By Rachel Kent and Dominic Hill
Does CETA provide a workable model for market access in the financial services industry? At the risk of spoiling the plot: no, not really. What does the industry mean when it says it wants market access?
The IRSG/CityUK Report on Third Country Regimes and other Alternatives to Passporting noted the UK Government's desire to seek as much mutual access in financial services as possible. Given that the UK Government has also rejected the option of EEA membership, passporting – at least in its current form – is off the agenda. The Report concluded that, in this case, a bespoke mutual access deal providing something as close as possible to passporting is the optimal solution.
The draft EU Guidelines issued in response to the Article 50 notice said "The European Council welcomes and shares the UK's desire to establish a close partnership between the Union and the United Kingdom after its departure. While a relationship between the Union and a non Member State cannot offer the same benefits as Union membership, strong and constructive ties will remain in both sides' interest and should encompass more than just trade."
Some commentators have suggested that CETA might form a useful basis for such a deal.
"The existing examples of free trade agreements (whether involving the EU or not) are complex documents in which every provision is likely to have been the subject of intensive negotiations. It is obvious that it will be increasingly important, as part of agreeing a post-Brexit deal, to be able to interpret those provisions – both to determine whether they provide helpful precedent but also to determine to what extent the UK and EU can reach their own agreement without violating the terms of existing agreements."
Rachel Kent, Partner, Hogan Lovells, London
What does CETA do in respect of financial services? Does it provide anything close to passporting?
Following normal concepts of international trade agreements, CETA confirms the position on financial services by reference to the following four "modes" of providing services between two territories:
- facilitating the provision of cross-border services from one territory to the other;
- permitting the sale of products in a territory for visitors from the other territory;
- the right to establish a physical presence such as a branch or a subsidiary in the other territory; and
- the right for individuals to visit the territory of the other in pursuit of financial service business.
CETA allows financial institutions from one party's territory to conduct cross-border activities under all four modes without fear of discrimination in comparison to financial institutions from within the territory of the other party.
So is this a big deal? Doesn't this sound familiar? Obvious, even? Can't Canadian businesses operate in the EU on this basis anyway? Yes - and that is because CETA follows closely the WTO's General Agreement on Trade and Services ("GATS"), to which the EU and Canada are signatories.
So does CETA provide market access in a way that mitigates the loss of passporting? Given that CETA does nothing to facilitate provision of services without a local licence (which would be the main purpose of such a deal in relation to financial services, since the licensing requirement is usually the most significant obstacle to the provision of cross-border financial services) it is difficult to see how that argument can be made.
"The CETA largely commits the parties to maintain existing levels of market access for services, including financial services. This does not include the right to provide financial services cross-border without a local licence. That said, if the EU subsequently liberalises cross-border access for financial services, CETA will to a large extent lock those changes in for the benefit of Canadian firms."
Matthew Kronby, Partner, Bennett Jones LLP, Toronto
Article 13.7.6 of CETA does appear to allow the parties to access each other's markets under the first two modes, as long as there is no physical presence, without the need for local authorisation. It provides that each party shall permit a person located in its territory (say, Germany) (and a national, wherever they are located) to purchase a financial service from a cross-border financial service supplier of the other party located in the territory of the other party (say, Canada).
At first sight, this has similarities to the exemptions that exist in various EU member states for access via reverse solicitation, and to the "UK Overseas Person Exclusion" ("OPE"), which permits overseas firms without a place of business in the UK to conduct business there subject to certain conditions. Counsel in Canada take the view that the provision could be read so that it would allow an EU person to purchase a product from a Canadian financial institution without the Canadian financial institution needing a licence in the EU member state in which the customer is based. As CETA was only entered into as recently as October 2016 and is not yet in force, it may be some time until the meaning of the provision is properly tested. Even if the wider reading of the article 13.7.6 is accepted, there are other provisions of CETA that could prevent it being used as the basis for a right of access for financial services firms:
- Range of services in scope
The conventional view is that the provisions of CETA that relate to financial services are – save in respect of a few member states who allow wider rights of access – limited to a few specific types of financial service, including certain types of insurance (maritime transport, commercial aviation and space launching and freight), reinsurance, certain banking-related services and portfolio management. Article 13.7.6 is not, however, expressly limited to those services in the way that other FS-related provisions of CETA are, and so it is arguable that the Article 13.7.6 applies to a wider range of financial services than is conventionally believed.
- No requirement to permit suppliers to do business or solicit
Article 13.7.6 states that it does not require a party to permit suppliers from the other territory to do business or solicit in its territory – and it allows each party to define what it means to "do business" or "solicit" in this context. If, for example, a party can define what it means to "do business" in its territory in such a way as to prevent its citizens from purchasing financial services from a supplier in another territory, that would negate the wider interpretation of Article 13.7.6 altogether.
Such an interpretation would, however, beg the question of what Article 13.7.6 was intended to achieve, if it could be circumvented so easily. The reason why this wording is used may lie in politics. Canada is also a party to the North American Free Trade Agreement ("NAFTA"), which contains an almost identical provision to Article 13.7.6 of CETA. The Canadians may have wanted to follow the NAFTA wording in the interests of consistency.
The view of US experts is that the equivalent provision of NAFTA would not give a supplier a general right to do business without a licence. In addition, the provision would allow a member state to define "doing business" and "solicitation" in a way that prevents outside parties from doing cross-border business without a licence. It could not do so in a discriminatory manner – e.g. by imposing licensing requirements on suppliers from a particular country only – but it could adopt a definition that applied to all WTO members equally and which, in effect, required them all to have a licence.
"The CETA language appears to have been drawn from NAFTA Article 1404, as the language is virtually identical, but NAFTA Article 1404 has never been interpreted to provide U.S., Canadian, and Mexican financial institutions anything that is close to resembling passport rights. It is intended to allow cross-border purchasing of the other FTA party’s financial services by individual customers, but it is highly unlikely that it could be used by financial services providers as the basis for systematically offering financial services across borders. It is also potentially subject to the Agreement’s prudential exception, registration requirements, and restrictions on ‘doing business’ and ‘solicitation’ if a financial services provider becomes overly enthusiastic."
Warren Maruyama, Partner, Hogan Lovells, Washington D.C.
CETA, like many FTAs (including GATS), contains an exemption known as the prudential carve out ("PCO"). The PCO is a carve out which allows a country to take measures (that might otherwise contravene CETA) for prudential reasons, such as to protect investors, maintain the safety and soundness of a financial firm or ensure the integrity and stability of a party's financial system. The measures must be reasonable.
Any alternative to passporting (whether limited to business with no physical presence or otherwise) would be likely to require some form of mutual recognition of the respective parties regulatory and supervisory regimes. In this context, CETA provides for laws to be made available promptly and in sufficient time to allow the other party to comment. There is nothing that requires any greater attempt at alignment. Without meaningful provisions on mutual recognition there seems little prospect of a passport-like regime to provide mutual access.
There are, however, other provisions in CETA which may help with the development of some of the more process-related requirements such as dispute resolution regimes.
In addition, there is another provision which, although at first sight, appears to provide a useful precedent might yet become a thorn in the side of the prospects of a UK/EU mutual access deal.
CETA contains a "Most Favoured Nation" ("MFN") clause. This means that neither party can treat the other party less favourably than it treats a third country. Its existence in CETA means that the EU cannot now offer the UK a more favourable deal than that contained in CETA – at least not without offering it to Canada (and possibly to other countries with the benefit of a similar provision) as well.
There appears to be a view that if an FTA (for example, between the UK and EU) is sufficiently broad, this this will disapply the MFN provisions. Indeed, if we look at the GATS rules, an MFN clause will not apply if the contracting parties are entering into a free trade agreement liberalising trade in services, provided that such an agreement:
(a) has substantial sectoral coverage (i.e. it is not limited to just one sector or a small number of sectors), and
(b) provides for the absence or elimination of substantially all discrimination in those sectors, through the elimination of existing discriminatory measures and/or the prohibition of new or more discriminatory measures.
It is, however, open to the parties to an FTA to agree more rigorous MFN provisions than GATS provides for, and CETA is an example of such an agreement. The MFN provisions in CETA will only allow a future FTA entered into by the EU to accord differential treatment to another country (such as the UK) if that future FTA:
(a) creates an internal market in services and investment;
(b) grants the right of establishment; or
(c) requires the approximation of legislation in one or more economic sectors.
In this context, an internal market means an area without internal frontiers in which the free movement of services, capital and persons is ensured. The UK, however, is unlikely to accept the free movement of persons.
Granting a right of establishment means an obligation to abolish in substance all barriers to establishment – and includes a right for nationals of the parties to set up and operate enterprises in the other country under the same conditions as apply to nationals of that country. Since the UK will want the right of establishment as part of an FTA with the EU, it could aim to satisfy this requirement. It remains unclear, however, whether a right for nationals to operate enterprises in the other country would require anything akin to free movement of persons.
The best bet for the UK and EU may be to ensure that their future FTA requires the approximation of legislation in one or more economic sectors. This would mean either aligning the legislation of one party with that of the other, or both parties incorporating common legislation into their law. Since any UK/EU FTA is likely to require a degree of regulatory alignment in any event, this may be the area that is most likely to satisfy the CETA requirements.
"Although the terms of CETA have been agreed, the agreement has not yet entered into force, even on a provisional basis, and so its provisions remain untested. The scope of those provisions, and in particular the exceptions to the most-favoured-nation clause, may yet prove to be important in framing the approach of the EU to any free trade agreement with the UK."
Lourdes Catrain, Partner, Hogan Lovells, Brussels
Whilst CETA therefore offers some pointers as to what certain specific provisions of a UK/EU FTA might look like, it does not in itself provide a model which could readily be used for the kind of wide scale access for financial services that the UK Government is looking for. Furthermore, the existence of MFN provisions in CETA and other FTAs need to be borne in mind in the context of determining the scope of future trade deals.