary role. In case the law applicable is in contradiction with the principles of
international law, the tribunal shall apply the rules of international law (the corrective role).
For example, in ICSID case No. ARB/81/1 Amco Asia Corporation, Pan American
Development Ltd. and P.T. Amoco Indonesia (AMCO) v. Republic of Indonesia, the
tribunal decided to apply the rules of international law to fulfill gaps in the local law
applicable to the dispute.
3.3. Arbitral Tribunal and Arbitration Proceedings 47
ICSID settles investor-state disputes in accordance with the ICSID Convention, which is
further specified in the Financial and Administrative Regulations (the Regulations), the
Rules of Procedures for the Institution of Conciliation and Arbitration Proceedings
(Institution Rules) and the Rules of Procedures for Arbitration Proceedings (Arbitration
Rules). ICSID arbitration procedures are governed exclusively by the ICSID Convention
and excluded from the application of the arbitration laws and the control of the courts of
Contracting States. 48 Recourse to arbitration under the ICSID Convention is entirely
voluntary. No contracting state or national of such a state is obliged to resort to arbitration
without having consented to do so. In principle, the parties to an ICSID arbitration can
exclude the provisions of the Arbitration Rules. Article 44 of the ICSID Convention reads
“Any arbitration proceeding shall be conducted in accordance with the provisions of this
Section, and, except as the parties otherwise agree, in accordance with the Arbitration
Rules in effect on the date on which the parties consented to arbitration.” The official
languages of the Centre are English, French and Spanish. However, the parties may agree
on the use of one or two languages to be used in the proceeding. If the parties agree on any
language that is not an official language, approval from the Secretary General is required.
47
Most ICSID cases, both concluded cases47 and pending cases47, are subject to arbitration proceedings at the
request of the parties. Of over 350 cases so far, there are only 6 cases, with original arbitration, concluded
through conciliation proceedings47 (e.g. CONC/83/1 Tesoro v. Trinidad and Tobago and CONC/82/1 Seditex
v. Madagascar , the disputes were settled upon the parties’ agreement through conciliation proceedings, and
the arbitration proceedings closed). That’s the reason why the parties prefer to arbitration to conciliation. In
that sense, this paper will explore only ICSID arbitration proceedings.
48
A. REDFERN, M. HUNTER, N. BLACKABY AND C. PARTASIDES, LAW AND PRACTICE OF
INTERNATIONAL COMMERCIAL ARBITRATION (4th ed. 2004).
Source: ICSID Annual Report, 2010
3.3.1 Initiation of Arbitration Proceedings
Any Contracting State or any national of a Contracting State may request initiation of
arbitration proceedings by means of addressing a request to that effect in writing to the
Secretary-General 49 who shall register the request unless he finds that the dispute is
manifestly outside ICSID’s jurisdiction on the basis of information included in the request.
Such information is subject to requirements set forth in Article 36 of the ICSID
Convention which is further specified in Rule 2 of the Institution Rule. Procedural
requirements set forth in the parties’ arbitration agreement or document containing consent
(e.g. BITs) must be observed by the claimant.
3.3.2 Arbitral Tribunal
Once the request is registered, an arbitration tribunal shall be constituted and consists of a
sole arbitrator or any uneven number of arbitrators appointed upon the parties’ agreement.
Appointment of arbitrators of the same nationality with the parties is not prohibited,
provided that the parties so agree and the majority of arbitrators shall be of a nationality
49
ICSID Convention, Art. 36(1).
different from the nationality of any party, unless the parties agree otherwise. 50 If the
tribunal is not constituted within 90 days as of the date of registration of the request, the
Chairman of the Administrative Council, at the request of either party, will appoint any
arbitrators that the parties have failed to appoint. 51
The tribunal has the power to consider any objection by a party to the dispute concerning
the jurisdiction of ICSID and the competence of the tribunal itself, and to decide whether
to deal with it, provided that the objection is filed with the Secretary-General "no later
than the expiration of the time limit fixed for the statement of defense,..., unless the facts on
which the objection is based are unknown to the party at that time” 52. The tribunal has the
powers and functions that are commonly seen in international arbitration, e.g. ask for
submission of evidences, visiting the scene, determination on additional claims at request
by the parties, recommendation on provisional measures, etc 53. The tribunal shall decide a
dispute based on applicable law 54 , and on principles of non liquet (where there is no
applicable law) and ex aequo et bono (according to the right and good) 55.
3.3.3 Conducting the Arbitration
The ICSID system is unique because of its autonomous nature. Unlike other international
arbitrations, neither the tribunal nor the parties in an ICSID arbitration are constrained by
the arbitration rules of national law. They are subject to the rules of the ICSID Convention
and the Arbitration Rules. Put it in other words, the mandatory requirements of the
arbitration law at the situs of the arbitration shall not apply 56. Additionally, the parties can
freely exclude or modify the rules of the ICSID Convention and of the Arbitration Rules
upon agreement between them. In that sense, party autonomy is highly respected. Within
60 days of its constitution, the tribunal shall, unless otherwise as agreed by the parties,
commence its first session. The tribunal shall seek the parties’ viewpoint of the procedures
and make decisions required for conduct of the arbitration.
3.4
Provisional Measures
As provided for in Article 47 of the ICSID Convention, “Except as the parties otherwise
agree, the Tribunal may, if it considers that the circumstances so require, recommend any
provisional measures which should be taken to preserve the respective rights of either
party.” The parties can file request for provisional measures with the tribunal so as to
protect their rights. Such request must prove its urgent nature that cannot await the final
award. For example, in ICSID case No. ARB/81/1 Amco Asia Corporation, Pan American
Development Ltd. and P.T. Amoco Indonesia (AMCO) v. Republic of Indonesia, the
respondent filed a request for injunction against press campaigns but the tribunal refused
with the ground that no actual harm could have arisen from the newspaper article nor could
it have aggravated the legal dispute before the tribunal. 57
50
For more details on the constitution of an arbitral tribunal, see ICSID Convention, Chapter IV, Section II,
Art. 37-40.
51
ICSID Convention, art. 38.
52
ICSID Convention, Arbitration Rules, Rule 41 “Objections to Jurisdiction”.
53
For more details see ICSID Convention, Chapter IV, Section II, Art. 41-47.
54
See Section 3.2 of this paper.
55
ICSID Convention, Art. 42.
56
ICSID Convention, Art. 44.
57
Christoph H. Schreuer, supra, at 771
However, the tribunal cannot issue binding orders on provisional measures but just
recommend them. Such recommendation is further extended to provisional measures
initiated by the tribunal itself. Provisional measures may include interim, protective and
conservatory measures. 58 The parties cannot apply for conservatory measures (preservation
of rights and interests) with domestic courts unless they have expressly reserved this right
in their agreement recording their consent to ICSID arbitration (Rule 39, the Arbitration
Rules).
3.5 Arbitral Awards and Their Recognition and Enforcement
3.5.1 Arbitral Awards
Article 48 of the ICSID Convention stipulates that the tribunal shall decide issues by a
majority of votes of all its members. The tribunal’s award shall be made in writing with the
signatures of all its members who voted for it. The parties may request interpretation of the
award as to the meaning and scope of the award by filing an application in writing to the
Secretary-General. Certified copies of the award shall be dispatched by the SecretaryGeneral to the parties. The award may be published by ICSID provided that the parties
give consent to the publication 59 . However, the arbitral award may be set aside by an
ICSID ad-hoc committee at the request of each party by filing an application in writing
with the Secretary General 60 if one of the following grounds is found 61:
-
The tribunal was not properly constituted;
-
The tribunal has manifestly exceeded its powers;
-
There was corruption on the part of a member of the tribunal;
-
There has been a serious departure from a fundamental rule or procedure; or
-
The award has failed to state the reasons on which it is based.
Upon receipt of the application, an ad hoc committee, consisting of three arbitrators who
may not be the same members of the award-rendering tribunal, shall be established by the
Chairman to set aside the award or any part thereof. The proceedings to set aside an award
shall be in accordance with the provisions of Articles 41-45, 48, 49, 53 and 54, and of
Chapters VI and VII with their mutatis mutandis application. 62 For instance, in ICSID case
No. ARB/84/4 Maritime International Nominees Establishment v. Republic of Guinea 63,
the applicant requested to set aside the award because (i) the award did not contain reasons;
(ii) the tribunal had exceeded its powers; and (iii) there had been a serious departure from a
58
Id, at 744-483.
ICSID Convention, Art. 49.
60
The application shall be filed with the Secretary General within 120 days after the date of rendering the
award, except that when setting aside is requested on the ground of corruption, the application shall be
submitted within 120 days after discovery of the corruption, but in any event within three years after the date
on which the award was rendered, ICSID Convention, Art. 52(2).
61
ICSID Convention, Art. 52(1).
62
ICSID Convention, Art. 52(4).
63
See more at
http://icsid.worldbank.org/ICSID/FrontServlet?requestType=CasesRH&actionVal=showDoc&docId=DC663
_En&caseId=C126.
59
fundamental rule of procedure. There was an ad hoc committee decision partially annulling
the Award issued on December 22, 1989. In addition, the ad hoc committee has also the
power to stay enforcement of the award if the committee considers that the circumstance so
requires, or at the request by the applicant (often the respondent). In case of the application,
the committee shall stay provisionally the enforcement of the award until it rules on such
request. 64 In ICSID case No. ARB/81/1 Amco Asia Corporation, Pan American
Development Ltd. and P.T. Amoco Indonesia (AMCO) v. Republic of Indonesia, 65 the ad
hoc committee stayed the enforcement of the award under the condition that the respondent
(Indonesia) must deposit a security at the bank as a guarantee for payment on the basis of
the award.
Even in case the award is overturned, the jurisdiction of the Centre is not exhausted. As
provided for in Article 52(6), 66 either party may submit the dispute to a new tribunal in
accordance with the provisions in Section 2 of Chapter IV of the ICSID Convention. It is
further specified in Rule 55 “Resubmission of Dispute after an Annulment” in the
Arbitration Rules. It is noted that “if the original award had only been annulled in part, the
new Tribunal shall not reconsider any portion of the award not so annulled” (Rule 55(3)
in the Arbitration Rules).
3.5.2 Recognition and Enforcement of Arbitral Awards
Under Article 53, ICSID award is binding on the parties and the parties have the obligation
to comply with the terms of the award. The award shall not be subject to any appeal or any
other remedy, except those set forth in the ICSID Convention. In that sense, each
Contracting State must consider the award as a final judgment rendered by a court in that
State and is obliged to recognize and enforce “the pecuniary obligations” imposed by the
award within that State’s territory. 67 If the executing Contracting State fails to comply, it
will negatively affect its investment climate, or the State shall be exposed to the possibility
of proceedings against it before the ICJ on account of violation of its obligations under the
ICSID Convention. Under Article 64 of the ICSID Convention, “any dispute arising
between Contracting States concerning the interpretation or application of this Convention
which is not settled by negotiation shall be referred to the International Court of Justice by
the application of any party to such dispute...”
In order to enforce an ICSID arbitral award, the party seeking recognition or enforcement
of the award in the territory of a contracting state shall furnish to a competent court or
other authority designated by such state for this purpose a copy of the award certified by
the Secretary General. Each Contracting State should notify the Secretary General of such
competent court or other authority. 68 However, the ICSID Convention does not extend to
the enforcement of ICSID arbitral awards. The enforcement of the award is governed by
the law of the State in whose territory such enforcement is sought. Though Contracting
States are imposed with obligations to enforce ICSID awards, the ICSID Convention does
not mean to derogate the law of the enforcing Contracting State that stipulates that State’s
immunity from enforcement. There are certain cases where the enforcement of ICSID
awards was refused by the courts of Contracting States due to sovereign immunity. For
64
ICSID Convention, Art. 52(5).
See more at http://icsid.worldbank.org/ICSID/FrontServlet.
66
ICSID Convention, Art. 52(6) reads as follows: “If the award is annulled the dispute shall, at the request of
either party, be submitted to a new Tribunal constituted in accordance with Section 2 of this Chapter.”
67
ICSID Convention, Art. 54(1).
68
ICSID Convention, Art. 54(2).
65
instance, in ICSID Case No. ARB/01/6 AIG Capital Partners, Inc. and CJSC Tema Real
Estate Company v. Republic of Kazakhstan, the successful claimants requested the UK
court to enforce the award. The High Court in London allowed the claimants to register the
award as a judgment of the Court in accordance with the U.K Arbitration Act 1966. 69 The
claimants then obtained interim payment order against cash and securities held by banks in
London for the National Bank of the Republic of Kazakhstan. However, in October 2005,
the High Court discharged the interim orders 70 and held that assets in question were
deemed as non-commercial and immune from the enforcement under the 1978 State
Immunity Act of the U.K since the assets were property of the National Bank of
Kazakhstan – a central bank that falls under the scope of the Act.
3.5.3 Relationship with the 1958 New York Convention
The recognition and enforcement of ICSID arbitral awards is independent of the 1958 New
York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the
New York Convention). The recognition and enforcement under the New York Convention
is subject to certain limitations, such as limited application of the New York Convention
by Contracting States to certain disputes (For instance, Norway does not apply the New
York Convention to disputes over real property as well as rights in such property in
Norway); there are reservations made by Contracting States on certain provisions in the
New York Convention (e.g. Vietnam has a reservation stating that the interpretation of the
New York Convention before the Vietnamese courts or competent authorities should be
made in accordance with the Constitution and the law of Vietnam). 71 Also under the New
York Convention, the recognition and enforcement of an award may be refused if certain
conditions are met, e.g. incapacity of the parties, improper notice and etc. 72 Meanwhile, the
recognition and enforcement of awards under the ICSID Convention is not subject to such
limitations. Moreover, under Article 54 of the ICSID Convention, there is no distinction
between the recognition and enforcement of awards against the investors, and that against
the host states.
3.5.4 Major Differences between ICSID Arbitration Rules and UNCITRAL Arbitration
Rules
As stated in the Section 1, an ever-increasing number of investor-state disputes have
proliferated investor-state dispute settlement mechanisms, they are domestic courts and
international arbitrations (arbitration under ICSID Rules or UNCITRAL Arbitration Rules),
embodied in most investment treaties. Among those settlement mechanisms, ICSID
arbitration and arbitration under UNCITRAL Rules are most used by investors. While
some investors wish to submit their disputes with states/state agencies to ICSID, others
wish to have their disputes arbitrated under UNCTRAL rules. There are certain differences
between the two systems. The two main differences, which would benefit the host country
but prove disadvantageous to the investor, or vice versa, will be examined, as follows:
69
The Act implements the ICSID Convention.
See Judgment of Oct. 20, 2005, High Court of Justice, Queen’s Bench Division, Commercial Court,
LLoyd’s Law Reports, 2006, Vol.1.
71
David A.Gantz, “Investor-State Arbitration under ICSID, the ICSID Additional Facility and the UNCTAD
Arbitral Rules”, US-Vietnam Trade Council Education Forum 3 (2004). Available at
http://usvtc.org/trade/other/Gantz/Gantz_ICSID.pdf
72
New York Convention, Art. V.
70
The first difference is institutional back-up. The most significant aspect is that ICSID
Arbitration Rules are supported by a knowledgeable Secretariat as part of the World Bank.
Under Article 9 of the ICSID Convention, the Secretariat consists of a Secretary General,
one or more Deputy Secretaries General and staff. The Secretariat acts as a registrar and
has the power to authenticate arbitral awards rendered under the ICSID Convention, and to
certify copies thereof. 73 Meanwhile, UNCITRAL Arbitration Rules are just rules and
basically a bi-lateral process without any secretariat or institutional back-up. In that sense,
ICSID Arbitration Rules, from host country’s perspective, would benefit them in terms of
constitution of arbitral tribunals if it is the objective of the host country to delay the
arbitration proceedings, 74 while it would be disadvantageous to investors. The constitution
of the tribunal often takes more than 90 days and the parties may agree to extend this
period. Even in the absence of such agreement, the Chairman of the Administrative
Council will not intervene without being prompted by either party and have to consult with
both parties as far as possible on the appointment. 75 On the contrary, UNCITRAL
Arbitration Rules may prove its advantage to investors since it takes less time than ICSID
Arbitration Rules in constitution of arbitral tribunal. 76
Review of arbitral awards is the second main difference between the two systems. Review
of arbitral awards aims to uphold the interest of the parties. If the defeated party feels
dissatisfactory with the arbitral award, the party may seek to set aside the award. The
possibilities to challenge the award vary, depending on the arbitration rules chosen by the
party, whether it is ICSID Arbitration Rules or UNCITRAL Arbitration Rules. The ICISD
Convention is a self-contained mechanism that stipulates the internal control to cover the
interpretation, revision and annulment of ICSID arbitral awards (only the internal ICSID
ad-hoc committee permits any review). 77 The ICSID system prevents domestic courts from
reviewing any ICSID awards and obligates Contracting States to recognize and enforce the
awards as final judgment rendered by the domestic courts of such States. 78 This feature
proves advantageous to investors who are successful claimants in getting payment from the
host countries. This advantage is however not seen under the UNCITRAL Arbitration
Rules. There is no restriction on lodging appeals against UNCITRAL arbitral awards with
domestic courts. UNCITRAL awards can be challenged under the law at the seat of
arbitration. The losing party may request the domestic court of the arbitration forum to set
aside the award. This could be a big barrier successful claimants (investors) have to
overcome.
3.5.5 Conclusion
The above-mentioned overview has provided a panorama of how investor-state disputes
are settled under the ICSID Convention – a forum where investors’ rights are protected and
enforced, and where Contracting States’ sovereign rights are still preserved. Becoming a
Contracting State to the ICSID Convention does not at the same time mean that such State
73
ICISD Convention, Art. 11.
Under the ICSID Convention, the host state may prolong the constitution of the arbitrator tribunal. Art. 38
of the ICSID Convention reads “If the Tribunal shall not have been constituted within 90 days after notice of
the registration of the request has been dispatched by the Secretary General in accordance with paragraph
(3) of Article 36, or such other period as the parties may agree, the Chairman shall, at the request of either
party and after consulting both parties as far as possible, appoint the arbitrator or arbitrators not yet
appointed”.
75
ICSID Convention, Art. 38; the Arbitration Rules, Rule 4.
76
UNCITRAL Arbitration Rules, Art. 8 -10.
77
ICSID Convention, Art. 50 – 53; the ICSID Arbitration Rules, Rules 51 - 53.
78
The recognition and enforcement of ICSID awards is further analyzed in Section 2.5.2 of this paper.
74
gives consent for submission of its disputes with investors of other Contracting States to
ICSID. 79 This is usually done in investment agreements 80 that contain dispute settlement
provisions invoking ICSID jurisdiction over investor-state disputes. Such agreements play
an indispensable role in making the dispute settlement mechanism under the ICSID
Convention alive. Amongst investment agreements, BITs take a central position because (i)
BITs were born right after the notion of promotion and protection of investment came up;
and (ii) they have been a launching platform for establishment of regional or multi-lateral
agreements on investment and trade, e.g. NAFTA, CAFTA, AFTA... Section 3.6 will
examine BITs in the context of ICSID arbitration to see how investors apply provisions in
BITs to invoke ICSID jurisdiction over their disputes with the host state.
3.6 ICSID Arbitration under BITs
3.6.1 Overview of BITs
In the past several decades, an ever-increasing volume of foreign investment has become
one of the principal factors accelerating the international economy in the context of
globalization, which has therefore required an international legal framework to govern
international investment relation. “It consists of many kinds of national and international
rules and principles, of diverse forms and origin, differing in strength and degree of
specificity. The entire structure rests on the twin foundations of customary international
law and national laws and regulations and relies for its substance on a multitude of
international investment agreements and other legal instruments.” 81 As a major element in
the legal framework for foreign investment, a large number of bi-lateral investment
promotion and protection treaties have been so far concluded by many countries. From
1959 up to 2011, there have been more than 2278 BITs concluded, 82 most of them in the
1990s. In early stage, BITs were mainly concluded between developed countries (home
countries) and developing countries (host countries). 83 For the years, there have been
remarkable achievements in BITs with diversified participation in the way that a number of
BITs were concluded between developed countries, or even between countries and
economies in transition. From the beginning, most BITS have mainly focused on
investment protection in the forms of protection of investments against expropriation or
nationalization, assurance of free transfer of funds and provision for investor-state dispute
settlement mechanisms. The current tendency of conclusion of BITs has shown that the
scope of BITs also extends to other areas, such as non-discrimination in the treatment, the
entry of foreign-controlled enterprises, etc. 84 Today, typical BITs cover the following five
principal pillars:
−
Scope and Definition: providing for its geographical coverage (Contracting
Parties, and territorial limits), temporal application (date of entry into force and
79
For more details see Section 3.1.4 of this paper.
David A.Gantz, supra, at
81
UNCTAD, 2004, “International Investment Agreements: Key Issues”, UNCTAD/ITE/IIT/2004/10 (Vol I),
United Nation Publication
82
ICSID Database of Bi-lateral Investment Treaties, available at:
http://icsid.worldbank.org/ICSID/FrontServlet.
83
Home country means the country of investor while host country is the country receiving investment.
84
UNCTAD, 2004, “International Investment Agreements: Key Issues”, UNCTAD/ITE/IIT/2004/10 (Vol I),
United Nation Publication.
80
retroactive effect), subject matters (major dimensions of economic activities under
the scope of a BIT) and definition of investment and investor 85.
−
Admission and Establishment: Host country’s control requirements of entry
and establishments of aliens within its territory: (i) control over access to the host
country’s economy (e.g. quantitative restrictions, closing certain sectors,
restrictions on certain forms of entry, exchange control requirement, etc.); (ii)
conditional entry into the host country’s economy (e.g. general conditions –
compliance with screening procedures, conditions based on capital requirements,
licensing...); (iii) control over ownership (e.g. restriction on foreign ownership,
nationality restriction, fade-out requirement); (iv) Control based on limitation of
shareholder power (e.g. types of shares, foreign shareholder rights) ; (v) control
based on governmental intervention on the running of the investment (e.g. golden
shares, right reservation); and (vi) other requirements.
−
Post-Admission Treatment: Three main internationally-recognized
principles in most BITs: National Treatment, Most-Favored Nation, fair and
equitable treatment with diversification depending on negotiation and reciprocity.
−
Investment Protection: Principles of expropriation and nationalization with
proper compensation; investors’ right of transfer of capital, profits and other
legitimate incomes; currency exchange.
−
Dispute Settlement: stipulating dispute settlement mechanism between
Contracting States concerning the interpretation and application of the BIT;
principle of settlement of investor-state disputes through negotiation and
consultation; and settlement mechanisms on investor-state disputes (under domestic
courts, ICSID, ICSID Additional Facility Rules, arbitration under UNCITRAL
Rules...) in case negotiation and consultation fail.
The rapid proliferation of BITs has proven its important role as a catalyst to the economy
of a nation, of a region and even of the world. BITs are also considered as a signal of the
positive attitude of host countries that welcomes foreign investors and favors foreign
investment. BITs have become an indispensable constituent element of the investment
environment of any countries that are interested in attracting foreign investment. In
addition to this important role, it is no doubt that BITs are also a tool to protect foreign
investors against violations of provisions of BITs committed by host states. BITs allow
investors to institute international arbitration proceedings against host states for such
violations. Section 3.6.2 below attempts to analyze ICSID arbitration under BITs.
3.6.2 BITs and ICSID Arbitration
As mentioned in Section 3.6.1 above, a typical BIT contains provisions that aim at
protecting foreign investors’ rights when they do business in host countries. Let’s see how
some provisions in BITs work in practice to protect the investment of investors:
3.6.2.1 Provisions on Expropriation
85
For more details see Sections 3.1.1.2 and 3.1.2.2 of this paper.
In ICSID Case No. ARB/05/16: Rumeli Telekom A.S. and Telsi Mobil Telekomunikasyon
Hizmetleri A.S. v. Republic of Kazakhstan, Rumeli Telekom A.S. and Telsi Mobil
Telekomunikasyon Hizmetleri A.S., telecommunications companies incorporated in
Turkey, acted as the claimants to institute ICSID arbitration proceedings against the
Republic of Kazakhstan (the respondent) for a dispute related to the latter’s expropriation
of an investment in the telecommunications industry. The Tribunal rendered its award
directing the Republic of Kazakhstan to pay a compensation in the amount of 175 million
to the claimant due to the respondent’s violation of the expropriation provisions set forth in
Article III of the Turkey-Kazakhstan Agreement Concerning the Reciprocal Promotion and
Protection of Investments that reads as follows:
“1. Investments shall not be expropriated or nationalized or subject directly or indirectly,
to measures of similar effect except for a public purpose, in a non-discriminatory manner,
upon payment of prompt, adequate and effective compensation, and in accordance with
due process of law and of the general principles of treatment provided for in Article II of
this Agreement.”
3.6.2.2 Provisions on MFN, NT, and Fair and Equitable treatment
In ICSID case No. ARB/97/7: Emilio Agustin Maffezini v. Kingdom of Spain, Mr. Emilio
Agustin Maffezini, a national of Argentina, submitted his dispute with the Kingdom of
Spain to ICSID concerning discrimination made by the respondent to the claimant’s
investment in Spain, which was a breach of the MFN clause in the Argentina-Spain
Agreement on Reciprocal Promotion and Protection of Investment. 86 The case was
registered by the Secretary General of ICSID. The dispute involved a chemical joint
venture incorporated in Spain between Mr. Maffezini and a Spanish publicly-owned entity,
and the treatment allegedly received by Mr. Maffezini from Spanish authorities from the
time he decided to withdraw from the project and liquidate his investment in Spain.
3.6.2.3 Dispute Settlement Provisions
Under a BIT, foreign investors are permitted to sue the host state for the latter’s violation
of the BIT before (i) the domestic court of the host state; or (ii) international arbitrations,
namely ICSID, ICSID Additional Facility, arbitration under UNCITRAL Rules or others
as agreed by the parties. However, BIT-based investor-state dispute settlement mechanisms
differ according to BITs. For example, under Article 11 of the Netherlands-Singapore
BIT, 87 investor shall have the right to submit any dispute that may arise in connection with
the investments to ICSID for arbitration or conciliation provided that all local
administrative or judicial remedies have been exhausted. It means that priority is given to
the local court of the Contracting State. China-Indonesia BIT 88 goes in a slightly different
way that investors can refer their disputes to domestic court or ad-hoc arbitration in which
the tribunal may, in the course of determination of procedures, take as guidance ICSID
Rules. In other words, ICSID arbitration is not stipulated as one of the settlement
86
For more details visit
http://icsid.worldbank.org/ICSID/FrontServlet?requestType=CasesRH&actionVal=showDoc&docId=DC566
_En&caseId=C163
87
Netherlands-Singapore BIT, available at
http://www.unctad.org/sections/dite/iia/docs/bits/netherlands_singapore.pdf.
88
China-Indonesia BIT, available at http://www.unctad.org/sections/dite/iia/docs/bits/china_indonesia.pdf.
mechanisms in China-Indonesia BIT. To a full extent, Vietnam-Japan BIT 89 permits
investors to refer their disputes with the host state (Vietnam in most circumstances) to
domestic court, ICSID (as long as the ICSID Convention is in force between the
Contracting States 90), ICSID Additional Facility Rules (so long as the ICSID Convention
is not in force between the Contracting Parties), or arbitration under UNCITRAL Rules.
3.6.2.4 Umbrella Clause
An umbrella clause in BITs plays an important role in the protection of investments against
any violation of BITs made by host states. Umbrella clause in BITs can be construed as
that any Contracting Parties shall observe any obligations it may have assumed in regard to
investments, e.g. “constantly guarantee the observance of the commitments it has entered
into” or “observe any obligation it has assumed”. 91 However, to use this clause to invoke
ICSID’s jurisdiction much depends on the wording of the clause. For instance, in ICISD
case No. ARB/02/6: Societe Generale de Surveillance S.A. v. Republic of the Philippines,
the Tribunal held that “[it] has jurisdiction over the present dispute under Article VIII(2) of
the BIT in combination with Articles X(2) 92 and IV)” (para. 177 of Decision of the Tribunal
on Objections to Jurisdiction 93).
The Switzerland-Philippines BIT, Art. X(2) provided that Each Contracting Part shall
observe any obligation it has assumed with regard to specific investments in its territory
by investors of the other Contracting Party. Meanwhile, in ICSID case No. ARB/01/13:
Societe Generale de Surveillance S.A. v. Republic of Pakistan, the Tribunal concluded that
“[it] has no jurisdiction with respect to claims submitted by SGS and based on alleged
breach of the PSI Agreement which do not also constitute or amount to breaches of the
substantive standards of the BIT” (para. 162 of the Tribunal’s Decision on Jurisdiction).
The conclusion was based on Article 11 of the Switzerland-Pakistan BIT saying that each
Contracting Party shall constantly guarantee the observance of the commitments it has
entered into with respect to the investments of the investors of the other Contracting Party.
It is worth saying in these two cases that the protection of investors is dependent on how
umbrella clause is developed.
3.6.2.5 Retroactive Effect
BITs are international treaties. Accordingly, BITs can only grant rights and impose
obligations on contracting states only for a period of time during which they are in force
between the contracting states. As stipulated in the 1969 Vienna Convention on the Law of
Treaties, "unless a different intention appears from the treaty or is otherwise established,
its provisions do not bind a party in relation to any act or fact which took place or any
situation which ceased to exist before the date of the entry into force of the treaty with
89
Japan-Vietnam BIT, available at http://www.unctad.org/sections/dite/iia/docs/bits/japan_vietnam.pdf
Vietnam hasn’t become a Contracting State to the ICSID Convention.
91
OECD, Interpretation of the Umbrella Clause in Investment Agreements, Working Papers on International
Investment, No. 2006/3.
92
Switzerland-Philippines BIT, Art. X(2) provided (originally in French) “Chacune des Parties contractantes
se conformerar à toutes ses obligations à l’égard d’un investissement effectué sur son territoire par un
investisseur de l’autre Partie contractante”, available at
http://www.unctad.org/sections/dite/iia/docs/bits/switzerland_philippines_fr.pdf.
93
Decision of the Tribunal on Objections to Jurisdiction, available at
http://icsid.worldbank.org/ICSID/FrontServlet?requestType=CasesRH&actionVal=showDoc&docId=DC657
_En&caseId=C6
90
respect to that party." 94 Therefore, investors cannot in principle submit their disputes with
the host state to international arbitration before the entry into force of the BIT. However,
the Contracting States to a BIT can make certain arrangements between them under which
the BIT has retroactive effect, though it seems to be an impossible mission. No host state
wants to expose itself to risks that can be foreseeable. Another way out for investors is that
they can refer to international customary law as a basis to claim retroactive effect of BITs.
Such approach may be taken in ICSID case No. ARB/05/20: Ioan Micula, Viorel Micula
and others v. Romania. 95 The tribunal in this case stated “Both Parties concur that the
BIT’s substantive provisions apply only from the date of its entry into force and do not
apply retroactively. This is a clear temporal rule embodied in Article 28 of the Vienna
Convention on the Law of Treaties. The temporal application of the substantive provisions
of the BITs is indeed different from the matter of jurisdiction rationae temporis. The
Tribunal will examine alleged breaches of the BIT based on acts that preceded the entry
into force of the BIT if (i) there is a violation of another rule different from the BIT, if and
when applicable, or (ii) the violations are of continuing or composite character.” 96 In that
sense, violation of norms of customary international law is referred to seek the tribunal’s
jurisdiction over the dispute. However, this task seems to “look for a needle in a haystack”.
3.6.2.6 Conclusion
With the analysis above, BITs have become a very effective tool for investors to protect
their investments and to enforce their rights that are infringed upon by host states/state
agencies. On the other hand, BITs are also utilized by host states to avoid ICSID
jurisdiction over their investment disputes with foreign investors. Section 3.6.3 below will
take a look at BITs Vietnam has concluded to find how the State of Vietnam’s behavior
towards foreign investors, particularly possibility of invocation of international arbitrations
for settlement of investor-state disputes.
3.6.3 BITs Vietnam Has Concluded
Being aware of the importance of foreign investment to the national economic
development, Vietnam has concluded a large number of BITs with many countries and
territories, 97 such as U.S. Bi-lateral Trade Agreement; Vietnam – Japan Agreement on
Liberalization, Promotion and Protection of Investment; Vietnam-Australia Agreement on
the Reciprocal Promotion and Protection of Investments; Vietnam-South Korea Agreement
for the Promotion and Protection of Investments; Vietnam-Cambodia Agreement
concerning the Promotion and Protection of Investments. Most of the BITs contain
standard provisions on admission, MFN, NT, protection of investment (expropriation,
nationalization) and dispute settlement and etc. that are seen in typical BITs in the world. 98
Accordingly, foreign investors are equally treated and their rights are protected by different
investor-state dispute settlement mechanisms, such as domestic court or international
94
1969 Vienna Convention on the Law of Treaties, Art. 28, available at
http://untreaty.un.org/ilc/texts/instruments/english/conventions/1_1_1969.pdf.
95
ICSID case No. ARB/05/20, available at http://italaw.com/documents/Miculav.RomaniaJurisdiction.pdf.
96
ICSID case No. ARB/05/20, available at http://italaw.com/documents/Miculav.RomaniaJurisdiction.pdf,
para 157.
97
Since the first BIT - Italy-Vietnam Agreement on Promotion and Protection of Investment - was concluded
in 1990, Vietnam has, until 1st June 2011, concluded 58 bi-lateral investment treaties97 with countries and
territories.
98
For details see Section 3.6.1. of this paper.
arbitrations, such as ICSID, ICSID Additional Facility, and arbitration under UNCITRAL
Rules. 99 For example, Article 4 of the US-Vietnam BTA 100 reads as follows:
“1...
2. In the event of an investment dispute, the parties to the dispute should attempt to
resolve the dispute through consultation and negotiation, which may include the
use of non-binding third-party procedures. Subject to paragraph 3 of this Article, if
the dispute has not been resolved through consultation and negotiations, a national
or company of one Party that is a party to an investment dispute may submit the
dispute for resolution under one of the following alternatives:
A. to the competent courts or administrative tribunals of the Party in the territory
of which the covered investment has been made; or
B. in accordance with any applicable, previously agreed dispute-settlement
procedures; or
C. in accordance with the terms of paragraph 3.
3. A. Provided that the national or company concerned has not submitted the
dispute for resolution under sub-paragraph 2.A or B, and that ninety days have
elapsed from the date on which the dispute arose, the national or company
concerned may submit the dispute for settlement by binding arbitration:
(i) to the Centre, if both Parties are members of the ICSID Convention and the
Centre is available; or
(ii) to the Additional Facility of the Centre, if the Additional Facility is available;
or
(iii) in accordance with the UNCITRAL Arbitration Rules; or
(iv) if agreed by both parties to the dispute, to any other arbitration institution or in
accordance with any other arbitration rules.
Contrary to dispute settlement provisions in most BITs that provide for all available
investor-state dispute settlement mechanisms as mentioned in US-Vietnam BTA above,
some BITs just stipulate only one of these mechanisms, e.g. only arbitration under
UNCITRAL Rules. For instance, Article 13 of Vietnam-Singapore BIT 101 stipulates:
“..2. If the dispute cannot be thus resolved as provided for in paragraph (1) of this
Article within six months from the date of the notice given thereunder, then the
Contracting Party and the investor concerned shall refer the dispute to either
conciliation in accordance with the United Nations Commission on International
Trade Law Rules of Conciliation, 1980 or to arbitration in accordance with the
United Nations Commission on International Trade Law Rules of Arbitration,
1976...”
One of the big concerns foreign investors have is that they cannot institute ICSID
arbitration proceedings against Vietnam or its agencies under BITs since one very
important requirements for invocation of ICSID jurisdiction is that Vietnam must be a
Contracting State to the ICSID Convention while Vietnam hasn’t been. This has somehow,
on the one hand, negatively affected foreign investors' trust in the business environment in
Vietnam which is now very attractive. On the other hand, Vietnamese investors’ rights and
interests would not be well protected in host countries. This concern has raised two
99
For example, Vietnam – Japan Agreement on Liberalization, Promotion and Protection of Investment, Art.
14, para 3.
100
Full text of the US-Vietnam BTA, available at http://www.usvtc.org/trade/bta/text/full_text.htm.
101
Vietnam-Singapore BIT, available at
http://www.unctad.org/sections/dite/iia/docs/bits/vietnam_singapor.pdf.
questions: Firstly, does Vietnam feel comfortable with the dispute settlement mechanism
under the ICSID Convention? And secondly, what benefits and losses would Vietnam have
if it becomes a Contracting State to the ICSID Convention? To find the answers, Section 4
will examine the advantages and disadvantages of the investor-state dispute settlement
under the ICSID Convention from Vietnam’s perspective.
4. An Effective Settlement Mechanism from Vietnam’s Perspective?
4.1
Host Country’s Perspective
4.1.1 Sovereignty
It is a fundamental principle of international law that states are independent and sovereign.
A state has legislative, executive and judicial powers over its territory and population. The
ICSID Convention respects sovereignty by means of precluding ICSID’s jurisdiction from
investor-state disputes involving a Contracting State and a national of such State (Article
25(2)(a)). 102 If there is an investment dispute between a state and its domestic investor, the
domestic court shall have jurisdiction over the dispute. Under international norms, no
international institutions or institutions of other countries can intervene in the adjudication
of such dispute. 103 However, it is also worth noting that accession to the ICSID Convention
means that the judicial right – the right to adjudicate – of the State shall not be fully
exercised in case of foreign investor-state disputes, because foreign investors prefer ICSID
arbitration to domestic court.
Another sovereignty factor embodied in the ICSID Convention is that the ICSID
Convention does not extend to the enforcement of ICSID arbitral awards. The enforcement
of the award is governed by the law of the State in whose territory such enforcement is
sought. Though Contracting States are imposed with obligations to enforce ICSID awards,
the ICSID Convention does not mean to derogate the law of the enforcing Contracting
State that stipulates that State’s immunity from enforcement.
4.1.2 Autonomous Nature of ICSID Arbitration
As one of the features of ICSID arbitration, autonomy benefits the host state. First, once
the parties have consented to ICSID arbitration, they are not permitted to seek remedies in
domestic courts or other international arbitrations, and are only allowed to pursue their
claim through ICSID. Second, once ICSID arbitration process has been instituted, any
interference into the process is prohibited. Third, Contracting States to the ICSID
Convention are prevented from invoking diplomatic protection over any investment
disputes between their own nationals and other Contracting States once the parties to the
dispute have consented to or have started ICSID arbitration proceedings. This feature
protects the host state against other forms of foreign or international litigation. 104 To enable
this feature, Contracting State’s consent to ICSID arbitration plays a crucial role.
Otherwise, Contracting States cannot benefit from this feature.
102
Anibal Sabater, The Weakness of the “Rosatti Doctrine”: Ten Reasons Why ICSID’s Standing Provisions
Do Not Discriminate Against Local Investors, 15 Am. Rev. Int’l Arb. 465 (2004).
103
For more details see Section 3.1.4. of this paper.
104
Ibid. at footnote 103.
4.1.3 Institutional Support
Like other institutional arbitrations, such as International Chamber of Commerce (ICC)
Court of Arbitration, London Court of International Arbitration (LCIA), Singapore
International Arbitration Centre (SIAC), etc., ICSID arbitration provides institutional
support and assistance through its knowledgeable Secretariat to arbitration proceedings, e.g.
registration of cases, arrangements of hearings, translation, interpretation, preparation of
drafts, communication between the parties, and between the parties and the arbitrators, etc.
Moreover, thanks to ICSID’s own rules and regulations, ICSID arbitration proceedings are
self-contained and independent from outside interference. This settlement mechanism
makes Contracting States, particularly developing States, feel safe and comfortable when
they participate in ICSID arbitration proceedings.
4.1.4 Jurisdiction over Limited Disputes
Under the ICSID Convention, ICSID shall have jurisdiction over only disputes arising out
from investment between a Contracting State and a national of another Contracting
State. 105 As analyzed in Section 3.1, if a dispute (i) is not a legal dispute; (ii) does not arise
directly out of investment; and (iii) involves only one of the States concerned, either the
host State or the home State, who is a Contracting State to the ICSID Convention, such
dispute shall not fall under ICSID’s jurisdiction. In addition, “any contracting state may, at
the time of ratification, acceptance or approval of this Convention or at any time thereafter,
notify the Centre of the class or classes of disputes which it would or would not consider
submitting to the jurisdiction of the Centre.” Accordingly, a Contracting State can further
“indirectly” limit ICSID’s jurisdiction by such notification. For instance, China has
notified that it would not consider submitting disputes over compensation resulting from
expropriation and nationalization. Jamaica excluded legal disputes arising directly out of
an investment relating to minerals or other national resources. Saudi Arabia reserved its
right not to submit all matters in connection with oil and acts of sovereignty. 106
It is further noted that accession to the ICSID Convention does not mean submission to
proceedings under this Convention. To invoke ICSID’s jurisdiction, it requires consent to
the jurisdiction in writing from Contracting States. The consent can be given in different
ways, e.g. under national legislation, international treaty or specific agreement. 107
4.1.5 Contribution to Economic Development
In addition to its primary objective to protect foreign investor’s rights and interests, the
ICSID Convention also aims to promote economic development through the creation of
favorable investment climate and the facilitation of private international investment, which
is clearly expressed in its Preamble: “Considering the need for international cooperation of
economic development, and the role of private international investment.” Accordingly, an
effective and efficient settlement mechanism for investment disputes under the ICSID
Convention was established to achieve such an objective. This mechanism will contribute
to a Contracting State’s creation of a more attractive business and investment environment
in order to attract foreign investment and to welcome potential foreign investors, thereby
105
For more details see Section 3.1 of this paper.
Christoph H. Schreuer, supra, at. 342.
107
Ibid. at footnote 103.
106
accelerating the economic development of such Contracting State, particularly developing
and emerging ones.
With the above analysis, it can be said that ICSID dispute settlement mechanism has
proven advantageous to host states which are Contracting States to the ICSID Convention.
If Vietnam becomes a Contracting State of the ICSID Convention, it will get benefits from
this mechanism. From host country’s perspective, such accession will create a more
attractive business and investment environment in Vietnam where foreign investors who
are doing business in Vietnam will further expand their scope of business and those who
are looking for investment opportunities in Vietnam will be more encouraged to enter
Vietnam.
4.2 Home Country’s Perspective
4.2.1 Effectiveness of Arbitration
Investor-state dispute settlement by the domestic courts of the host countries carries, from
the investor’s perspective, certain disadvantages. The domestic courts, particularly those in
less-developed or developing countries, are not always impartial in all cases and their legal
proceedings often take long time. Domestic courts are bound to apply domestic law even in
case the law is not in conformity with international law in terms of protection of investors’
rights. In addition, domestic courts are not equipped with sufficient knowledge and
expertise in dealing with international investment disputes of complex nature.
Even, the parties in an investor-state dispute agreed to submit such dispute to the domestic
court of the home state or of a third state, this settlement mechanism appears to be
inconvenient or impracticable because of state immunity (a state is not subject to any
adjudication by the domestic court of another state), act-of-state (in case of expropriation,
nationalization or regulatory actions conducted by the host state) and non-justificiability
(the domestic court of the home state or of a third state may not accept the case because the
subject-matter of commercial nature of the dispute did not occur in territory of the home
state or a third state).
As a result, investors would be in a weak and disadvantageous position, thereby resulting
in a situation where their rights and interests are not fully protected. ICSID is definitely an
effective settlement alternative where investors can have a direct access to a form of
international investment arbitration that is speedy, neutral, cost-effective and confidential;
where investors are not restricted to the domestic courts of the host states; and where
investors are not dependent on willingness of their home states to invoke diplomatic
protection.
4.2.2 Exclusivity of ICSID Arbitration
Once the parties consented to ICSID arbitration, either of party is not allowed to exhaust
any other remedies, including local administrative or judicial remedies. 108 For example, in
ICSID case No. ARB/81/1 Amco Asia Corporation, Pan American Development Ltd. and
P.T. Amoco Indonesia (AMCO) v. Republic of Indonesia, the domestic court of Indonesia
suspended its proceedings when ICSID arbitration was instituted by Amco under their
108
ICSID Convention, Art. 26.
claim that Amco had suffered damages caused by Indonesia’s seizure of their investment
and cancellation of their investment license. 109
4.2.3 Recognition and Enforcement of Award
4.2.3.1 Binding Nature of Awards
A unique feature of the ICSID Convention that is to say a self-contained review system,
ICSID award is binding on the parties and the parties are obliged to comply with the terms
of the award. ICSID awards shall not be subject to any appeal by domestic courts, 110
except in the circumstance where the awards are subject to the annulment procedures set
forth in the ICSID Convention itself. 111 Such prohibition prevents the host state to the
dispute under ICSID arbitration from initiating action before its domestic court or another
forum to seek the annulment of the ICSID award. It can be further interpreted that a
domestic court of a Contracting State to the ICSID Convention would be obliged to
dismiss such action, and have no jurisdiction to review that award for substantive
correctness or procedural irrelevance. If a State party to ICSID arbitration fails to comply
with the award, the State of the investor’s nationality may exercise diplomatic
protection. 112 Therefore, this mechanism has benefited investors.
4.2.3.2 Recognition and Enforcement
In that sense, each Contracting State must consider the award as a final judgment rendered
by a court in that State and is obliged to recognize and enforce “the pecuniary obligations”
imposed by the award within that State’s territory. The recognition and enforcement of
ICSID arbitral awards is independent of the 1958 New York Convention, under which the
recognition and enforcement of an award may be refused if certain conditions are met, e.g.
incapacity of the parties, improper notice and etc. 113 Thus, investors have a more effective
mechanism of recognition and enforcement of ICSID awards. The “losing winner”
situation could be avoided.
With a rapidly increasing volume of outward investments, 114 protection of Vietnamese
investors over their investments in foreign countries and territories has become one of the
hot topics on the current agenda. To do so, there must be an effective protection
mechanism for them so that they feel secured, safe and comfortable when investing abroad.
One of the widely-accepted protection mechanisms is the dispute settlement under the
ICSID Convention. From home country perspective, if Vietnam becomes a Contracting
State to the ICSID Convention, Vietnamese investors will be provided with a very
effective tool to deal with their investment disputes with host countries where their
legitimate rights and interests are infringed upon.
109
Christoph H. Schreuer, supra, at 366; Amco v. Indonesia Decision, available at
http://icsid.worldbank.org/ICSID/FrontServlet?requestType=CasesRH&actionVal=showDoc&docId=DC663
_En&caseId=C126.
110
ICSID Convention, Art. 53. See more in Section 3.5.1 of this paper.
111
Supra, at footnote 110 supra.
112
ICSID Convention, Art. 27(1).
113
New York Convention, Art. V.
114
According to the statistics made by Vietnam Foreign Investment Agency, there have been, up to February
2011, 575 investment projects worth of approximately US 23,8 billions in 55 countries and territories, such
as Laos, Cambodia, Taiwan, the US, Germany, South Africa, China, India..., covering a wide range of
industries and services, e.g. mining, real estate, agriculture, construction, education and etc.
4.3 Drawbacks
Though the dispute settlement under ICSID has proven much advantageous to Vietnam in
both roles as a host country and a home country, there have been certain concerns and
criticisms, especially those coming from Latin American countries, on this investor-state
arbitration that should be taken into consideration for Vietnam’s accession to the ICSID
Convention.
4.3.1 Elevation of Foreign Investors
Once a nation becomes a Contracting Party to the ICSID Convention, foreign investors can,
based on BITs concluded, enjoy “greater rights” than those granted to domestic investors
of that nation in the way that foreign investors can bring their disputes with the host state
to ICSID while it is in principle an impossible mission for domestic inventors of that
nation. This appears to give foreign investors a comparative advantage over domestic
investors, which would result in an unequal treatment. This criticism particularly has come
from Latin American countries on the basis of the so-called “Calvo Doctrine”, according
to which foreigners should be treated the same as citizens of Latin American countries. 115
In that sense, domestic investors would be in a less competitive position than foreign
investors.
4.3.2 Lack of Review of ICSID Arbitral Awards by National Court
The ICSID Convention does not allow any national court’s review of ICSID arbitral
awards. ICSID tribunal’s jurisdiction or the merits of the case may not be subject to reexamination by national courts. For example, in case the national interest of the defendant
state is a part of the claim brought by the foreign investor before ICSID, the state cannot
use its power, which is recognized by international law, to review the arbitral award if that
state thinks that the ICSID arbitration process was not conducted in a good faith. Not even
public policy of the state within which recognition and enforcement of an ICSID award is
sought is considered a valid ground for a refusal to such recognition and enforcement. This
would trigger certain concern from host countries in a case where the defendant country’s
national court cannot review the ICSID award that is against the public policy of that
country.
Although, the ICSID Convention provides for its own review mechanism (ad hoc
annulment committee) to review ICSID awards, this review may not satisfy the state’s
concern of such since there would be some potential favor from arbitrators of recognizing
corporate interests over public interest.
4.3.3 Conclusion
As a rule, in a football match, the advantages of one team would be the disadvantages of
the other team, and vice versa. That has actually happened in the dispute settlement
mechanism under the ICSID Convention. However, this mechanism has, with the above
analysis, offered more advantages than disadvantages to both host states and investors.
115
Osvaldo J Marzorati, Arbitration under the 1965 Washington Treaty; Thoughts on the Scope of Protection
under Investment Treaties with Argentina”, IBA Arb. & ADR News (2005).
Furthermore, both of them also enjoy the same benefits produced by this mechanism, such
as institutional support, self-containedness, independence, non-interference from outside.
Therefore, it is possible to say that the mechanism, apart from certain disadvantages from
host country’s perspective, has become an efficient and effective tool for both host states
and investors. That is also true for Vietnam that acts as a host country and as a home
country. In my personal view, Vietnam’s accession to the ICSID Convention is just a
matter of time. However, accession to the ICSID Convention surely imposes certain
“internal” challenges that Vietnam has to cope with. Section 5 will dicsuss the challenges
and propose a number of recommendations for Vietnam to tackle them and to be ready for
its accession to the ICSID Convention.
5. Internal Challenges and Recommendations
5.1 Internal Challenges
5.1.1 Legislative Challenge
To attract foreign investment, Vietnam has so far made great efforts and commitments in
creating a healthy and sound investment and business environment by means of enacting a
large number of laws and regulations governing investment-related activities within its
territory, such as the Law on Investment, the Law on Enterprises, the Land Law, the Law
on Environmental Protection, the Law on Minerals, the Civil Procedure Code and etc., and
by concluding many international legal instruments on investment and trade, both bi-lateral
and multi-lateral. However, there still remain certain shortcomings and lacunae in
Vietnamese laws and regulations of foreign investments, such as pre-admission procedures,
(e.g. licensing procedures), post-admission treatment, incompatibility between domestic
law and international treaties. This situation would trigger a possibility of investment
disputes between foreign investors and Vietnam/state agencies. Such dispute would be
subject to ICSID’s jurisdiction if Vietnam becomes a Contracting State to the ICSID
Convention.
5.1.2 Judicial Challenge
Under the Law on Investment, foreign investors can submit their disputes with Vietnam or
its agencies to the courts of Vietnam, or domestic or international arbitrations, including
ICSID and ICSID Additional Facility. However, foreign investors prefer international
arbitration to the domestic courts of Vietnam because they are afraid of unfair trial or
prolonged legal proceedings, which resulted from the domestic courts’ insufficient
knowledge and expertise of international investment disputes that are often very complex
in nature. As a result, there seems to be no room for the domestic courts to maneuver in
this regard.
5.1.3 Personnel Challenge
The dispute settlement under the ICSID Convention is a novelty to Vietnam while legal
and judicial officials and staffs of Vietnam are not familiar with, or have limited
knowledge and understanding of international investment dispute settlement mechanisms,
particularly, the ICSID system. The same situation can be found in the court system where
judges, court officials and staffs haven’t been equipped with sufficient skills, techniques
and skills on conducting court proceedings over international investment disputes. Besides,
Vietnamese lawyers only get familiar with domestic legal affairs rather than international
ones of complex nature (e.g. investment and trade disputes with foreign participation).
That is the reason why foreign lawyers are often hired by Vietnamese parties to represent
them before international arbitrations over their disputes with nationals or corporations of
other countries. Such hiring costs a huge amount of money that the Vietnamese parties
have to incur. As a result, personnel issue could be a disadvantage for Vietnam when it
becomes a Contracting State to the ICSID Convention.
5.2 Recommendations to Vietnam in Its Accession to the ICSID Convention
5.2.1 Legislative Improvement
Disputes between the State of Vietnam and foreign investors mainly arise from Vietnam’s
implementation of provisions on equal treatment and investment protection set forth in
BITs. The main cause to such a situation comes from shortcomings and lacunae in
Vietnam’s legal system as well as the incompatibility between the domestic law and
international law as mentioned above. To remove such shortcomings and lacunae and to
fill gaps between the domestic law and international law, the existing substantive and
procedural laws and regulations governing investment-related matters, including
provisions on investment dispute settlement, must be screened and revised to the extent
that they are in conformity with international law, standards and practices by means of
transformation and incorporation of provisions in international investment agreements,
both bi-lateral and multi-lateral, into the national law (e.g. provisions on admission and
establishment of investment; provisions on investment licensing; provisions on
expropriation and nationalization of foreign investors’ property with proper compensation;
provisions on fair and equitable treatment; provisions on investor-state dispute settlement;
provisions on recognition and enforcement of foreign arbitral awards; provisions on
transparency; and etc.).
5.2.2 Judicial Reform
Vietnam’s court system should be further reformed in the way that provincial-level courts
are capable of handling foreign investor-state disputes in a fair, transparent, speedy manner
and without any interference from the outside. Judges, court officials and staffs should be
equipped with sufficient knowledge and understanding of international law and practice,
especially in the field of international investment, and with adjudicating and conciliating
skills and techniques in conformity with international standard. There should be a study of
adaptation of case law, which is one very important source of law for international
investment dispute settlement. At the same time, Vietnamese lawyers should be trained
with the necessary skills and techniques to provide legal advices and to represent clients
before international arbitration proceedings, and have a good understanding of dispute
settlement under international arbitration, especially ICSID settlement mechanism.
5.2.3 Capacity Building for Government Agencies and Officials
It is recommended to promote capacity building for government agencies and officials to
improve their expertise and knowledge of international law, international customary law
and different international investment dispute settlement mechanisms, particularly the
settlement under ICSID Rules so that they become good advisors to the State in field of
foreign investment and investor-state dispute settlement, and are fully capable of
participating in international investment arbitration proceedings. In addition, there should
be an agency designated as a focal point in representing Vietnam in investment disputes
submitted to international arbitrations.
5.2.4 ADR Improvement
Finally, alternative dispute resolutions, e.g. conciliation, mediation, arbitration and etc.,
need to be further enhanced in Vietnam in conformity with international standards and
practices. For instance, the Vietnam International Arbitration Center (VIAC) established
in 1993 is now a good venue for both foreign and domestic investors to have their dispute
resolved. Therefore, the Vietnamese Government should create more favorable conditions
for VIAC to heighten its position in the map of international arbitration centers so that
foreign investors feel secured and safe when they bring their disputes to VIAC. By doing
so, foreign investors could use ADRs in Vietnam to settlement their disputes without
invoking international arbitrations, e.g. ICSID, which can only be considered as a last
resort.
It is admitted that the above-mentioned “internal” challenges appears to be a barrier that
may delay Vietnam’s progress of accession to the ICSID Convention. Therefore, once such
challenges can be successfully tackled by the State of Vietnam on its own efforts and
commitments, Vietnam could feel more confident in walking onto a smooth and flat road
leading to the ICSID Convention, and even after becoming a Contracting State to the
ICSID Convention.
6. Conclusion
In the context of international economic integration, international investment plays an
important role in the economic development of every country from the perspectives of both
host countries and home countries. It is also considered a momentum for the world
economy development. Given international investment’s inherent nature of complexity that
involves parties of different nationalities, there have been an increasing number of
investment disputes that involve private parties of different nationalities and even
states/constituent agencies. To deal with this phenomenon, international arbitrations have
been established and soon become an effective tool that are most chosen by the parties,
especially investors. Amongst international arbitrations, arbitration under the ICSID
Convention is most preferable by both foreign investors and host states thanks to its
advantages that outweigh certain disadvantages. That is the reason why numerous
investment agreements, both multi-lateral and bi-lateral, between states and foreign
investors contain dispute settlement clauses that invoke the dispute settlement under the
ICSID Convention. In addition, investment law in many countries also offers to foreign
investors ICSID arbitration.
It is regretted that this ICSID mechanism does not work for Vietnam since Vietnam is not a
Contracting State to the ICSID Convention. This has triggered certain concern from
foreign investors when they invest in Vietnam because their investments would not be well
protected though the domestic legislation of Vietnam and many international investment
agreements concluded by Vietnam have offered domestic courts and international
arbitrations to foreign investors in case of their disputes with Vietnam/constituent agencies.
Such concerns would somehow have a negative impact on the investment environment in
Vietnam, which is inherently very attractive to foreign investors. 116 On the other hand, it is
also a concern from Vietnamese investors who have been looking for their business
opportunities in foreign countries and territories in the form of investment since their
investments could be infringed upon by host states at any time, thereby causing damages to
the investors and indirectly curtailing their investment opportunities.
Therefore, it is, in my opinions, time for Vietnam, in parallel with the improvement of its
investment environment and legal framework, to become a Contracting State to the ICSID
Convention. With the analysis and examination in this paper, Vietnam can feel quite
confident and comfortable in the investor-state dispute settlement provided under this
Convention.
ANNEX
116
Vietnam, with its comparable advantages, such as cheap labor with knowledge and skills, a large market,
being rich in mineral resources, has become one of top countries with the most attracting investment
environments in the world. Vietnam ranks the 12th in Foreign Direct Investment Index 2010 and the 11th in
Ease of Doing Business.
JOURNAL OF INTERNATIONAL LEGAL STUDIES
ISSUE
04
2011
Contents
Articles
ADMINISTRATIVE TOOLS AND IMPROVING THE REGULATION
OF INTERNATIONAL FINANCIAL TRANSACTIONS
Matthew Perry Canini
SHAREHOLDERS’ GENERAL MEETINGS AND THE ROLE OF
PROXY ADVISORS IN FRANCE AND JAPAN
Edouard Dubois
CREATIVITY, COPYRIGHT, AND COMMUNITY: AN EXPLORATION OF THE ISSUES SURROUNDING FAN-CREATED WORKS
UNDER U.S. AND JAPANESE COPYRIGHT LAW
Adrienne Lipoma
INVESTOR-STATE DISPUTE SETTLEMENT UNDER THE ICSID
CONVENTION – A COMFORTABLE ROOM FOR VIETNAM?
Dang Tran Anh Tuan