Cutting through Concepts: Extraterritoriality 

“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean — neither more nor less.”

The ability of words to change their meaning in response to social and environmental change is one of the main sources of the power and flexibility of language. At the same time, it can also lead to ambiguity and confusion. In specialized contexts such as the world of financial services, words and concepts can acquire particular significance; they can also be used in incorrect or contradictory ways.

In this, the first of a series of regular columns, we take a look at a concept which is attracting increasing attention: extraterritoriality.

Traditionally, the concept of extraterritoriality focused on an individual, an institution or a location being exempt from the legal jurisdiction which would generally apply to a particular location. A classic case is diplomatic immunity, where a diplomat serving his nation overseas is not liable to the legal framework of his host country but remains accountable to his native law. To give a comparatively trivial example, diplomatic missions and international organizations in the UK typically refuse to pay up to £500,000 in parking fines each year¹. Extraterritoriality can also apply to physical locations: the headquarters of the United Nations in New York, and the International Court of Justice in the Hague enjoy extraterritorial status; the extraterritorial status of the US base at Guantánamo Bay is disputed by Cuba.

However, although the core emphasis of the concept in this view is on removal from particular jurisdiction, this also implies the extension of some other jurisdiction outside its normal scope. This is the sense in which it is applied increasingly commonly in areas of international law. More correctly termed extraterritorial jurisdiction, it describes the efforts of national legislatures to impose their laws and regulations on governments and citizens outside their borders.

In the financial services world, in the wake of the financial crisis, the G20 has taken a strong lead in promoting new systems of financial regulation. Leaders recognized that a single set of global regulations would be impractical given differences in local market structures and legal frameworks. Instead the emphasis is on developing agreed principles which individual national legislatures commit to incorporating within their domestic legal codes.

Nevertheless, the boundaries between domestic and extraterritorial jurisdiction are becoming blurred, and there is an inevitable temptation for legislators to seek to impose their will beyond the national boundary. Such attempts can be seen in the European Commission’s increasing use of Regulations rather than Directives to legislate for member states’ behavior. These developments give rise to tricky issues of jurisdiction, legal competence and national sovereignty.

Any state can, in principle, claim legal powers over persons or places external to it. However, the force of law depends in the end on two factors: the consent of those to whom it applies, and the ability of the legislature in question to impose its authority, by force if necessary. Hence the most powerful source of contemporary extraterritorial ambition is the USA. The implications of legislation such as the Dodd-Frank Act or FATCA are increasingly controversial. Disputes over extraterritoriality have the potential to disrupt progress towards a more stable international financial structure.

Recent serious concerns which have been raised include:

• A spokesperson for Michel Barnier, Internal Market and Services Commission at the European Commission, said, “We are aware of the extraterritorial application of the Dodd- Frank Act; we are not happy with it and this is something we are discussing closely with our US counterparts, hoping to find mutually convenient solutions.”²
• The chairman of the International Swaps and Derivatives Association said, “With regard to extraterritoriality, there are today large and growing concerns regarding the applicability of the Dodd-Frank Act outside the US. These concerns have been raised both by US and non-US entities. There is a great deal of uncertainty among market participants about whether and how to implement a new regulatory framework that might duplicate or conflict with that of their parent country.”³
• Eight trade associations wrote to the European Commission and the US Treasury expressing concern that regulatory change may create conditions that will lead to “fragmentation of markets, protectionism and regulatory arbitrage”.⁴
• The European Commission has complained to US Treasury Secretary Timothy Geithner and to Commissioner of the IRS Doug Shulman about the “severe impact” that FATCA will have in terms of costs of compliance and penalties in cases of non-compliance. The Commission also points out that FATCA may conflict with EU member states’ internal data protection laws.⁵
• Jim Flaherty, Federal Minister of Finance in Canada has expressed concern both about FATCA and about the “nerve-wracking” effect that the Foreign Bank Account Report (FBAR) reporting rules have on Canadians, complaining that the US legislation would essentially cause Canadian banks to become extensions of the IRS.⁶

It may seem a rather technical concept. But extraterritoriality is actually at the heart of the current debate about constructing a sounder, more consistent global framework for financial services regulation. It gives rise to inevitable tensions between those who seek to make and impose the rules and those who are subject to them. It is important that policymakers and legislators can find agreed routes through these difficulties. If not, the world could retreat into self-interest, protectionism and regulatory arbitrage.

For individual financial services firms, extraterritoriality brings a different set of complexities. It means that in some jurisdictions they will find themselves complying with two sets of rules – home and host. And it probably adds duplication. Much of the push for extraterritoriality reflects a lack of confidence by home supervisors in the effectiveness of the rules proposed in the host jurisdiction, so recognition of similar reporting and practices is limited.

Article author

1. Hansard, HC Deb, 19 July 2011
2. Paulina Dejmek, speaking at the Association for Financial Markets in Europe’s annual post-trade conference in London 11 May 2011
3. Thomson Reuters Dodd-Frank Watch, 26 October 2011
4. FX Week 11 Jul 2011
5. STEP Journal www.stepjournal.org
6. KPMG Canada 20 September 2011