The European Economic Area

53. When we began this inquiry in late 2016, continuing UK membership of the Single Market, via non-EU membership of the European Economic Area (EEA), was the favoured option of most witnesses. The Professional and Business Services Council said that although the Single Market was “far from perfect”, it was “still the most integrated market in the world for services that is not a single State”.61 Representing small and medium-sized enterprises (SMEs) in the professional business services sector, Ian Harris, Director of Z/Yen, told us that the “EEA model is the only one we could possibly, possibly, in practical terms, implement without damaging ourselves economically within the time-frame permitted”.62

Free trade agreements (FTAs)

The Government’s view

54. Membership of the Single Market or of the EEA was ruled out by the Prime Minister, in her Lancaster House speech on 17 January 2017. She made it clear that the UK would pursue a “bold and ambitious” FTA with the European Union which would “aim for the freest possible trade in goods and services” between the UK and the EU.63

55. Commenting on the content of a future UK-EU FTA, the Prime Minister said that the Government would “not seek to hold on to bits of membership as we leave”, but that it might “take in elements of current Single Market arrangements in certain areas”, such as the “freedom to provide financial services across national borders”. She described this as a pragmatic approach: “It makes no sense to start again from scratch when Britain and the remaining Member States have adhered to the same rules for so many years.” The Prime Minister said that an FTA should also “give British companies the maximum freedom to trade with and operate within European markets and let European businesses do the same in Britain”.64

EU FTAs

56.A FTA is an agreement between two or more countries, or between international organisations and countries, that aims to liberalise the trade of goods and, in the case of comprehensive FTAs, services. Rather than providing completely free trade, they provide preferential market access relative to a situation in which no agreement exists. Depending on the comprehensiveness of what is negotiated, FTAs can provide increased market access and lower non-tariff barriers for services compared to trading under WTO rules.65

57.FTAs can and do vary significantly in the levels of market access they provide, and the extent to which they reduce non-tariff barriers for different goods and services sectors. However, in order to abide by WTO rules (under Article V of the GATS), FTAs must have “substantial sectoral coverage”.66 This means that individual sectoral trade agreements (covering just telecoms, for example), outside a wider FTA, would not be legal under WTO rules. This is an important constraint, given that some sectors appeared to be calling for a sectoral agreement with the EU. We acknowledge that Article V and other WTO conditions have rarely been raised in dispute settlement procedures at the WTO, have been poorly enforced, and that there is considerable uncertainty over the definitions used. Nonetheless, they would appear to preclude the UK from pursuing separate trade agreements for individual sectors.67

58. Generally, the services aspects of a FTA can be negotiated differentially, according to a ‘positive’ or ‘negative’ list approach. Under a ‘positive list’ approach (similar to the approach taken at the WTO under the GATS), signatories choose which sectors to list, and what commitments to make to their trading partner, understanding that no commitments are undertaken for the sectors not listed. Under a ‘negative list’ approach, signatories are required to list all services sectors in which they wish to maintain restrictions towards foreign individuals and firms and what those restrictions are. The negative list approach increases transparency for businesses and encourages greater liberalisation (as parties have to review all the domestic legislation that affects these sectors). However, negotiations may require more time, as signatories need to consolidate and process a vast array of information. The EU has adopted both approaches, and hybrid approaches, in the past, but the recent EU-Canada FTA adopted a negative list approach.68

59. Examples of some of the most comprehensive EU FTAs regarding services are outlined below in Boxes 1, 2 and 3.
Box 1: Treatment of services in Swiss-EU bilateral agreements

Over the last two decades, Switzerland and the EU have negotiated a bespoke bilateral trade arrangement, which encompasses over 100 individual agreements covering a diverse range of issues and sectors. Among the most significant of these agreements is the 1972 Free Trade Agreement, which laid the groundwork for trade relations. It also provided the foundation for seven sectoral agreements (known as ‘Bilateral Agreements I’) signed in 1999, which covered the free movement of persons, technical barriers to trade, public procurement markets, agriculture, research, civil aviation and overland transport, and nine agreements covering broader topics (known as ‘Bilateral Agreements II’), which were signed in 2004. Although the trade relationship between the EU and Switzerland is made up of hundreds of bilateral agreements, in its entirety, it substantially liberalises trade and would seem to be comprehensive enough to meet the WTO’s conditions for ‘substantial sectoral coverage’.69

The EU and Switzerland do not have a specific agreement to facilitate trade in services. Instead, services trade is indirectly facilitated by the individual sectoral agreements under Bilateral I. Importantly, all the agreements under Bilateral I are linked, so that if either party reneges on an individual agreement, they all fall.71Relevant sectoral agreements within Bilateral I include:

Free movement of persons. Under this agreement, Swiss and EU nationals are entitled to the same working and living conditions in Switzerland and the EU. This agreement covers the temporary cross-border provision of services for short periods and includes employed, self-employed and other persons who have sufficient means. Importantly, the mutual recognition of professional qualifications and the coordination of social security payments are included within this agreement.
Air transport. This is the most comprehensive agreement between Switzerland and the EU. Switzerland is included in the EU’s single aviation market, and Swiss airlines have similar rights to EU airlines.71 In exchange, Switzerland has accepted the EU’s acquis in this sector and the EU’s rules on state aid.
Public procurement. This extends the WTO’s Global Agreement on Procurement (GPA) and includes provisions on market access in the telecommunications and rail transport sectors.

Audiovisual media services. Prior to 1992, Switzerland and the EU both belonged to the MEDIA programme, which promoted the creation and distribution of European films and training for film professionals. When Switzerland rejected membership of the EEA in 1992, its participation in this programme ended. Instead, trade in audiovisual media services relies on Switzerland’s participation in the European Council Transfrontier Television Convention.72
The EU and Switzerland have also agreed to liberalise trade in legal services, and the Lawyers’ Services Directive 77/249/EC and the Lawyers’ Establishment Directive 98/5/EC apply to Swiss lawyers in addition to lawyers qualified in the EU.73

Negotiations to expand the scope of these bilateral agreements to include greater trade in services have stalled, and the Council of Ministers has said it will not enter into further trade liberalisation without improvements to the institutional framework governing these agreements. Suggested changes include the creation of a supervisory body to monitor the implementation of EU legislation in domestic law, and an improved dispute resolution mechanism, ostensibly requiring similar institutions and processes to those used for non-EU EEA countries.74 Currently, dispute resolution is handled by joint committees representing both Switzerland and the European Commission, which are established for each of the principal agreements. Each joint committee is responsible for managing the agreement, ensuring its correct application and taking steps to adjust or revise the agreement where necessary.75
Box 2: Treatment of services in the EU-South Korea FTA

This agreement liberalises a number of services sectors. In telecoms, South Korea has relaxed its foreign ownership requirements, and EU satellite broadcasters also have the right to operate directly cross-border into Korea without having to liaise with the Korean regulator. On transportation, the agreement provides rights of establishment for EU shipping firms in Korea.

The agreement allows European law firms to open offices in South Korea, and to advise foreign investors or Korean clients on non-Korean law. Law firms are also able to form partnerships with Korean firms and recruit Korean lawyers, while all lawyers are allowed to use their domestically acquired qualifications. The agreement also includes provisions on investments and movement of capital.

The agreement improves on the WTO’s trade-related provisions on intellectual property rights (TRIPS), regarding recourse for copyright infringements, and includes provisions on unregistered designs (discussed in greater detail in Chapter 6). Both parties have agreed to prohibit and sanction anti-competitive practices and base their dispute resolution mechanisms on WTO processes.

Source: European Commission, ‘EU-South Korea FTA: a quick reading guide’ (October 2010): http://trade.ec.europa.eu/doclib/docs/2009/october/tradoc_145203.pdf [accessed 15 February 2017]

Box 3: Treatment of services in the EU-Canada Comprehensive Economic and Trade Agreement (CETA)

In relation to services, CETA contains provisions on increasing the transparency of Canadian rules and regulations at national and regional levels that might affect EU service providers. It liberalises trade for postal, telecommunications and marine transport services. The agreement follows a negative list approach, and binds Canada and the EU to not introduce new restrictions in these sectors in future. It includes an investment chapter about the flows of capital between the parties.
CETA also includes provisions on the temporary cross-border provision of services, principally by extending the time limit on intra-corporate transferees for up to three years, on a reciprocal basis. It also enables spouses and family members to accompany a transferee. It extends the time individual service suppliers or professionals can stay in either the EU or Canada from six to 12 months, and establishes a framework for the mutual recognition of professional qualifications, enabling detailed negotiations on specific professions to begin in due course.

The agreement, and any disputes, are managed by the CETA Joint Committee, which can reach binding decisions. Such decisions are made by consensus between the parties to the Joint Committee, including representatives from Canada and the EU.76

Source: European Commission, ‘CETA: Summary of the final negotiating results’ (February 2016): http://trade.ec.europa.eu/doclib/docs/2014/december/tradoc_152982.pdf [accessed 24 February 2017] and Theresa May MP, Speech on The Government’s negotiation objectives for exiting the EU, 17 January 2017: https://www.gov.uk/government/speeches/the-governments-negotiating-objectives-for-exiting-the-eu-pm-speech [accessed 15 February 2017]

The implications for a UK-EU FTA

60.In our report Brexit: the options for trade we concluded: “Negotiation of a Free Trade Agreement between the UK and the EU would be unprecedented. While FTA negotiations usually aim to increase market integration between two sides, the UK would start from a position of full integration, and would presumably seek to maintain many aspects of the status quo while reducing integration in some areas.”77

61.We note that a UK-EU FTA would also need to be broader in scope than existing FTAs. Raoul Ruparel, then Director of Open Europe and a witness to our previous inquiry, said services would “clearly be the most difficult sector” to negotiate in a UK-EU FTA, because “there is no precedent for third-country access to the Single Market in financial services and other services”.78 Markus Gehring, Professor of European Law at the University of Cambridge, said: “Let us be honest: the current acquis of EU rules is normally much broader [than a FTA].” While the CETA agreement included “some mild form of mutual recognition of qualifications”, there were “quite a few areas of the existing EU acquis that I have not seen in any FTA in a bilateral relationship”.79 Mr Ruparel noted that while CETA provided “some rights of establishment, and the ability to set up subsidiaries and entities in the EU”, it was “far short … of providing a passport and being able to provide a service from your home base in the UK”. There were also “hundreds of pages of restrictions”, and he concluded that a similar agreement between the UK and the EU “would be a big change for the UK, particularly on the services side”.80

62.Witnesses to the present inquiry echoed these views. The UK Trade Policy Observatory explained: “Broadly speaking … in the past services [FTAs] have done little in terms of actually improving market access.” They concluded that to replicate current conditions on trade in services would require a FTA of “unprecedented depth”.81

63.In her Lancaster House speech, the Prime Minister said that she wanted “to have reached an agreement about our future partnership by the time the 2-year Article 50 process has concluded”.82 In our previous report we noted that “FTA negotiations with the EU are complex and slow moving”, and highlighted the lack of clarity over whether negotiations on a UK-EU FTA could begin under the Article 50 process, or only post-withdrawal. We concluded that, even if it were possible to begin negotiations on a future UK-EU FTA during the Article 50 negotiating period, “it would be impossible to agree it within two years”. We also concluded that a UK-EU FTA including services would probably be a ‘mixed agreement’, therefore requiring the agreement of individual Member States, and, depending on their constitutional arrangements, national and regional parliaments. We recommended that, were the Government to seek to negotiate a FTA, “it should clarify whether it is also considering a transitional trading arrangement”.83

64.Finally, we concluded that a UK-EU FTA might require “stronger institutions than are normally included in FTAs to police their trading relationship”.84 In FTAs, the most common procedure for resolving trade disputes is state-to-state dispute settlement: a state complains about violations of the agreement by the other state to a joint panel or committee, including representatives of both parties. We noted that the establishment of a UK-EU court could improve on this, but might be regarded as an indirect way of imposing decisions made by the CJEU.85

Trading under World Trade Organization (WTO) rules

65.The Prime Minister also emphasised that the Government would be willing to forgo a preferential FTA with the EU, stating: “No deal for Britain is better than a bad deal for Britain.” A ‘no deal’ scenario would result in the UK trading with the EU on the basis of WTO rules.86

66.The aim of the WTO, and the WTO’s agreements, is to provide a stable and predictable global trading environment by ensuring member countries all agree on the basic rules for trade. As a general rule for all forms of trade, member countries must follow the WTO’s non-discrimination principles, which includes the Most Favoured Nation (MFN) principle. This means that countries cannot normally discriminate between their trading partners, and are obliged to offer the same market access conditions to all WTO members.87

67.The General Agreement on Trade in Services (GATS), which came into force in 1995, is the main global agreement governing international trade in services. Under this agreement, WTO member states can outline restrictions to trade in services across sectors and modes of supply (under their individual schedule of commitments). These restrictions can fall into two categories:
(1)those limiting ‘market access’ for a foreign firm or individual service provider entering a domestic services market (the GATS Art. XVI); and(2)those that affect the ‘national treatment’ of a foreign firm or individual compared to domestic competitors (GATS Art. XVII).88The GATS follows a ‘positive list’ approach, whereby member countries choose which sectors or sub-sectors to list.

68.The GATS framework does recognise the right of member countries to introduce new regulations, and to tailor their commitments in line with national policy, in cases where changes to domestic regulation do not discriminate against foreign service providers.

69.Trade disputes in the WTO are handled on a state-to-state basis between governments, and action on behalf of individuals or businesses is not possible. Allegations are heard by a panel of three to five experts (appointed by both sides). Their final recommendations are adopted by the General Council, convening as the Dispute Settlement Body, unless rejected by negative consensus. Although panel reports are generally adopted by the Council, both parties can appeal the outcome to a standing Appellate Body. If panel recommendations are not implemented, a party can request the authorisation of sanctions after a further round of consultations has failed.89

Agreeing the UK’s services schedule

70.Currently, the UK shares both the General Agreement on Tariffs and Trade (GATT) schedule, which covers goods, and GATS schedule with the EU. Post-Brexit, the UK will need to have its own schedules established under both agreements, and each schedule will have to be certified by other member countries of the WTO in order for the UK to be able to trade under WTO rules.

71.Our previous report found that gaining agreement to the UK’s schedules for goods and services raised a number of legal questions, not least in relation to whether, after enlargement, the EU’s current schedules have been certified by other WTO member countries—though Mr Eglin, Senior Trade Advisor at White and Case LLP, told us that a services schedule could be certified within in 45 days.90 The UK has made few derogations regarding market access and national treatment restrictions to the EU’s services schedule.

72.In evidence given to a separate inquiry into Brexit: trade in goods, Lord Price CVO, Minister of State for Trade Policy at the Department for International Trade, told the EU External Affairs Sub-Committee that the Government’s objective remained to “replicate as far as possible the schedule that we have today”.91
Implications of WTO rules for UK-EU trade in services

73.UK trade in services with the US (the UK’s second most important trading partner for services) is currently governed by WTO rules. More information on UK-US trade in services is provided in Box 4.
Box 4: UK-US trade in services under the WTO rules

The UK and the US do not trade on the basis of a preferential FTA, but on the basis of their respective services schedules under the GATS at the WTO. We note that the trade policies applied between the UK and US are in practice more liberal than provided for under GATS, but also that such policies can in in principle be withdrawn or tightened at any time. The Office of the US Trade Representative has stated that the US position in relation to the GATS is to “maintain current levels of market openness”, and to “remove significant trade impediments, such as local presence requirements, foreign equity limitations, and limitations on forms of establishment”.92

According to the US Department for International Commerce, the UK was the United States’ largest market for services exports in 2015 (worth $67 billion). Overall, the US imported $111 billion worth of goods and services from the UK in 2015, with ‘other business services’ being the largest services sector. In 2014, the UK-US had a direct investment relationship valued at $1.05 trillion.93

The OECD has created a Services Trade Restrictiveness Index (STRI), which identifies policy measures that restrict trade. The index measures trade restrictiveness (between 0 to 1, with 0 being the most open and 1 the most restricted) in 22 services sectors across 44 countries.94 On this index, in December 2016, the OECD reported that the US scored lower than average for 16 of the 22 services sectors covered. The sectors that were the most open were legal services, telecommunications services and rail freight transport. The sectors with the greatest restrictions were air and maritime transport, and courier services.95

In comparison, the UK was “one of the most open economies in services” out of the 44 countries included in the index, with a below average score on all 22 services sectors, except architecture. The UK’s most open sectors were legal services, rail freight transport and broadcasting. The UK’s most restricted sectors were accounting, architecture and engineering services.96

74.The UK Trade Policy Observatory observed that, as illustrated in Box 4, a country’s policies on trade in services were almost always appreciably more liberal than their GATS schedules. This situation is referred to as the ‘commitments overhang’. However, they added that trading on the basis of “applied MFN regimes”, rather than their stated schedules, “lack[ed] the legal certainty and predictability of membership [of] the Single Market”.97

75.In our previous report, we concluded that trading services under WTO rules would involve “much greater restrictions” than exist within the Single Market.98 Piet Eeckhout, Professor of EU Law at University College London, explained that when the GATS was agreed in 1995, it aimed to capture “the current state of domestic liberalisation”, but did not strive to be “a major liberalising force” for services. While the extent of market access in services provided by WTO agreements varied sector by sector, some industries, like aviation, were “hardly touched upon by WTO commitments”, and would be particularly badly affected.99

76.Reliance upon the WTO for the temporary cross-border movement of service providers (classified as mode 4 under GATS) could be particularly restrictive. The UK Trade Policy Observatory told us: “What is plain is that mode 4 clauses of the sort currently offered by the EU, would not provide access to anything like the numbers of workers that free mobility currently does.” More broadly, commitments on mode 4 “have to be applied on a most favoured nation basis” (and so cannot distinguish between persons by country of origin), which has discouraged greater liberalisation.100

77.Finally, we noted in our earlier report that WTO mechanisms for dispute resolution were “only accessible to businesses and individuals through governments”.101 Professor Barnard said the “reality” of the GATS was that “the enforcement vehicle is extremely cumbersome”:
“Because it is an international law agreement, it means one state bringing action against another. Will the UK Government be concerned that my little business, from which I want to provide some services in France, cannot get on to the French market, or the French are making it very difficult, and will the UK start a panel proceeding on my behalf? The answer is categorically no.”102

Conclusions

78.Although the EU Single Market in services is significantly less integrated than that in goods, it remains, even in its imperfect form, the most integrated market for trade in services in the world, and it continues to integrate further.

79.In the absence of Single Market membership, it will be much harder to liberalise trade in services than trade in goods. This is because trade in services often involves the movement of persons and either the harmonisation or mutual recognition of regulatory frameworks regarding how services should be supplied. The EU does not have harmonised trade policy in relation to trade in services with third countries outside the Single Market, meaning that UK businesses could face differing non-tariff barriers between Member States, which will be difficult to identify and quantify.

80.The UK’s starting-point in negotiations with the EU on a FTA is unprecedented and unique, in that, even though the Single Market in services is incomplete, the rules and regulations in the UK and EU will be, at the point of departure, completely harmonised. On the other hand, existing FTAs have not led to great liberalisation in trade in services. Rather, they tend to reduce the difference that exists between countries’ formal restrictions to trade listed at the WTO and the actual trade policies they apply (which tend to be more liberal). Even terms similar to those agreed under the most ambitious FTAs agreed by the EU, such as CETA, would represent a deterioration of trading conditions for UK businesses. This would be the case both for sectors in which a harmonised Single Market framework exists, and also for sectors that are reliant on the EU acquis for the elimination of non-tariff barriers to trade, such as the mutual recognition of professional qualifications, free movement of persons, and the free flow of data. In short, the UK will require the most comprehensive FTA in services ever agreed with the EU.

81.A deal which did not provide market access for all services sectors, or no deal at all, would result in the UK trading services with the EU on the basis of WTO rules, which would provide less favourable trading conditions than membership of the Single Market or a FTA. WTO terms would require the UK and the EU to comply with the ‘Most Favoured Nation’ principle: the UK would not be able to trade on more preferential terms with the EU, unless it applied those same terms to all other WTO member countries (and vice versa).

82.A dispute resolution mechanism will undoubtedly be a feature of the UK’s future trading relationship with the EU, implying an inherent trade-off between liberalising trade and the exercise of sovereignty. Under either a FTA or WTO rules there will be a fundamental change to the way in which trading terms are presently enforced for the UK. The Government needs to engage with service providers and clarify the dispute resolution mechanism it will seek in a FTA. It will also need to consider how individuals and businesses who were formerly able to appeal to domestic courts, and ultimately the Court of Justice of the European Union (CJEU), would be able to petition the Government to act on their behalf under an FTA or WTO trading rules scenario.