The MFN clause as a challenge to a bold and ambitious UK-EU FTA

Posted in WTO and international trade

The UK is leaving the EU. Negotiations are yet to commence in earnest given the intervention of an unexpected snap election in the UK but it is clear that the UK wishes to secure a free trade agreement (FTA) as the cornerstone of a new and special UK-EU partnership. To this end, the UK has proposed to negotiate a “bold and ambitious” FTA that “should be of greater scope and ambition than any such agreement before it so that it covers sectors crucial to our linked economies such as financial services and network industries”.

It is thus clear that the UK Government’s objective is to secure an FTA that provides for the maximum possible level of market access and which avoids the cliff-edge that would follow if a deal was not in place on Day 1 after exit, which would otherwise entail trade between the UK and the remaining EU 27 being in WTO terms only. In other words, the UK is seeking to retain as far as possible the trade benefits it currently enjoys as a member of the EU single market but without being a member of it (and being subject to all of the restrictions that apply to membership). An FTA of this ambition would go significantly beyond those previously negotiated by the EU, including the CETA arrangement with Canada and the FTA with Korea –perhaps the most advanced FTAs the EU has concluded to date. The question is then whether this is feasible – can an ambitious FTA UK-EU FTA replicate the advantages of the single market? And will the EU be prepared to enter into an agreement that goes further than FTAs it has negotiated with third countries?

There are many factors that influence the potential scope of trade deal between sovereign states - political, legal and technical complexities, not to mention anticipation of the ratification process for its entry into force (i.e. will the negotiating governments be able to “sell” the final deal to their national parliaments and domestic interest groups). Another important factor can be the application of restrictions that apply in deals already done. For example, FTAs already in force might include a Most Favoured Nation (MFN) clause inserted. This could prove significant in the case of the UK-EU FTA as many of EU’s FTAs with third countries include a MFN clause, for example the EU’s FTAs with South Korea, Canada, Singapore and CARIFORUM[1] amongst others.

The MFN principle is a cornerstone of the multilateral trading system. The WTO framework mandates its state members to extend immediately and unconditionally to every other WTO member any trade or market access concession made to any country. In that sense, every concession is “multilateralised” as every WTO member will benefit from every concession listed in any of the members schedules of concessions.

But – importantly, a comprehensive FTA is an exemption to the multilateral MFN principle under the WTO framework, because such agreements are – by definition – understood to advance trade liberalisation by allowing two or more countries to reduce trade barriers between them even further than they would be prepared to offer unilaterally to “all comers”. Hence, concessions made within an FTA only apply between the parties to the agreement as a deal struck for mutual benefits above and beyond the liberalisation achieved through WTO membership.

The inclusion of the MFN in preferential trade agreements, such as the FTA, however serves a different purpose. Its inclusion is to protect the interests of the parties to the agreement by locking-in the preferential market access and other benefits to avoid the erosion of those benefits through one country subsequently granting more liberalised concessions to other countries. In that way, parties to the original FTA also ensure that they will benefit from any trade concessions that the other party might grant in the future, at least in respect of the areas covered by the prior agreement.

The type of MFN clauses included in the EU FTAs with third countries will not apply to the entirety of concessions and commitments granted across the FTA. Rather, it is usually included in the FTAs within specific sectors, notably within chapters concerning trade in services and investments. For example, in the EU-South Korea FTA an MFN clause applies to provisions facilitating market access for services suppliers “cross-border” (i.e. businesses outside the EU being able to sell services into the EU) and for those provisions that support establishment (i.e. allowing foreign businesses to establish a commercial presence in the EU from which to trade).

So, how might this affect the detail of a UK-EU FTA? It means that any area covered by an MFN in an existing EU FTA could be relevant to – and a potential break on - the EU’s willingness to grant the UK greater market access or provide any additional concessions or commitments to the UK. Why? Because – where an MFN applies – the EU would also have to grant that improved market access to those other preferential third countries (with which an FTA is already in place), without obtaining anything further in return from that country. For example, if an UK-EU FTA granted more favourable market access than the services commitments already extended to South Korea, those benefits will need to be extended immediately to South Korea as well. In that sense, the UK could end up negotiating a better deal for itself and third countries that are parties to existing FTAs with the EU in some areas.

The extent to which the EU will be constrained will depend on the text of particular MFN clause and the third country agreement itself. In many cases, the inclusion of the MFN clause is followed by specific exceptions and conditions to its application. For example, in the case of South Korea, the MFN clause does not apply to measures providing for recognition of qualification, licences or prudential measures in accordance with Article VII or the Annex on Financial Services or concerning certain exemptions.

The existence of MFN clauses in existing EU FTAs with third countries might therefore impose limitations as to the degree of liberalisation to be achieved. The EU might be constrained from granting the UK more ambitious concessions than those currently granted to preferential third countries, such as South Korea or Canada.

What does this mean for the chances of a UK-EU FTA, and the UK Government’s objective that the new trade deal will replicate as much as possible the market access obtained under the Single Market? At worst, it could mean it will be impossible to achieve that objective in some areas (e.g. in services) because the price of agreeing this on the EU’s side will involve granting benefits not just to UK businesses but to businesses in third countries, and this price could be too high. But, at the very least, it constitutes a further challenge for UK and EU negotiators to ponder as they embark on the negotiations.

[1] Economic Partnership between the EU and the CARIFORUM States (Dominican Republic, Antigua and Barbuda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Haiti, Jamaica, Saint Christopher and Nevis, Saint Lucia, Saint Vincent and the Grenadines, Suriname and Trinidad and Tobago).