JOB(05)/190

Page 1

JOB(05)/19019 September 2005

Council for Trade in Services

Special Session

FINANCIAL SERVICES

Information Note by the Secretariat[1]

I.INTRODUCTION

  1. All Members recognize that financial services are not only important in themselves, but also of significance to the rest of the economy. All branches of economic activity today are fundamentallydependent on access to financial services. Members also recognize that a healthy and stable financial system, underpinned by sound macroeconomic management and prudential regulation, is an essential ingredient for economic development.
  2. An analysis of commitments carried out by some Members[2] reveals that most of them cover the core services in insurance, banking and securities. Fewer Members have made commitments in areas such as insurance intermediation, brokerage, asset management, settlement and clearing services, and provision and transfer of financial information. Only about half of the Members which have commitments have made them in derivatives trading. Commercial presence is often a precondition for the supply of financial services, even if the commitments on mode 3 are subject to numerous and significant reservations. There are fewer specific commitments for modes 1 (cross-border supply) and 2 (consumption abroad), suggesting a lesser degree of liberalization.

II.CLASSIFICATION ISSUES

  1. Most Members favour the use of a common classification system in order to improve the comparability of commitments – the current situation being that Members have resorted to a multitude of classification systems. While a majority of Members have adopted the classification contained in the Annex on Financial Services in whole or in part, others have applied the classification contained in document MTN.GNS/W/120 or national classification methods.[3] Some Members cross-referenced their commitments using the UN Central Product Classification (CPC); others decided not to use any code. In that regard, it is worth noting that a clear majority of Members have expressed a preference for the classification in the Annex on Financial Services[4], which provides a flexible and comprehensive framework for scheduling commitments[5], and which is more disaggregated and therefore more appropriate for the purposes of scheduling than the provisional CPC codes used in the W/120 classification.[6] According to a Member[7], the broad definitions in the Annex also cover services the purchase of which is compulsory (e.g. certain types of insurance).
  2. A few Members[8] have raised classification issues, which have not been thoroughly examined thus far at the multilateral level. According to one proposal[9], (i) some Members have found it difficult to integrate their own regulatory structures into the Annex's classification, making the reading of commitments difficult and not transparent; (ii) new products, such as electronic merchanting systems, have difficulty in finding a place in the current classification or may indeed be classified in any one of several categories; and (iii) the convergence between banking and insurance activities has made the classification of the Annex somewhat obsolete. It is worth noting, however, that according to another Member[10], the definitions in the Annex are not inflexible and provide the means to address and provide further liberalization for certain sub-sectors (for example, addressing marine, aviation, and transport insurance separately from the rest of nonlife insurance in order to record crossborder commitments). According to this view, although financial services have continued to evolve since the time that the Annex was developed, the broad definitions in the Annex remain relevant, provide plenty of flexibility for anyconvergence of financial services, and can accommodate different regulatory approaches.
  3. Clarifying classification issues related to the evolution of financial services since the conclusion of the Uruguay Round has been proposed by another Member.[11] According to this view, although the classification in the Annex is comprehensive, it is not clear whether certain activities that have emerged since the last round of negotiations are captured by that classification. Such activities include, for example, alternative trading systems; venture capital; electronic bill presentment; and securitisation. How to address these services in the classification remains open.[12]
  4. New definitions of marine and energy insurancehave been proposed for the purposes of scheduling commitments.[13] In the case of marine insurance, it has been proposed to broaden the definition used in the Understanding on Commitments in Financial Services (hereinafter "the Understanding") in order to clearly identify (non-life) insurance services with regard to i) transportation of passengers (scheduled or non-scheduled), and ii) larger fishing vessels.
  5. In the case of energy insurance, the new definition proposed addresses the insurance of the commercial upstream – or the so-called "offshore" – segment of the market; i.e. all insurance related to:

(a)exploration;

(b)development;

(c)production activities; and

(d)properties in the petroleum sector, both onshore and offshore.

  1. According to this proposal, the insurance products would normally cover a petroleum company's assets and liabilities during the exploration and operation phase, including vessels operating in these activities. This consists of insurance relating to drilling and producing oil and gas; transportation to terminals by pipelines or vessels; gathering, separation, storage, terminals and other processes prior to arrival at refinery; marine liabilities and pollution liability; business interruptions arising form physical damage to installations, etc.; terrorist coverage; and other associated properties or plants relating to the upstream activities, including mobile offshore units, supply boats, safety vessels and related vessels and units. Insurance related to refineries (which is considered down-stream business) could also be included. However, liability insurance in relation to occupational injury or illness is not included.
  2. Potentially relevant issues:

(a)Have Members found it difficult to schedule commitments with regard to new products that may have emerged since previous negotiations (e.g. electronic trading systems)?

(b)Is there a need to clarify the classification of some services, as suggested by Members (e.g., alternative trading systems; venture capital; electronic bill presentment; and securitisation)?

(c)Do Members agree with the definitions proposed for marine andenergy insurance?

(d)Do Members consider that the Committee on Trade in Financial Services should review these and other classification issues, as suggested by some Members[14]?

III.SCHEDULING ISSUES

  1. Some Members advocate the adoption of the Understanding[15], so as to achieve more coherent and clear sets of commitments. Alternatively, some of them[16] encourage Members to take into account the Understanding, even if commitments are made in accordance with the usual scheduling approach under Part III of the GATS. Other Members consider that the adoption of the Understanding may force some Members to adopt financial liberalization beyond what their financial circumstances allow for..[17]
  2. The lack of a clear distinction between modes 1 and 2 has also been evoked by many Members, who consider that although this is a matter of concern for all services sectors, it is especially important for financial services.[18] A recent submission takes stock of the discussion, reviewing some of the issues discussed in the past[19], and proposing to debate the matter with a view to achieving a common understanding among Members.[20] Diverse approaches have been proposed in the current negotiations to solve the issue. For one delegation, the ambiguity in the distinction between the two modes could be solved if each Member inscribed that distinction in its schedule as clearly as possible.[21] Others consider that in order to avoid divergences or doubts as to the mode of supply of the relevant transaction affecting legal certainty, care should be taken to ensure that where appropriate, commitments undertaken for mode 1 are consistent with those offered for mode 2.[22]Even the possibility of merging both modes of supply has been mentioned as a matter that could be explored by the Committee on Trade in Financial Services.[23] Finally, another Member considers that the Understanding is a good step in clarifying the distinction between the two modes.[24]
  3. Potentially relevant issues:

(a)What are the problems associated with the current distinction between Modes 1 and 2 in the financial services schedules? Has a difficulty in the interpretation of the schedules led to practical problems in relation to the commitments of other countries?

(b)What criteria have countries used to distinguish between Modes 1 and 2? What possible improvements could be made to the current distinction between Modes 1 and2?

(c)Should Mode 2 be clarified so as to include only the physical movement of consumers instead of applying a distinction based on the place of supply and consumption of the service?

(d)Is the concept of "solicitation" or "active marketing" useful in making the distinction clearer? What are the practical problems in applying this distinction?

(e)Does the Understanding[25] provide a good basis to distinguish between the two modes of supply? If so, why?

IV.ISSUES RELATING TO ARTICLES XVI AND XVII

A.SECTOR FOCUS

  1. Most proposals stress the consideration of a comprehensive range of financial services when making commitments. Some of them, however, although expressing broad interest in all financial services, focus on specific sectors. One proposal has highlighted the insurance sector as deserving particular attention in the current negotiations.[26] Members could now take more commitments in the sector, particularly with respect to life insurance, intermediation and auxiliary services. Within banking and other financial services, the following sub-sectors are considered to be subject to significant reservations in schedules: brokerage, asset management, settlement and clearing services, and supply and transfer of financial information. Another proposal also highlights asset management services, including pension fund management, as a particular area of interest.[27] Finally, one delegation favours improved commitments on marine and energy insurance (see also the previous section for an explanation of the definitions proposed).[28]
  2. Commenting on the proposals to undertake commitments on all financial service sub-sectors, some Members, particularly developing country ones, have stressed that it should be left to individual countries to decide the sub-sectors on which to make commitments depending on their level of development, and in light of Article XIX:2 of the GATS.

B.BARRIERS IDENTIFIED

  1. Improving commitments on mode 3 for all financial services appears to be a priority area for many Members.[29]Some horizontal limitations have been identified as particularly affecting the financial services sector[30]:

(a)Unspecified authorisation requirements;

(b)Economic needs tests;

(c)Certain limitations on the purchase or rental of real estate;

(d)Restrictions on equity holdings;

(e)Nationality requirements;

(f)Certain tax and subsidy measures.

  1. Specific barriers affecting the financial sector, as identified in the proposals, include the following:

(a)restrictions on the form of commercial presence (e.g. prohibition to establish through branches; requirements to operate joint-ventures with local partners);

(b)restrictions on the level of equity participation;

(c)quantitative limitations on the number of service suppliers or on the number of licences to be granted;

(d)mandatory cession requirements;

(e)economic needs tests;

(f)restrictions on geographic expansion;

(g)restrictions as to the types of activities that can be carried out in different geographical areas;

(h)prohibitions of new entry;

(i)restrictions on transfers of key personnel;

(j)unspecified authorization requirements;

(k)nationality and residence requirements for executives and members of the board of directors;

(l)monopoly by state insurance agencies;

(m)discriminatory tax treatment;

(n)discriminatory application of laws, regulations, and practices;

(o)different regulations applied by sub-central and local governments;

(p)discriminatory access to payment systems, funding and refinancing facilities;

(q)discriminatory membership in any self-regulatory body, stock/securities/futures exchange or market, clearing agency or other organisation or association.

  1. Some developing countries have however supported recourse to some of those measures, e.g., restrictions on the supplier's ability to establish any form of commercial presence (including restrictions on direct branching); quantitative limitations on the number of service suppliers; and restrictions on the expansion of foreign banks; use of economic needs tests.[31]
  2. Some Members also consider that the protection of acquired rights of existing investments in the sector should be guaranteed by commitments (grandfathering).[32] Several developing countries sought further clarifications on the concept of grandfathering, including with regard to its consistency with the Most-Favoured Nation (MFN) obligation.
  3. Support for further commitments on modes 1 and 2 has been widespread, with several Members supporting the adoption, as a minimum, of the cluster of commitments in paragraphs B.3 and B.4 of the Understanding.[33] Without proposing a complete liberalization of cross-border trade (particularly mode 1) for all financial services, some Members would like, however, to go beyond the current level of commitments required by the Understanding. While some of these Members have identified specific sectors where further cross-border commitments could be undertaken, others have pointed to different approaches that might be followed to identify the sub-sectors more amenable for further commitments.
  4. Some Members have identified marine and energy insurance services as possible candidates for improved commitments on both modes 1 and 2 (see previous sections for definitions)[34]. Others consider that commitments on mode 2 may be undertaken with respect to all financial services sub-sectors included in the Annex classification, while commitments on mode 1 can be made on the following sub-sectors: financial information and advisory services; reinsurance and retrocession; marine, aviation, and transport (MAT) insurance; insurance intermediation, such as agency/brokerage; and services auxiliary to provision of insurance, such as consultancy, actuarial, risk assessment, and claim settlement services.[35] The approaches proposed to identify services where further commitments on mode 1 could be undertaken include (a) the expansion of cross-border commitments in such activities that may be less problematic from the point of view of consumer protection and other security requirements; and (b) priority being given to products targeted at sophisticated customers, that is, those that are well informed about the implications of the services being used and can manage any attendant risk.[36] The following market participants would qualify as sophisticated customers: financial departments of corporate institutions; professional pension fund managers; and professional portfolio managers. In other words, commitments on cross-border trade could be made with respect to wholesale, corporate, and investment banking services. In the same vein, it has been stated that commitments could be made to allow mutual funds (collective investment schemes) located in the Member making the commitment to obtain certain investment advice and portfolio management services from financial services suppliers located outside its territory.[37]
  5. Developing countries have approached liberalization of cross-border trade with more caution, arguing that the liberalization of cross-border transactions might bring about a sudden increase in capital flows, which could eventually lead to financial instability and ultimately to a crisis. Some of them consider that liberalization of mode 1 should be limited to those services which assist other economic activities, and are not related to large-scale capital movements, such as financial consulting services and credit rating business.[38] More recently, some developing countries have also advocated further commitments on item (xv) of the Annex classification – "provision and transfer of financial information, and financial data processing and related software". Countries supportive of the Understanding consider that the commitments envisaged in such a document would generally not lead to destabilizing financial flows. It is argued in that regard that activities such as information and advisory services, MAT insurance, and reinsurance do not imply capital account movements.
  6. Some Members have also focused on the movement of natural persons in this sector, seeking greater freedom for intra-corporate transferees and contractual service suppliers, i.e. service suppliers having received a contract to provide services requiring the presence of natural persons. All financial services could potentially be concerned by this form of delivery but it is especially relevant for services auxiliary to insurance and for advisory and other auxiliary financial services as defined in the Annex classification.[39]
  7. Finally, the need for individual Members to phase-in commitments over a specified period of time has been recognized by some proposals.[40]One ofthem goes even further by suggesting that a method for phasing in commitments should be agreed upon.[41]
  8. Potentially relevant issues:

(a)What are the major remaining trade restrictions in financial services schedules? Are the barriers on mode 3 recently identified by a group of Members[42] the most serious ones (e.g. restrictions on the form of establishment of new companies, restrictions on the acquisition of existing companies; discrimination between domestic and foreign suppliers regarding application of laws and regulations; and non-discriminatory limitations such as monopolies, numerical quotas or economic needs tests and mandatory cessions)?

(b)Do Members agree that commitments on mode 3 (commercial presence) be undertaken for all financial services?

(c)Would it be necessary to agree on a common method for phasing in commitments?

(d)In which sub-sectors could cross-border commitments be expanded?

V.REGULATORY ISSUES (INCLUDING PROPOSALS RELATED TO ARTICLEXVIII)

  1. All Members agree that a pre-requisite for a successful and orderly opening of financial markets is the existence of an appropriate regulatory and supervisory framework. In that regard, all of them recognize the importance of the so-called "prudential carve-out", contained in paragraph 2(a) of the Annex on Financial Services. A few Members consider,however, that this provision is so broadly defined that Members have sometimes felt compelled to schedule measures that might be considered of prudential nature. According to this view, the Committee on Trade in Financial Services should start working on a more precise definition of the exceptions that can be invoked in relation to prudential regulation.[43]This proposal was not well received by a large number of Members, who preferred not to modify this provision for fear that negotiations might erode Members' right to impose prudential regulations under the terms described in the Annex on Financial Services.
  2. Alternatively, some Members have supported tackling regulatory issues in this sector, with a particular focus on improving transparency in regulation.[44] Specific disciplines regarding the development, adoption, and application/enforcement of regulations, including those related to licensing procedures, have been proposed.[45]According to this view, while the crosssectoral work of the Working Party on Domestic Regulation (WPDR) continues, it would be useful for Members to have a more focused discussion of these and other principles as they apply to the financial sector. This work might usefully take place in the Committee on Trade in Financial Services, in parallel with the on-going work of the WPDR. A sectoral discussion seems warranted because of the following reasons: i) given the needs of financial markets for transparency, financial regulators are already fairly familiar with such concepts; ii) the financial sector is highly regulated, hence the issues of transparency in the regulatory process are crucial to ensure that the market access commitments are supported by adequate principles; and iii) a separate discussion on transparency for the financial sector would enable Members to consult with, and draw upon, the expertise of financial services regulators.[46]
  3. Although the idea of developing sectoral disciplines on transparency has received some support, many Members expressed a preference for this work to be conducted on a horizontal level by the Working Party on Domestic Regulation, which is developing disciplines that will be relevant for all services sectors, including financial services. They acknowledged, nevertheless, that the relationship between these future disciplines and the so-called "prudential carve-out" would needed to be considered and discussed. Some Members, particularly developing country ones, considered that the proposal on transparency put forward by a Member may be too prescriptive, and thus affect the right to regulate in pursuance of national policy objectives.
  4. The lack of recognition of qualifications obtained overseas and of prudential measures of other Members has also been mentioned as an important impediment to trade in financial services.[47] It has been proposed in that regard that Article VII.4(b) of the GATS be implemented to afford enhanced opportunities to Members to become party to agreements and arrangements on the recognition of prudential measures.[48]
  5. Potentially relevant issues:

(a)Have Members encountered any problems in interpreting the scope of prudential measures as defined in the GATS Annex? If so, what would be the possible solution to such problem?