Transcript Slide 1

BEIJING BRUSSELS CHICAGO DALLAS FRANKFURT GENEVA HONG KONG LONDON LOS ANGELES NEW YORK SAN FRANCISCO SHANGHAI SINGAPORE SYDNEY TOKYO WASHINGTON, D.C.
THE OBAMA FINANCIAL REFORM PLAN
AND ITS RELEVANCE TO COLOMBIA
Congreso de Derecho
Financiero
Asobancaria
Cartagena de Indias
October 22, 2009
NY1 7117725v.1
Andrew C. Quale Jr.
Partner
Sidley Austin LLP
787 Seventh Avenue
New York, NY
[email protected]
TABLE OF CONTENTS
I.
The U.S. Financial Crisis
II.
The Financial Reform Plan: Overview
III.
Supervision and Regulation of Large Financial Firms
IV.
Regulation of Financial Markets: Securitization and
Derivatives
V.
Consumer Financial Protection Agency
VI.
Tools for Managing Financial Crises Like the Current Crisis:
A Resolution Regime
VII. Raise International Regulatory Standards and Improved
International Cooperation
VIII. Prospects for the Reform
IX.
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Aspects of the U.S. Financial Reform Potentially Relevant to
Colombia
I.
THE U.S. FINANCIAL CRISIS
A. Some Causes of the Crisis
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●
Artificially low interest rates
(the “Greenspan Effect”)
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Excess liquidity
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Reckless lending generally
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Reckless mortgage lending
●
Reckless securitization of
mortgage-backed securities
and structured products in
pursuit of high yields
I.
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THE U.S. FINANCIAL CRISIS
●
Reckless use of currency swaps
●
Reckless use of credit default swaps; not merely to hedge—
“naked” CDS.
●
Questionable credit ratings by rating agencies
●
Reckless search for high yielding assets. The search for
yield increased the demand for structured products and
made possible the making of mortgage loans on poor
credit/underwriting standards.
●
Excessive leverage among financial institutions, sometimes
as high as 50 to 1
●
Perverse compensation incentives: high commissions paid
upon closing a transaction without regard for the creditworthiness or long-term performance of the transaction
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●
Moral hazard, both on an individual basis and institutional
basis
●
Greed
●
More greed
●
Even more greed
B.
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Some Consequences
●
The housing bubble burst
followed by widespread defaults
on mortgage loans. Mortgage
rates reset to much higher rates.
●
High default rate on commercial
loans, especially leveraged buyout loans
●
Financial entities suffered
tremendous losses on certain
financial assets, particularly
mortgage-backed securities,
leveraged buy-out loans and
credit default swaps.
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●
Loss of confidence led to a liquidity run (massive
withdrawals from money market funds) and a flight to
quality (Treasuries)
●
The credit mark froze with no credit even being extended to
other banks (e.g. Libor); commercial paper market shut
down; banks stopped lending to customers
●
A “run” on investment banks and some commercial banks;
e.g., Bear Stearns, Lehman Brothers, others
●
Bear Stearns rescued by the Treasury, the Fed and JPMorgan
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Lehman Brothers bankruptcy
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Bail out of AIG
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Distressed sales of Countrywide, Wachovia, Washington
Mutual and Merrill Lynch
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741.00 jobs lost in January 2009
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Worst GDP contraction in 50 years
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Stock market crashed more than 50%
●
US$10 trillion loss in household wealth
C. U.S. Government’s Immediate Response
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●
The response of the Treasury and the Fed was rapid and
massive
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The response halted the freefall
●
The cost was enormous
●
Big challenge for the Treasury and the Fed to wind down the
massive expansion of credit without stopping growth or
causing inflation
●
If the Fed cannot soak up all the liquidity it has created, the
risk of inflation and a new bubble will be high
●
Depreciation of the dollar against other currencies continues
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A long-term financial reform is needed
D. Have we “turned the corner”
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●
The credit market is showing signs of
recovery
●
Corporate bond issuances, especially
investment grade, have surged
●
General increase in the price of
securities, stock market has soared
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Too much, too fast?
●
But, consumer spending still depressed
●
Unemployment still high and growing,
but at a slower pace
●
Earnings sluggish
●
We still have a long way to go before
true recovery takes hold!
E.
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Long-Term Financial Reform is Needed
II.
THE FINANCIAL REFORM PLAN: OVERVIEW
A. President Obama Announced the
Financial Reform Plan on June 17,
2009.
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●
The Obama Administration
seeks legislative action by the
end of 2009.
●
Hearings are currently being
conducted on the legislative
proposals.
●
Prospects for major legislative
action are unclear.
B.
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The Plan Focuses on Five Areas:
● Promote strong supervision and regulation of all financial
firms, especially those that present systemic risk;
● Establish comprehensive regulation of financial markets,
including asset-backed securities, over-the-counter (OTC)
derivatives and clearing systems;
● Establish a new consumer protection agency to protect
consumers and investors from financial abuse;
● Create a new government resolution/intervention authority
over large non-bank financial institutions; and
● Enhance international regulatory standards and financial
supervision.
III.
A.
SUPERVISION AND REGULATION OF LARGE
FINANCIAL FIRMS
Regulation of Tier 1 Financial Holding Companies (“Tier 1
FHC’s”)
● The Board of Governors of the Federal Reserve System (the
“Fed”) will designate those financial firms, including not only
banks and bank holding companies, but also investment
banks, insurance companies and private funds, which the Fed
believes because of their size and leverage could pose a
systemic threat to the country’s financial stability if they
failed (“too big to fail”).
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● Tier I FHCs would be subject to enhanced supervisory
authority by the Fed, which may include:
 extensive oversight by the Fed;
 regulation under the Bank Holding Company Act, even if
the FHC does not have a bank subsidiary;
 higher capital and liquidity requirements than those
normally applicable to bank holding companies;
 the obligation to establish a “rapid resolution plan” to
provide for the orderly “resolution” (liquidation/
intervention) of the FHC if it becomes subject to financial
difficulties.
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●
Issue under debate: Should the regulation of these largest
institutions be concentrated primarily in the Fed?
●
A Financial Services Oversight Council, consisting of the
heads of various bank and other regulatory agencies, such
as the FDIC, the Fed, the FCC, etc., would be created to
advise the U.S. Treasury on certain aspects of systemic risk
and to advise the Fed as to which financial firms should be
considered Tier I FHCs.
B.
New Standards to be Applied to All Banks and BHCs not
Just Tier 1 FHCs
● Establishment of New Executive Compensation Guidelines for
Regulating Financial Firms:
 Compensation should be based in part on the
performance of credit transactions over time;
 Compensation should reflect evaluation of the risks
inherent in the transaction created by the executive;
 For Tier 1 FHCs regulated also by the SEC, executive
compensation should be determined by a committee of
totally independent directors;
 Large financial institutions, which do not have a bank
subsidiary and which were previously supervised solely by
the SEC, would now be primarily supervised by the Fed.
(Examples, Goldman, Morgan Stanley)
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C.
Regulation of Private Investment Funds, including Hedge
Funds, Private Equity and Venture Capital Funds
● Advisers to funds with more than $30 million of assets under
management would be required to register with the SEC
● A “foreign private adviser” would be exempt from SEC
registration provided that it:
 has no place of business in the United States;
 has less than 15 clients;
 has assets under management attributed to clients in the
United States of less than $25 million; and
 does not hold itself out to the U.S. public as an
investment adviser and does not act as an investment
adviser to an investment company registered under the
Investment Company Act of 1940.
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● Advisers registered with the SEC would be subject to
substantial regulatory reporting with respect to their assets,
leverage and off balance sheet exposures and would be
required to disclose significant information to investors,
creditors and counterparties
● Regulation by the Fed:
 Reports required to be submitted to the SEC would also
be submitted to the Fed and the Oversight Council;
 The Fed would supervise and regulate all private funds
that meet Tier 1 FHC criteria and thus present systemic
risk.
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D.
Oversight of the Insurance Industry
● An Office of National Insurance (“ONI”) would be established
within the Treasury to monitor the insurance industry;
● The ONI would identify the potential occurrence of market
problems that could contribute to a financial crisis and
recommend to the Fed any insurance companies that it
believes should be regulated as a Tier 1 FHC. (E.g., AIG)
● The Treasury will support various principles/objectives to
modernize the regulation of insurance, including: effective
systemic risk regulation; strong capital standards; increased
national uniformity of regulation; regulation of insurance
companies and affiliates on a consolidated basis; and
coordination among international regulatory authorities.
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IV.
REGULATION OF FINANCIAL MARKETS:
SECURITIZATION AND DERIVATIVES
A. Reform of Securitization Transactions
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●
Loan originators will be required to retain 5% of the credit
risk of securitization transactions that they originate (the
“skin in the game” requirement).
●
Reforms designed to align/link compensation incentives
with long-term asset performance (avoid perverse
incentives/moral hazard).
●
Compensation not to be based simply on the production,
origination or sale of the product.
● Commissions paid to loan brokers that will not have any
ongoing ownership of the loans they generate would be
required to be disbursed and paid over the life of the loan
and would be reduced if the quality of the loan deteriorates.
● Compensation of brokers, sponsors, originators and
underwriters involved in securitization transactions must be
linked to the long-term performance of securitized assets.
● Securitization originators or sponsors would be required to
provide strong, standardized representations and warranties
relating to the origination and underwriting practices
employed with respect to such securitizations.
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B. Legal Documentation for Securitized Transactions Would be
Standardized to Make it Easier for Purchasers to Value
Accurately the Securitization
C. Reforms Would be Adopted with Respect to Credit Rating
Agencies:
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●
To enhance the disclosure of any conflicts of interest which
credit rating agencies may have with respect to the issuers
whose debt they are rating;
●
To provide additional disclosure information about the
performance of instruments they have rated in the past;
●
To provide fuller disclosure about the methodology that they
use to rate structured products.
D.
Regulation of OTC Derivatives
● Overview. Recognizing the significant role that certain
derivative products, particularly credit default swaps, played
in the financial crisis, a comprehensive new regulatory
regime of OTC derivatives and participants in the OTC
derivatives markets is proposed.
● All “standardized” OTC derivatives would be required to be
executed on exchanges or electronic trading platforms and
cleared through regulated central counterparties (“CCPs”).
● The use of exchange-traded derivatives will increase the use
of standardized derivatives, enhance transparency, reduce
the need for “customized” derivatives and, ultimately,
substantially decrease the cost of such derivatives to the
purchaser (and the profits of the banks—banks are resisting).
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● OTC derivative dealers and other market participants would
be subject to regulation and supervision, including minimum
capital requirements, business conduct standards and
reporting and disclosure requirements.
● Protection for unsophisticated parties entering into derivative
transactions would be enhanced, including: more restrictive
requirements for persons to participate in OTC derivatives
trading; increased disclosure requirements and improved
standards of care for marketing OTC products to lesssophisticated parties. (Would such standards, if they had
been in place, have avoided the losses incurred by allegedly
“unsophisticated” counterparties in Mexico and Brazil from
speculative trading in derivatives?)
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V.
A.
CONSUMER FINANCIAL PROTECTION
AGENCY
Establishment of a Consumer Financial Protection Agency
(“CFPA”)
● The CFPA would be an independent agency with
responsibility for supervision of financial services and
products offered to consumers, such as mortgage and credit
card loans, as well as savings and payment services.
● The CFPA would have jurisdiction over not only banks, but
also non-bank financial service companies.
● The CFPA would require increased transparency relating to
financial services provided to consumers.
● Form documents should be developed that should be “clear,
simple and concise” and terms and other information should
be easily understood.
● Financial services companies would be encouraged to provide
“plain vanilla” financial products.
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● Abusive prepayment penalties and unfair or deceptive
practices would be prohibited.
● Mortgage brokers would be required to meet certain
standards of fairness and care in respect to the treatment of
consumer clients and would have a duty to determine
whether products are affordable and suitable for their
customers
● Compensation received by mortgage brokers for arranging
loans would be paid over the life of the loan and not only at
its origination and be linked to the performance of the loan.
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VI.
A.
TOOLS FOR MANAGING FINANCIAL CRISES: A
RESOLUTION REGIME
Creation of a Resolution Regime for Failing BHCs and Tier 1
FHCs.
● Currently banks and other insured depositary institutions are
subject to a resolution regime (liquidation/intervention)
provided by the Federal Deposit Insurance Act (“FDIA”) when
such institutions suffer severe financial difficulties.
● BHCs are not subject to the FDIA resolution regime since they
are not banks or depository institutions and, accordingly,
would be governed in the event of insolvency by the Federal
Bankruptcy Code. Similarly, investment banks, such as
Lehman Brothers, are not covered by the FDIA but rather are
governed by the Federal Bankruptcy Code. As is evident from
the Lehman bankruptcy, bankruptcy proceedings under the
Federal Bankruptcy Code are cumbersome, costly and
extraordinarily time consuming. More importantly, the
bankruptcy of Lehman created enormous turmoil in the
global financial markets.
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● To avoid such systemic risk, a special “resolution regime” is
proposed to permit the orderly resolution of failing BHCs and
Tier 1 FHCs, which would otherwise be subject to the FDIA, in
situations in which the stability of the financial system is at
risk.
● This special resolution regime would be modelled on the
existing resolution scheme under the FDIA.
● Such regime could only be activated by the U.S. Treasury and
only after the Treasury had consulted with the President and
obtained the approval of the Fed and the FDIC or the SEC or
the proposed ONI depending upon whether such institution’s
principal subsidiary was a bank, an SEC registered entity or
an insurance company.
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●
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Pursuant to the resolution regime, the Treasury would have
the power to follow a number of options, including:
appointment of a conservator or a receiver, as it did in the
case of Fannie Mae and Freddie Mac; and/or attempt to
stabilize the failing firm by providing loans to the firm,
purchasing assets from the firm, guaranteeing its liabilities
or making equity investments in it. (As the Treasury did in
the case of a number of major banks during the current
crisis.)
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●
The conservator or receiver would have the power to
repudiate contracts of the financial institution (even those
that are not executory and so would not be subject to
repudiation if the affected entity was in bankruptcy under
the Federal Bankruptcy Code) and transfer all or part of the
assets of the institution to another entity or financial
institution. (This would help reduce the systemic risk
created by the Lehman bankruptcy.)
●
Under such regime, counterparties to securities contracts,
repurchase agreements and swap agreements would be
temporarily prevented from closing out such contracts
pending a determination by the receiver as to whether such
contracts should be transferred to another entity,
notwithstanding any contractual rights to terminate the
contracts if a receiver were appointed.
VII.
●
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RAISE INTERNATIONAL REGULATORY
STANDARDS AND IMPROVE INTERNATIONAL
COOPERATION
Greater cooperation and coordination with the financial
regulators of other countries is sought
VIII. PROSPECTS FOR REFORM
A. Will a Substantial Reform Package, with Teeth, be Passed
and Effectively Implemented?
●
Banks, both large and small, and other financial institutions
are lobbying to weaken the reform
●
The Obama Administration is pushing hard, but it and
Congress may be distracted by health care reform
●
Previous financial reform efforts that would have
significantly reduced the severity of the financial crisis were
stymied by Congress and lobbyists. E.g., supervision of
hedge funds and regulation of derivatives
B. Will a Perfectly Good Crisis be Wasted?
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IX.
A.
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ASPECTS OF THE U.S. FINANCIAL REFORM
POTENTIALLY RELEVANT TO COLOMBIA
The U.S. Financial Reform Could Affect Colombia and the
Availability of Credit
● The availability of credit from U.S. financial institutions to
Colombian borrowers could be adversely affected due to:
 Bank lending could be reduced due to higher capital
requirements and tighter controls on the liquidity of U.S.
banks;
 Leverage for some U.S. financial institutions has dropped
from 50 to 1 to 10 to 1 thus reducing their lending capacity,
in theory, by 80%;
 Loans to emerging market countries are often subject to
higher capital requirements making them less attractive to
capital-starved lenders;
 Availability of financing in the capital markets may be tighter
due to more conservative investment criteria being applied
by institutional investors and concerns that the expected
inflation will soon lead to higher interest rates.
B.
●
The availability and cost of derivatives may be affected. If
derivatives are exchange-traded the cost will drop
considerably, which could be beneficial to Colombia.
●
Credit default swaps and other derivatives can be highly
risky if used not to hedge exposure risk but as naked bets
on market changes.
Lessons/Issues for Colombia arising from the U.S.
Experience
●
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The impact of the global financial crisis on Colombia has
been relatively moderate:
 The Colombian financial system has remained relatively
strong;
 The availability of credit has declined, but not due to the
seizing up of the credit markets, but rather lack of
demand from borrowers;
 Exports have fallen due to decline in world demand;
 Commodity prices have fallen;
 The Colombian economy has slowed;
 The use by Colombian companies of derivative
instruments has apparently not resulted in the massive
losses that have been incurred by some Brazilian and
Mexican companies.
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●
Does this mean that Colombia is relatively immune from a
financial crisis such as this?
 Hardly. Colombia should be grateful that the impact of
the crisis on it has been modest, but future financial
crises will occur and Colombia should take advantage of
this opportunity to make thoughtful financial reform.
●
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What aspects of the U.S./global financial crisis are relevant
to Colombia? What lessons can be drawn?
C.
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Questions for the Colombian Government and the Banking
Sector to Consider
●
Are there banking/financial and/or industrial groups in
Colombia whose failure would cause systemic risk? Too big
to fail? But, also, too big to regulate? Or, save?
●
If one of such groups were about to fail, would the
government have sufficient power to save such institution?
Can it provide sufficient capital? Provide credit or other
financing? Guarantee the failing institution’s or the entire
financial sector’s obligations? Buy troubled assets? How
quickly could the government act? Could the government
effectively prevent a crisis such as occurred in the United
States?
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●
Do the government and such large institutions have a
resolution regime if needed? Is it adequate?
●
Is there comprehensive consolidated supervision/regulation
of such groups within a single regulatory body or, as in the
U.S., is it dispersed among several regulatory agencies?
●
Would it be advantageous to coordinate through some type
of Oversight Council, as is proposed in the U.S., the
regulatory/supervisory powers of the Ministry of Finance,
Banco de la Republic, Superintendencia Financiera, etc.?
●
Does Colombia need a consumer protection agency? Does
it have regulations that require adequate disclosure, in clear
and simple language, of the terms of mortgage loans and
other credit facilities, charges and penalties? (Such
regulations protect not only the consumer but also the
lender.)
●
Are lending standards/criteria used by banks for making
mortgage loans and other loans appropriate to ensure
satisfactory loan quality?
●
Are derivative instruments used wisely and appropriately to
hedge risk or are they being used for speculative purposes
as bets on future market moves? Should naked swaps be
prohibited or curtailed?
D. Colombia Should Not Waste this Opportunity
• Hopefully, Colombia can take advantage of the
enormous pain and losses the U.S. has suffered to learn
from the mistakes of the U.S. and implement appropriate
reforms that will help prevent future financial crises from
occurring and enable the government and the financial
sector to avoid problems or remedy them if and when
they arise.
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ANDREW C. QUALE, JR.
Andrew C. Quale, Jr. is a partner in the New York office of the international law firm, Sidley Austin LLP. His legal practice focuses
on international corporate and financial matters, including cross-border mergers and acquisitions, banking and capital markets
transactions, project finance, securitizations, and privatizations. He advises multinational financial institutions and industrial
groups, sovereign governments and state-owned enterprises on transactions and projects involving the United States, Latin
America, Europe and Asia.
Mr. Quale has served as a consultant to the World Bank, the Inter-American Development Bank and the United Nations on
international financings, project finance and privatizations. He is a frequent lecturer and author on international financial issues,
and has testified before the United States Senate Banking Committee and spoken at conferences throughout the United States
and in Bogotá, Buenos Aires, Caracas, Lima, London, Madrid, Milan, Nigeria, Sao Paulo, and Singapore on international
financings, privatizations, private equity investing, bank regulatory and insolvency and the international debt problem. His recent
publications include articles on American/Global Depositary Receipts, privatizations, cross-border securitization transactions and
international debt restructurings for publications such as The International Lawyer, The Economist and LatinFinance publications.
Mr. Quale has advised Latin American governments and state-owned enterprises on international financings, privatizations,
securitizations, foreign trade, corporate governance, international litigation matters and regulatory framework and concession
arrangements for the distribution of energy. Mr. Quale has served as an advisor to the governments of Colombia, France,
Indonesia, Sweden and Venezuela on legal reform projects and the acquisition and sale of state-owned enterprises. He served as
an advisor to the Minister of Finance and the Colombian government as a member of the Comisión de la Reforma Tributaria
which was directed by Harvard Professor Richard Musgrave. He also advised the Banco de la Republic and the Colombian
Ministries of Finance, Justice, Economic Development and Telecommunications on various legal regulatory reforms and financing
and privatization transactions. He taught at the Faculties of Law at Universidad de los Andes and Universidad Externado.
Education:
Harvard College, A.B., Magna Cum Laude
Harvard Law School, LL.B., Cum Laude
Cambridge University (Harvard Knox Fellow)
Sidley Austin LLP, 787 Seventh Avenue, New York, New York 10019
Phone: 212-839-7360 Fax: 212-839-5599 E-mail: [email protected]
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