Part Two: Introduction to Free Trade Agreements

Ursula Johnston: Hello and welcome to the next module in the Gowling WLG World Trade Organisation and International Trade Law series.

Today we are going to talk about free trade agreements with the object in providing you with an overview and introduction to the subject.

I am Ursula Johnston, a director I the EU Trade and Competition Team based in London and today I am really pleased to be joined by my colleague Natalie Jukes, an Associate in our team also based in London.

So just as a quick reminder what we are trying to do with this series is to take you through a number of key topics at a very introductory level to enable you to have an understanding of some of the frameworks that govern international trade.

So today we are going to cover well what is a free trade agreement, or FTA, what are some of the key characteristics, what is the current EU pre-trade agreement landscape, who are its current trading partners under one of these particular frameworks, what is the impact from the UK's departure from the EU on the UK's participation in those current EU trade agreements.

The WTO as we discussed on one of the earlier modules is a multilateral framework which has more than 160 countries engage in negotiations on an on-going basis to seek to reduce tariffs on certain sectors and also to remove other non-tariff barriers to trade, for example by reducing the amount of licences or paperwork required at the border.

As we also discussed there are several agreements that contain the specific rules that govern international trade for which the WTO has mandate to oversee their implementation. So there is nothing however in the WTO agreements or the general agreement on the tariffs and trade or the general agreement on the trade and services that prevents countries from entering into other smaller trade arrangements in addition to the WTO. So therefore you can affectively agree to have a trade relationship that sits outside the WTO framework, and these arrangements can take a number of forms, including free trade agreements, which is the topic for today, but it is also important to bear in mind that there are other types of agreements, they could be referred to as preferential trade arrangements which is just looking at duty rates predominately, regional trade agreements where you have a number of countries forming a broad economic alignment and seeking to reduce internal barriers amongst themselves and essentially what happens is that, you know, each different type of agreement they create a mini trade regime, if you like, and that link that seeks link those members in a number of ways.

It is just very key as we go through this to remember that under WTO rules the country, so members of the WTO, cannot discriminate between their partners because they have to appear as principle as most favoured nation, the MFN principle and they can only move outside of that MFN principle when FTA is in place.

So just thinking about what is the current UK's position, how is the UK integrated into the framework of international trade, well on the one hand it trades with non-WTO members, so for example Iran, Belarus, Sudan and those terms they are not governed by the WTO. We then trade with members of the WTO, notably big trading partners such as India, the US, China with which we have no existing trade agreement. We then trade with countries such as Japan, Canada, Mexico, Chile, Peru which we do have trade agreements and those trade agreements have different levels of sophistication, depth of integration, sectoral coverage and what you see is as pre-trade agreements have developed over the last 20 years they are becoming more and more comprehensive, so whereas initially the first trade agreements that were signed they really focused on goods and tariff collection on those goods and the rates that could be levied, but now we see with agreements such as the Canada agreements which I know I know Natalie will discuss in some more detail later, when you are looking much broader than that we are looking at services, we are looking at working at labour, we are looking at access to government procurement, and what that means is that we almost step away from this idea of preferential trading to looking at really what when why it becomes more like regulatory alignment.

The UK then obviously is a customs union with the EU, although at the moment we are in a transitional phase, this webinar is being recorded in April 2020 and at the time of the recording it still is the plan and it still in law that the UK will leave the EU by the end of this year, so we will move out of the current EU customs union and what that means is that we share an external border for customs purposes, we sign free trade agreements as one trading unit effectively and we obviously do not charge customs duties on trade that move between member state to member state and similarly we have free market access to services.

We then have a sort of slightly different arrangement with Turkey. So the EU/Turkey customs union creates a customs union between Turkey and the EU, so it says what it does on the tin. However, there are a few carve-outs, for example, agricultural products, some service sectors, and so therefore we call it a customs union with reservations, it is incomplete.

This is just to really recap on what I have just been through but what is an FTA a free trade agreement, it is a treaty, it is a formalised legally binding treaty between two or more countries that seek to produce or eliminate barriers to trade and to encourage a strong economic relationship.

Natalie Jukes: It is also important to note that free trade agreements do not necessarily remove all control of imports and exports and what they cover is largely dependent on the preference of the signatory countries. So they work to encourage and foster trade relationships between those signatory countries for example by implementing trade facilitation measures which essentially provide a better market access by reducing the tariffs so for example the import duties and restrictions on goods or services that they trade between each other.

As Ursula will cover shortly each free trade agreement will confirm for example the various rules of origin and how to access preferential rates of duty for goods and service.

Some more comprehensive free trade agreements might also cover services for example the mutual recognition of professional complications or they may provide access to public procurement opportunities for example in relation to infrastructure within the signatory countries.

Ursula: So how does the WTO regulate trade agreements? Well they use regulated under the general agreement on tariffs and trade and the general agreement on trade and services and also there is an enabling clause which also covers trade negotiation.

The provisions in GATT and GATS essentially recognises five forms of potential agreements, so those that are mentioned in the slide formerly looked at the level of economic integration but just to recap. So you can have a free trade area so we do not have currently any free trade areas that the UK is a member of but a free trade area is typically when the members of that area try to further their WTO obligations and try and liberalise trade amongst themselves. You secondly have customs unions which are essential FTAs with a common external commercial policy and then you have the interim agreements. So you can have an interim agreement which you can enter into with the view that you will conclude a preferential trade agreement or an FTA. You have preferential trade agreements, PTAs, which really are used in particular for producing more trade liberalisation amongst less developed countries and then finally you have, particularly in the services area, what we refer to as economic integration agreements. And what it says is that, if you have an FTA, and RTA, a PTA, is that you can deviate from MFN treatment for the parties that are signatory.

I think what is quite important to note, and this is something that is a theme that hopefully is through this training, is looking at the strategy at the WTO and what role it can play in the current global trade environment is that PTS and FTAs are always intended to be the exception rather than the rule of the WTO. So the idea is that you would not need to call on these bilateral deals or multilateral deals with several parties because essentially the WTO could do that for you. That was the intention that WTO would liberalise and equalise trade without the need for side deals. But obviously now side deals have become the norm and we now have potential trade agreements being negotiated where you have potentially five, six, seven parties of a trans-pacific partnership agreement that is under negotiation.

So almost the constraints and size of WTO has forced countries to look at other ways to liberalise international trade and to open up market access between themselves and their preferred trading partners.

And what this has done is created what we call the spaghetti bowl effect of trade agreements. I think we now have nearly 450 trade agreements signed once the UK leaves the EU and starts to negotiate and finalise its new trade agreements that is going to obviously increase and we are looking at this from a commercial perspective, businesses find it really hard to understand how this spaghetti bowl of trade agreements overlay their commercial decisions around procurement, manufacturing, supply chain, routes to market because quite often and particularly if I look at the South East Asia region, what you can up at, is you can end up where actually you have a choice between one, two or even three different trade agreements under which to trade and this will add a layer of complexity for businesses who would like to benefit from these preferential trade agreements.

Natalie: So on the screen you will see the current EU free trade agreement landscape mapped out and what is interesting to see in all of this is that, although the EU has a number of various trade agreements in place, it notably does not have one in place with the more bigger players such as China and the US.

Now one of the key reasons as to why this may be is that negotiating a free trade agreement is a very lengthy process. A good example of just how long FTAs can take to negotiate and what goes into producing an effective free trade agreement is the comprehensive economic trade agreement CETA between the EU and Canada. So to put that in context the 2007 EU Canada summit mark the start of that free trade agreement process with negotiations commencing two years later in 2009 after some initial scoping and essentially the negotiations were concluded in 2014 and the agreement has applied provisionally since 2017. So all in all that process took some ten years from when that project, namely creating an effective free trade agreement commenced and to further put into perspective just how lengthy some of the free trade agreements can be in terms of their contents, the CETA text runs to some 1,598 pages with 860 of those pages being reservations, so in other words exceptions to the commitments in the free trade agreement.

An example of one of many exceptions included in the CETA includes restricting the cross border supply of health services from the UK. It is also important to note and as Ursula touched upon earlier that there are alternatives to free trade agreements which do not bring such deep integration as a free trade agreement.

So it is essentially possible to have a bilateral economic integration without being in a fully integrated partnership.

An example of such an agreement is the 2008 EU and Australia partnership framework which essentially facilitates trade and industrial products by reducing technical barriers and by improving trade in services and investment. However, this EU and Australia partnership framework is in no means a fully comprehensive free trade agreement.

Ursula: So I am hoping that now we have got to this stage in our discussion that hopefully some of the key aspects of a trade agreement have come across and we have not obviously entered into the nitty gritty yet, but ideally what should a trade agreement do, it should encourage industrial growth, encourage trade lower prices for consumer, help less developed countries to prosper and to grow. However, there is obviously a concern or there is obviously always the risk that the geopolitical landscape is such that people and leaders, governments can use trade agreement negotiations for their own political strategy and then this can in turn cause global instability as situations develop and people look at how these agreements have been implemented and what the provisions may or may not allow particular governments to do.

Ultimately we also run the risk when we are looking at the adoption of trade agreements that you have two parties in the negotiation process. Like anything, me and my children negotiating over iPad usage at the moment, for example, the weaker party essentially makes too many concessions and comes off worse and definitely in iPad negotiation right now, I am the weaker party.

So looking an FTA what is the content, what does it consist of? Well I will not run through all of these, hopefully there is enough differentiation on the pie chart, on the colour definition for you to see, but you will see that essentially a third of the agreements and if you were to print off all the pages then you would see a third of that is dedicated to looking at removing tariffs on goods.

Actually what might happen is those tariffs will have a schedule for reduction over time, particularly in more sensitive industries such as agriculture, automotive to allow domestic suppliers and purchasers to have that evening out so there is not such an immediate shock on domestic pricing.

And then I think around a fifth of a trade agreement is around services and then the next chunk around regulatory standards of cooperation it is becoming an increasingly important part of trade agreements and I think as we go into the negotiation process of the EU is that regulatory standards and cooperation will form much bigger proportion of the EU/UK trade agreement then perhaps it has done with other older style trade agreements.

And then all the other pieces that they really look to move barriers to trade so we come down to labour standards, environmental rules and when look at environmental rules for example, those are normally around commitment to upholding or aiming to uphold particular internationally agreed targets around omissions for example.

And then right at the end you will see the agreement deals with trade remedies, in case of a dispute or in case of we have uneven markets that have been created by this trade agreement, what are the options open to each party to try and level up the playing field again.

So if you looking at goods how do you ensure that your goods benefit from that free trade agreement, so that you can trade them with the lower or zero duty rates being applicable.

Well you have to demonstrate that they qualify, that they come from, they originate in that party to the agreement that you are basing or goods are being manufactured and there is essential four ways in that that can be demonstrated and each type of good will have its own rule attached. So typically for agricultural products the rule will be around wholly obtained so potatoes, they are dug out of the ground, they are clearly wholly obtained in the country in which the potatoes were originally planted.

Regional value content, that gets more complicated because they are saying oh there is a percentage threshold which you need to say that your goods originate, so how much value from that particular product or intermediate material has been generated in one of the member countries to that trade agreement. The threshold again will vary depending on what type of good and how sensitive it is in the respective markets.

Another potential rule that can apply as you say, well your goods started with manufacture, let us say, violins for example. So you clearly start with a piece of wood which has its own type classification, you have some other piece, horse hairs to make the bow, so actually what you are saying is that by the time I have manufactured a violin it was this kind of good but now I have managed to shift it through the manufacturing process being another type of good and that is known as a tariff shift.

And the fourth rule that applies is that it has to be substantial transformation, so it has to be more than just bringing in some goods for packaging, quality testing, it has to go further, you have to substantially transform those goods. So for example, let us take that violin again, I bring a violin from China but perhaps the strings are not attached and I am sure there is a much more technical way then calling the strings, but perhaps the strings are not attached, but they are actually in a packet, they come to the UK and I attach the strings. Unlikely that would be considered substantial transformation.

So where just to take an example, chocolate bar, we have all apparently been eating far too much chocolate under lockdown and we have just come out of Easter so potentially topical but, under the Canada/EU CETA agreement, it will be considered originating, it has to be manufactured from goods that have substantially changed, they have shifted from type of product to another, so using that tariff shift rule and then any, if we add non-local, so non-EU sourced sugar and dairy content it must be below a particular weight or total value of the resulting chocolate bar. So here, if you are manufacturer of chocolates, so we will say Cadburys, actually if you think about it to try and demonstrate to capture the data in your supply chain that can demonstrate that what you started with has shifted and then you have, you have managed to capture a particular threshold around grades and value of non-locally sourced dairy and sugar, that is quite difficult because if you are a big, if you run a big production line, you may not get your sugar and your dairy from the same space every time, because you will buy sugar according to global pricing and that starts to become a real challenge and we particularly see this in industries such as the automotive industry where duty rates are particularly high both on finished vehicle and parts but the supply chains that sit behind those manufacturing clients in the UK are really complex and so this is a big challenge for UK business and this will continue to be an even bigger challenge next year.

Natalie: So the more comprehensive free trade agreements will contain some form of alignment on the provision of services. Now in the UK the various services industries do make up roughly 45 percent of total UK exports. The same notion of the World Trade Organisation rules applies to the provision of services in that World Trade Organisation members are required to grant equal treatment for services and service to clients within the WTO network, unless, a free trade agreement applies and in the EU the services industries are of course more deeply integrated by virtue of the single market imperative guided by the four fundamental freedoms of which the free movement of services is one.

Where free trade agreements to contain provisions on services some market access restrictions are using left in place, for example, in areas of financial services or in the more sensitive service industries.

Lastly, some consideration needs to be given to digital trade in services.  Essentially what we mean by this is the cross border transfer of data, products or services by electronic means such as the internet and the internet as we know is a very powerful tool in today's globalised world and of course in the absence of global digital trade rules many countries have worked towards establishing provisions on digital trade through specific rules and provisions within their free trade agreements.  It is now therefore increasingly common to find standard chapters or articles dedicated to ecommerce issues alone.

In terms of some useful examples where free trade agreements cover digital trade and services in quite some depth, it is useful to look at the United States/Mexico/Canada agreement which essentially updates the North American free trade agreements and of course the comprehensive and progressive trans-pacific partnership which as Ursula alluded to earlier, spans across 11 signatory countries. These agreements contain provisions on issues such as data flows, data localisation and the removal of digital tariffs as well as covering new ground such as cyber security and regulatory corporation.

So there are several modes to provision of services within free trade agreements, for example, utilising cross-border supply including via the internet. Consumption abroad within the signatory countries. Having a commercial presence of a company in the territory for example a subsidiary operating in that country in question and the movement of natural persons.

Those modes are all outlined in the World Trade Organisation's general agreement on trade and services and are applied widely across various trade agreements.

So considering some examples of services then, more generally, in the comprehensive and economic trade agreement between the EU and Canada. The parties commit to ensuring a fair equal access to each other's services markets. For example in the legal accountancy transport and telecoms service spaces. The agreement, for instance, includes comprehensive measures on maritime services to ensure fair and equal access to ports and port services for commercial ships and additionally creates a framework of mutual recognition of professional qualifications which allow EU and Canada to recognise professional qualifications obtained on both sides of the Atlantic.

In certain industries, the EU and Canada have made some exceptions as I alluded to before, for example, in audio visual services and certain aviation services which are deemed more sensitive.

Some reservations also apply to the provision of financial services whereby financial services firms may only offer their services in a limited number of sectors, including insurance and banking sectors. And of course as I have just discussed the digital trading services, recognising the importance of the development of ecommerce. The CETA also contains separate provisions in this area and the two parties essentially promise to cooperate on issues related to ecommerce and digital issues. For example, on tackling spam or as we know it the unsolicited communications that we receive and it also seeks to remove digital customs duties on delivery transmitted by electronic means.

So as we all know the UK left the European Union on 31 January 2020 and is currently in a so called transition period which is currently due to end on 31 December 2020 and during this time the UK will essentially seek to agree its trade relationships with the EU and non-EU countries going forward.

As Usual also mentioned earlier and for now it remains unclear whether the UK will seek an extension to the transition period and it has until the end of June to do so. So essentially we should be in a better informed position on the UK's intentions with that extension by the end of June or early July. But for the purposes of the UK's trade relationships during the transition period, so until 31 December we assume. The EU actually sent some diplomatic correspondence to the World Trade Organisation in late January essentially confirming that the UK will be treated as an EU member state for the purposes of the EU's free trade agreements and other international agreements during this transition period.

So in anticipation of the 1 January 2021, when the UK will likely be a third country vis a vis the EU, the UK has now sought to transition the trade agreements that the EU has concluded and which currently apply with certain countries. The UK has already agreed a number of continuity agreements or rollover agreements as they are also known, with many of the third countries which will essentially take effect post transition period. These are in most part short form agreements which incorporate in so far as possible the relevant provisions of the underlying EU agreements with relatively few necessary modifications. Although they can also be long form, instead of short form, for example if we look at the agreed trade agreements between Switzerland the UK for example, that is adopting a long form format, so it really depends on the preference of the parties as to what those continuity agreements will look like.

So this slide outlines the countries which are considered key for UK trade and considers the status of those key agreements in relation to post transition period 1 January 2021. As we can see the UK is currently engaging in ongoing negotiations with respect to the future trading relationships with certain countries, including for example, Canada, Japan, Mexico and some of the European Free Trade Association member states namely Iceland and Norway. With regard to the former three so Canada, Japan and Mexico the UK has actually consulted on and is considering joining the comprehensive and progressive agreement for trans-pacific partnership which is a free trade agreement between Canada and ten other countries and essentially includes Japan and Mexico and it also potentially considers joining the United States/Mexico/Canada agreement which as I alluded to previously updates the North American free trade agreements.

As a side it should be noted that the UK and Japan have actually agreed to negotiate a new bilateral agreement which uses the existing EU agreement as a base. However, they are looking for opportunities to enhance areas of mutual interest, so perhaps joining the comprehensive and progressive agreement for trans-pacific partnership may provide that opportunity for the UK to enhance that mutual interest.

Looking at the FTA countries you will see that there are still ongoing negotiations with Iceland and Norway. Now interestingly the UK had actually initially signed up to a trade agreement with both Iceland and Norway back in 2019. However, that agreement was actually designed to maintain continuity of trade in preparations for the potential no deal Brexit and as we all know the no deal situation was essentially prevented by the approval and ratification of the withdrawal agreement. So that trade agreement that was actually signed between the UK, Iceland and Norway has since been withdrawn.

So what that essentially means is that the future trading relationship between the UK, Iceland and Norway is dependent on the outcome of any subsequent trade negotiations and as we know from the earlier slides in this presentation, if those countries do not conclude a trade agreement then the World Trade Organisation rules will apply.

So moving on from the side trade agreements, sorry moving on to the side trade agreements, which will take effect from 1 January you will note interestingly in comparison to the situation between the UK, Iceland and Norway that the UK has signed up to a trade agreement with Switzerland. So it is not as comprehensive as a free trade agreement, so it does not cover things like services and intellectual property, for example, and it is also good to note that the additional agreement between the UK, Switzerland and Lichtenstein brings in Lichtenstein under certain provisions of the UK/Switzerland trade agreement.

And just to cover the last few countries on this slide. The UK has also signed up to a free trade agreement with South Korea. It has signed to an association agreement with Chile which establishes a political and economic association essentially and also it has signed up to an economic partnership agreement with the South African Customs Union member states and Mozambique.

Ursula: Thanks Natalie and I think just what will be interesting to observe as the UK transfers its trade landscape eventually what, and we are talking about goods here, rather than services probably, but to what extent some of these trade agreements, so let us take Japan for example, will allow for diagonal accumulation so that is to say that essentially the EU content and UK content can become interchangeable for the purposes of accessing professional trade under those two agreements. Again that will create definitely an additional layer of complexity for businesses and government alike.

Well thanks very much Natalie for your contribution today, I have really enjoyed putting together this short session with you. If you do have any questions coming from this session or any of the other topics that we cover or anything related to trade at all, please do feel free to reach out to one of the team. We wish you well wherever you may be whilst you are listening or looking at this presentation and we look forward to meeting with you soon.

OK, thank you, bye-bye.