Nor Any Drop to Drink: A Call for Preemptive Regulation of Water-based Securities

Tyler Loveall

Vol. 43 Executive Editor

Despite long-standing economic focus on water as a resource,[1] little work exists on the effects of potential fresh-water financial instruments. In 2018, Nasdaq became the first major financial institution to launch a fresh-water price index.[2] Although related derivative contracts are yet to materialize, such derivatives are likely to come and with them potential speculation and instability in the underlying commodity, as may have led to the global food crisis in the mid-2000s.[3] Water securities would be deeply connected to international agreements on fresh water and international harmonization of derivatives regulation. Fully regulated derivative markets do not pose an inherent risk and may not negatively affect water access,[4] but international securities and fresh-water law currently lack the mechanisms and scope of objectives necessary to regulate water-backed securities, risking water access. Fresh-water commodities present unique challenges. Access to fresh water, unlike any other specific commodity, is a U.N. declared universal human right.[5] Yet the right is incredibly vulnerable. The human rights framework around water is often criticized as ill-defined, narrowly imposed,[6] and focused too heavily on economics and too little on water for sustenance and sanitation.[7] Therefore, fresh-water law and securities regulation need to fill the gap and protect water access where traditional human rights law may not. Despite the vast differences in guiding principles, areas of law, and subject-matter, fresh-water and derivatives law have much in common. Both have their roots in the ancient world.[8] Scholars in both fields widely agree that both issues present global problems requiring transnational responses.[9] Because of the global water cycle, fresh water must inherently be considered beyond traditional borders,[10] as must commodities regulation with its global markets and connection to international trade.[11] Yet international regulation of both operate along heavily sovereign lines, in water through bilateral or basin-based treaties,[12] and in derivatives predominantly at the national level.[13] The greatest commonality between the two may be that both need strong transnational, global law but lack such frameworks. Preexisting fresh-water law systems, with their roots in underinclusive concepts of riparian and drainage system rights,[14] are not prepared to regulate its financial derivatives. International water law historically imposes few limitations on exploitation.[15] Today, the U.N. Convention on the Law of Non-navigational Uses of International Watercourses is the predominant international agreement on fresh-water access and may be binding as customary law.[16] However, the convention only covers watercourses and their basins, not other important sources of water, such as icebergs, un-connected groundwater, and the atmosphere,[17] all of which have even less developed bodies of law.[18] Moreover, the treaty confines its jurisdiction by a state’s physical relationship to the watercourse and its water,[19] and expresses a system of no-priority free use.[20] In its current form, the U.N. Convention, because of its reliance on physical relationships to water and free use, could not effectively regulate water-based derivatives. The Convention does not prioritize drinking water or sanitation over other uses such as commodities trading.[21] If commodities markets did begin to negatively affect water access, the markets themselves have no relationship to a specific basin to connect any such harm. Derivative markets lack the physical relationship to water implicit in the convention and would affect fresh water on a global, not a basin level. Even in an expansive reading of the Convention that imposed limits within the basin where the markets reside, there is no physical relationship between global derivative markets housed in financial centers, in the U.S., U.K., and Germany, and many of the basins around the world. Application of the UN Convention to water-derivatives would require a reimagining of its entire framework to focus on fresh water as a global system and to prioritize individual water access for sanitation and sustenance over other uses. As this is the antithesis to the current basin-based system, solutions are better found elsewhere. Today’s international derivatives regulation is similarly ill-prepared to police water derivatives as a unique commodity. International derivatives governance is predominantly confined to regulation harmonization between nation-states with its locus in the G20 and the International Organization of Securities Commissions (“IOSCO”). [22] The predominant tools of IOSCO are restricted to information sharing, common standards, and regulation coordination.[23] These tools must be used pursuant to one of IOSCO’s three main objectives: 1) protecting investors, 2) ensuring fair, efficient, and transparent markets, and 3) reducing systemic risk,[24] all of which were reflected in IOSCO’s commodities principles (“IOSCO Principles”).[25] Nothing within the IOSCO Principles nor IOSCO’s powers suggests that the organization may police water’s unique nature as a commodity nor its connections to the environment or human rights. The proposed IOSCO Principles of November 2021 may be better suited.[26] The new principles call for increased supervision and regulation of commodities after the financial crisis and in acknowledgment of widespread abuse of the commodity market. [27] This shift may have stemmed from agricultural price volatility and the 2008 food crisis.[28] IOSCO also recently adopted principles for a specific commodity, Oil, recognizing the unique nature of an underlying commodity, creating uniform price-setting mechanisms to ensure less volatility in oil, and increasing regulatory oversight to reduce market manipulation of oil commodities.[29] Most importantly, the new principles incorporated consideration of sustainability and environmental protection,[30] amidst increasing evidence that poor fresh-water resource management can impact economic development and climate change.[31] This may serve as alternate grounds for regulation. All these factors suggest that IOSCO, through its proposed principles, could be better prepared to react and coordinate regulation of water derivatives than ever before. If water-based securities become prevalent and begin to negatively impact water access, then IOSCO has precedent for commodity-specific regulation and may have greater authority to act pursuant to its new objectives without requiring further changes to the institution or its principles. IOSCO should consider implementing added oversight over water derivatives, increased policing of market manipulation for fresh water, or even most extremely limits on the price variance of water contracts. Ultimately, current international law does not reflect the transnational nature of fresh water and potential associated derivatives. If water-securities are left under-regulated, then a world with increasingly scarce fresh-water resources could see artificial crises of fresh-water prices. If regulation is in place, then water securities could be a creative means of protecting the price of fresh water and ensuring continued access. The new IOSCO Principles, if adopted, may imply a greater ability to respond to any such development, but international law still may not be ready to respond if futures contracts begin to interfere with access to fresh water, a vital human right. To ensure the protection of water access, the international community should expand IOSCO’s guiding principles to further consider more non-economic factors and consider water specific regulation.

[1] International Conference on Water and the Environment, Dublin Statement on Water and Sustainable Development, Principle 4 (Jan. 26–31,1992); U.N. Conference on Environment and Development, Agenda 21, ¶ 18 (June 3–14, 1992); Piotr Szwedo, Cross-Border Water Trade: Legal and Interdisciplinary Perspectives 3 (2019). [2] Nasdaq Veles Water Indexes, Nasdaq, https://www.nasdaq.com/solutions/nasdaq-veles-water-index (last visited Feb. 4, 2022). [3] Anna Chadwick, World Hunger, the Global Food Crisis and (International) Law, 14 Manchester J. Int’l Econ. L. 92 (2017); David Mitchell, A Note on Rising Food Prices 3 (World Bank Working Paper, 2008); Alexandra Esmel, Food Speculation: Between Virtual . . . and Reality, 31 Am. U. Int’l L. Rev. 507, 509, 521 (2016). [4] Steven L. Schwartz, Regulating Derivatives: A Fundamental Rethinking, 70 Duke L. J. 545 (2020). [5] G.A. Res. 64/292, The Human Right to Water and Sanitation, U.N. Doc. A/RES/64/292 (July 28, 2010). [6] See Ndjodi Ndeunyema, Unmuddying the Waters: Evaluating the Legal Basis of the Human Right to Water Under Treaty Law, Customary International Law, and the General Principles of Law, 41 Mich. J. Int’l L. 455, 462 (2020); Amanda Cahill, The Human Right to Water––A Right of Unique Status: The Legal Status and Normative Content of the Right to Water, 9 Int’l J. Hum. Rts. 389, 391 (2005); Philippe Cullet, Water Law in a Globalised World: The Need for a New Conceptual Framework, 23 J. Env’t L. 233 (2011). [7] Frontier Dispute (Burk. Faso v. Mali), Judgment, 1986 I.C.J. 554, 659, ¶ 17 (Dec. 22)  (separate opinion by Abi-Saab, J.); Gabčíkovo-Nagymaros Project (Hung. v. Slovk.), Judgment, 1997 I.C.J. 7, ¶ 55 (Sep. 25). [8] Szwedo, supra note 1, at 13 (water law dates back to ancient Sumerian treaties); Micah Smith, A Privatized Approach to Derivatives Regulation: The CPMI-IOSCO’s Proposed Unique Transaction Identifier Scheme and Its Practical Effects on Transparency and Regulatory Arbitrage, 45 Ga. J. Int’l & Comp. L. 411, 419 (2017) (commodity derivatives date back to ancient Mesopotamia). [9] See Szwedo, supra note 1, at 5 (fresh water); Hugh B. Hamilton II., At the Water’s Hedge: International Insider-Trading Enforcement after Morrison, 68 Duke L. J. 1003, 1040 (2019) (derivatives); Hannah L. Buxbaum, Transnational Legal Ordering and Regulatory Conflict: Lessons from the regulation of Cross-Border Derivatives, 1 U.C. Irvine J. Int’l Transnat’l & Comp. L. 91, 92 (2016). [10] Cullet, supra note 6, at 234; Laurence Boisson de Chazournes et al., The U.N. Convention on the law of the Non-Navigational Uses of International Watercourses: A Commentary 20 (2018). [11] Esmel, supra note 3, at 513; Hal S. Scott & Anna Gelpern, International Finance: Transactions, Policy, and Regulation 971 (23d ed. 2020). [12] de Chazournes et al., supra note 10, at 8. Many basins have no governing treaty. Id. [13] Buxbaum, supra note 9, at 95. [14] de Chazournes et al., supra note 10, at 37; U.N. Convention on the Law of the Non-Navigational Uses of International Watercourses art. 2, May 21, 1997, 2999 U.N.T.S 77. [15] A. Dan Tarlock, Toward a More Robust International Water Law of Cooperation to Address Droughts and Ecosystem Conservation, 28 Geo. Envt’l L. Rev. 261, 269 (2016); C. J. Vörösmarty et al., Fresh Water Goes Global, 349 Sci. 478, 479 (2015). [16] de Chazournes et al., supra note 10, at 12. [17] Id. at 46. [18] Id. at 49 [19] U.N. Convention on the Law of the Non-Navigational Uses of International Watercourses art. 2(a), May 21, 1997, 2999 U.N.T.S 77. [20] Id. art 10. [21] Id. art 10. [22] Buxbaum, supra note 9, at 102; Heath P. Tarbert, Self-Regulation in the Derivatives Markets: Stability through Collaboration, 41 Nw. J. Int’l L. & Bus. 175, 203 (2021). [23] Int’l Org. of Sec. Comm’ns [IOSCO], By-Laws of IOSCO, § 1.2 (1996), https://www.iosco.org/library/by_laws/pdf/IOSCO-By-Laws-Section-1-English.pdf [24] Buxbaum, supra note 9, at 98. [25] Int’l Org. of Sec. Comm’ns [IOSCO], Principles for the Regulation and Supervision of Commodity Derivatives Markets Final Report, IOSCO Doc. FR07/11 (Sep. 2011), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD358.pdf. [26] Int’l Org. of Sec. Comm’ns [IOSCO], Principles for the Regulation and Supervision of Commodity Derivatives Markets Consultation Report, IOSCO Doc. CR05/21 (Nov. 2021) https://www.iosco.org/library/pubdocs/pdf/IOSCOPD689.pdf [hereinafter Consultation Report]. [27] Id. at 4. [28] Esmel, supra note 3, at 531. [29] Int’l Org. of Sec. Comm’ns [IOSCO], Principles for Oil Price Reporting Agencies Final Report, IOSCO Doc. FR06/12 (Oct. 5, 2012), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD391.pdf. [30] Consultation Report, at 7; Int’l Org. of Sec. Comm’ns [IOSCO], Sustainable Finance and the Role of Securities Regulators and IOSCO Final Report, IOSCO Doc. FR04/2020 (Apr. 2020). [31] Lauren Boisson de Chazournes, Christina Leb, &  Mara Tignino, International Law and Freshwater 140 (2013).   The views expressed in this post represent the views of the post’s author only.