WORLD TRADE
ORGANIZATIONWT/WGTI/W/142
16 September 2002
(02-4893)
Working Group on the Relationship
between Trade and InvestmentOriginal:  English
COMMUNICATION FROM THE UNITED STATES
The following communication, dated 12 September 2002, has been received from the
Permanent Mission of the United States.
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COVERING FDI AND PORTFOLIO INVESTMENT IN A WTO INVESTMENT
AGREEMENT
I. INTRODUCTION
1. For a number of reasons, investment agreements must have a broad, open-ended definition
that includes all types of investment, including por tfolio investment.  Long-standing U.S. practice is
to have the broadest definition of investment, covering both direct and portfolio investment.
European bilateral investment treaties also cover all types of investment.
2. In UNCTAD’s recent study of investment treaties, the number of bilateral investment treaties
grew fivefold during the 1990’s, from 385 to 1,857, with 173 countries concluding these instruments.
Moreover, the number of treaties signed by developing and emerging market countries increased
dramatically, rising from 63 at the end of the 1980s to 833 at the end of the 1990s.1  Many of these
treaties were with the US and Europe, and the preponderance cover both direct and portfolio
investment.  This growth indicates increasing acceptance by developing and emerging market
countries of the need to cover both direct and portfolio investment in order to maximize the gains
from investment liberalization and protection.
A. WHAT IS PORTFOLIO INVESTMENT ?
3. The principal difference between FDI and portfolio  investment is the extent of control.  A
direct investment is one in which the investor obtains a lasting influence in, and a degree of influence
over the management of, a business enterprise.  Portfolio investment is all other investment, including
investments in financial assets without the expectation of significant management control of the real
assets on which the financial assets are based.   Other examples of portfolio investment include,interests in concessions agreements, contractual rights, (such as rights embodied in intellectual
property interests), debt interests in business enterprise, and ownership interests in tangible and
intangible property, such as leases, mortgages, and liens.
                                                     
1 UNCTAD, Bilateral Investment Treaties, 1959-1999 (2000).WT/WGTI/W/142
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4. For statistical purposes, governments and international organizations may require a minimum
level of ownership for an investment to be treated as FDI.  The OECD and IMF, in compiling FDI
statistics, consider a direct investment to be one in which ownership is at least ten per cent of the
voting securities of an incorporated business enterprise, or the equivalent interest in an unincorporated
business enterprise.
5. While useful for statistical categorization, the "ten per cent" rule may be too rigid for practical
use in a legal agreement.  For example, an investor  might own only nine per cent of an investment but
still exercise effective control over the investment because other shareholders have extremely limited
holdings.  The extent to which an investment confers control is the most reliable indicator of whether
it represents direct or portfolio investment.
B. WHY INVESTMENT AGREEMENTS SHOULD COVER PORTFOLIO INVESTMENT AS WELL AS FDI
1. Portfolio investment is vital for economic growth and development.
6. Developing and emerging market countries benefit from portfolio capital inflows.  Portfolio
investment adds to national savings, helps broaden and deepen financial markets in developing
countries to mobilize capital more efficiently, broadens the array of lending available to domestic
businesses, promotes large-scale investments that capture economies of scale, and stabilizes the local
economy by spreading credit risk.   The investment and financial development impact of capitalaccount liberalization, which reflects increased FDI and portfolio investment, has been shown to
increase economic growth in developing countries by 0.5 per cent annually.
2   Excluding portfolio
investment from the definition of investment would be counter productive  for countries that hope to
use foreign investment to bolster their own growth.
2. Portfolio investment is key to financial market deepening.  Relegating portfolio
investment to second-class status discourages the creation of sound financial markets.
7. A well-developed financial market is able to match willing sellers of capital with willing
buyers in such a way that both parties can expect to benefit from the transaction.  To meet the various
needs of its customers, the financial market ideally has a range of instruments on offer, including
equity, debt, and the many variations on these conc epts that are found in modern financial centers.
Granting fewer rights to the holders of portfolio capital than to direct investors would only create a
bias against portfolio investment and stall the devel opment of an efficient, diversified capital market.
3. The definition of "portfolio investment" cov ers a broad range of investments that are in
common use worldwide.
8. Denying the benefits of an investment treaty to portfolio investments means leaving out such
standard types of investments as minority equity holdings, such as of shares and stocks; bonds,
debentures, and other forms of debt interests in a company; contractual rights, such as under turnkeycontracts, production or revenue-sharing contracts, and concessions; rights conferred pursuant to law,
such as licenses and permits; and other investments such as leases, mortgages, liens, and pledges.
9. One could ask whether it is worth negotiating an investment treaty that leaves such a wide
array of investments without coverage.  Certainly su ch a treaty could not be called "comprehensive."
                                                     
2 "International Financial Integration and Developing Countries," World Economic Outlook, IMF,
October 2001, p. 143.WT/WGTI/W/142
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4. Offering fewer protections to portfolio invest ors than direct investors increases the risks
associated with portfolio investment, rais ing the cost of borrowing foreign capital , which
is a drag on the economy.
10. Developing countries, already contending with scarce economic resources, can little afford to
worsen the terms facing domestic borrowers who wish to raise capital abroad.  Recent research showsthat increased openness to portfolio investment benefits the liberalizing country by decreasing the cost
of capital in that country and giving domestic investors access to global financial markets, which
enables them to share risk with other investors.
3  An IMF study of 38 developing countries over the
period 1980–1999 found that capital account liberalization generally leads to greater capital inflows
and, with good management of these inflows, more domestic investment and higher growth.  The
growth effects of liberalization on developing countries came from both FDI and portfolio
investment.4
5. It is not always possible to decide what constitutes a portfolio investment.
11. There is no easy way to distinguish between direct and portfolio investment in many cases.
For example, a venture capitalist might loan a foreign start-up company a large amount of money,
underlying a large share of the start-up's assets.  The venture capitalist may not hold any evidence of
ownership B because no shares have been issued, only debt B or have measurable control over the
start-up.  This type of start-up capital is critical to many successful businesses.
12. Because portfolio and direct investment are not always easily distinguished, removing
portfolio investment from the definition of investment would require case-by-case analysis to
determine which kind of investment a given investor had made, or intended to make, and whether it
was covered by the investment agreement.  At best, this would complicate the investment process
considerably; at worst, it could lead to disputes between treaty partners and weaken the treaty’s ability
to promote overseas investment in general.
6. Portfolio investment is a concomitant of direct investment.
13. It is not possible to isolate foreign direct investment from portfolio flows, because direct
investors will be engaged in portfolio investment as they manage their cash flows.  For example, the
treasurer of Ford’s operations in Europe will be in and out of the "portfolio" markets as he manages
the cash and other financial assets involved in the business.  Any classic direct investment of any size
and autonomy will have a similar treasurer’s function, and be an active portfolio investor.  Portfolio
investment characteristically accompanies direct investment across borders.  An agreement limited to
FDI denies the benefit of the agreement to portfolio investor partners and to the portfolio operations
within a direct investment and thus will act to discourage FDI.
7. Restrictions on portfolio capital flows to capital-starved countries is not a long-term
solution to financial instability.
14. In the aftermath of the financial crises of the 1990’s, there has been criticism of capital market
liberalization for promoting short term capital inflows – sometimes referred to as "speculative capital"
– into emerging market economies.  The problem is not with capital market liberalization, or with
short term capital flows per se.  Empirical research by the World Bank demonstrates that in the longrun, volatility tends to decrease  following liberalization and integration with world financial markets.
                                                     
3 "International Portfolio Flows and Security Markets", Rene M. Stulz, in International Capital Flows ,
edited by Martin Feldstein, University Chicago Press, 1999, pp. 257-293. Pre-publication working paper.
4 "International Financial Integration and Developing Countries", World Economic Outlook, IMF,
October 2001, pp. 152-159.WT/WGTI/W/142
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One study, which examined a sample of 103 countries from 1980 to 1996, found that portfolio
investment was only slightly more volatile than FDI.  Among 85 emerging market countries over the
same interval, the levels of volatility of FDI and portfolio investment were actually equal.5 However,
the process  of capital account opening has been shown to raise, temporarily, the danger of volatility.6
This argues for a careful approach to financial liberalization itself, mostly through the establishment
of supportive macroeconomic and structural policies, in particular, improved bank regulation,
prudential standards, and other safeguards.
15. In the Asian financial crisis, certain countries were vulnerable to sudden capital outflows in
part because their domestic banks had too much exposure in short-term foreign currency-denominated
borrowing.  In some cases, bank customers were permitted to borrow short-term in hard currency even
though proper credit analysis would have shown they were not good risks for such lending.   The
solution is not to restrict portfolio investment per se , but to improve financial supervision,
surveillance, and risk analysis, such as through standards developed by the Financial Stability Forum,
which was established shortly after the Asian financial crisis to strengthen international financial
cooperation and stability.
8. Excluding portfolio investment defeats the purpose of an international investment
agreement.
16. Governments should be as open to portfolio investment as they are to direct investment. There
is general agreement on the positive role of investme nt in promoting sustainable growth in developing
economies.   This is true of both direct and portfolio investment flows.  Potential investors would have
to question the commitment to liberalization and investment protection of a country that would not
agree to extend treaty rights to portfolio investment.
17. Including portfolio investment in the defini tion of investment does not mean that host
governments  will not be able to treat portfolio investment differently from direct investment.  Most
regulations of the financial markets need not violate the agreement, as they need not discriminate
between foreign and domestic investors.   In a U.S.  Bilateral Investment Treaty (BIT), for example,
the transfers provision permits financial market regulators to prevent or delay a transfer if necessaryfor the proper functioning of the market, and allows for the mandatory reporting of transactions that
may be required by financial regulations.
II. CONCLUSION
18. The United States favours a broad definition of investment that includes both direct and
portfolio investment.  Our experience, based on ne gotiation of more than forty BITs, the NAFTA, and
the ongoing FTAA and bilateral FTAs with Chile and Singapore, is that a broad, open-ended
definition is necessary to maximize the benefits of investment liberalization and protection.  Webelieve that covering portfolio investment can contribute to the development agenda of this round by
making developing and emerging market countries more attractive hosts to foreign capital, deepening
local financial markets, and furthering global economic integration.  We would be interested in
exploring with our colleagues how best to realize the advantages of portfolio investment coverage
while responding to the challenges, for example, through technical assistance and capacity building in
                                                     
5 "Negative Alchemy?  Corruption, Composition of Capital Flows, and Currency Crises", Shang-Jin
Wei and Yi Wu, Working Paper 8187, National Bureau of Economic Research, March 2001.
6 "Globalization, Growth, and Poverty: Building an Inclusive World Economy", World Bank, 2001.WT/WGTI/W/142
Page 5
the areas of bank supervision and regulation.  The task ahead is to build on our shared experience of
covering portfolio investment in our bilateral treaties, and to internationalize it in a high-standards
investment agreement from which all WTO members may benefit.
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