Incoterms_® and Commercial Contracts

Executive Summary

The services revolution is transforming the world economy. Every business depends on services, which account for the largest worldwide share of jobs, output and job growth. Coupled with the services revolution, the digital revolution has radically expanded the international movement of services.

Services can be traded internationally in four modes: (1) Cross-Border Supply, where the service product (such as a medical diagnosis or architectural drawings) travel internationally, by email, fax, or the like; (2) Consumption Abroad, where the service consumer travels to another country to receive the service (e.g., tourism); (3) Commercial Presence, where a company sets up an operation in another country (e.g., a bank branch); and (4) Presence of Natural Persons, where a person travels abroad to provide a service on a temporary basis (e.g., repairing sophisticated machinery). The General Agreement on Trade in Services (GATS), one of the Uruguay Round Agreements, was the first international agreement to provide comprehensive rules on service trade. It sets forth general obligations, and provides a mechanism for specific negotiated market-opening commitments.

The General Obligations include:

• Most-favoured-nation treatment;
• Transparency requirements;
• Rules relating to regulations; and
• A requirement that monopoly suppliers in sectors where market-opening commitments have been made do not abuse their position.

Specific Commitments are negotiated on a sector-by-sector and mode-by-mode basis (the WTO has created a list of twelve sectors, such as Business Services and Transportation). Market access can be limited by the number of suppliers, the total value of service transactions, and the number of employees in a particular sector. Restrictions can be imposed on the type of legal entity that can be established (e.g., subsidiary or branch), and the participation of foreign capital. In addition, national treatment can be limited or not granted at all. However, any restrictions on market access or national treatment must be recorded in the Member’s services schedule.

The GATS follows the so-called “positive list” approach, under which all market opening commitments and limitations are recorded in the Member’s schedule. Any sectors that are not scheduled are assumed to be closed. Some Regional Trade Agreements use the opposite, “negative list”, approach, under which all sectors and modes are assumed to be open unless a specific exception is taken.

* Peter Allgeier served as Deputy US Trade Representative and US Ambassador to the World Trade Organization. Most recently he was President of the Coalition of Service Industries (CSI). Olivia Burzynska-Hernandez was a Policy Associate at the CSI.

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1.0 Introduction

1.1 The Services Revolution

The global economy is in the midst of the Services Revolution, which is having as dramatic an effect on our work life and daily life as the Industrial Revolution in the 19th Century. Services make the world go around, for consumers, businesses and governments.

Just think of your daily routine. First thing in the morning, you wake up knowing that your family is safe because of the electronic security service that monitored everything while you slept, from the locks on your doors to the carbon monoxide in the garage. Then you probably check your e-mail, the football or cricket results, and the headlines from the Financial Times on your smartphone service. If you drive to work, you require car insurance; if you take the subway or bus, you are using a transport service. On the way to the office, you stop at your favourite coffee bar for breakfast. At the office, you put the package containing the birthday tie you want to return in the express delivery pick-up box. A quick check online of your bank balance, then you place calls to everyone who left you voicemails overnight, using one of the international telecommunications services.

Services make the business world go around. In fact, they make the entire world go around – if they are allowed to.

The Services Revolution is evident from the fact that services are by far the largest source of jobs (3.2 billion worldwide),¹output (70% of world GDP),²and job growth. The numbers are impressive, but the revolution is more than just numbers of workers or share of GDP. The most important thing to recognise is that all businesses – small and large – and all segments of the economy, including agriculture, manufacturing and energy, depend on services to be successful. Services are the enablers of all other economic activities.

GLOBAL VALUE CHAINS

The integration of services with manufacturing and agriculture is what produces global value chains, in which enterprises and countries specialise in tasks rather than goods. Every economic activity depends on supportive services, i.e., services that enable other producers (in manufacturing, agriculture, mining, and other services) to achieve their output and sales goals in the most efficient ways possible, especially if they are to plug into the supply chains that are the predominant phenomenon in international trade. Manufacturing jobs depend on services. For example, GE, Siemens, and Boeing depend on services workers in their own companies or from outside service suppliers – in accounting, finance, product design, distribution and logistics, advertising, computer-related services, telecommunications, express delivery, just to name a few. Likewise, ask any farmer about his or her reliance on services: crop insurance, extension services, financing, storage services, distribution and marketing, equipment maintenance, etc.

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Developing countries and small businesses are in particular need of access to efficient, economical services in order to compete in international markets and to maximise efficiency and competitiveness at home. International services (Internet, electronic payments, express delivery) enable millions of small, even micro, enterprises throughout the world to engage in “random” exports of goods and services without any need for a physical presence overseas.

Businesses will profit enormously if they pay attention to how services affect their daily activities, and if they become aware of the economic advantages they can reap by taking better advantage of the international, regional and national rules governing trade in services.

1.2 The Digital Revolution

At the centre of the Services Revolution is a second revolution: “The Digital Revolution”, of which the Internet is emblematic. The Internet has enabled services to be delivered digitally across borders to a degree that was unimaginable 20 years ago. Many items that were formerly delivered as goods (e.g., software, movies and music) are now being delivered digitally. Keep in mind that Amazon.com was only founded in 1994, and Facebook was founded 10 years later.

The Internet is the Great Silk Road of the 21st century. Just as the Great Silk Road provided the transmission route for trade among Asia, Europe and North Africa during the 6th through 14th centuries, so the Internet now plays that role for the entire world.

In this digital age, companies in international markets constantly need to move data digitally across the globe for their own internal operations and to serve their customers. While this may be obvious in the case of insurance firms processing claims or accounting firms verifying and reviewing audits, it is actually essential for any international business. For example, think of express delivery companies tracking packages across the globe, or an airline company remotely monitoring its engines while its planes are in flight. Retailers have to manage their worldwide procurement and inventory, and car manufacturers have to manage their supply chains. Health professionals seek second opinions from specialists across the globe via the Internet.

None of this was contemplated 20 years ago when countries negotiated the General Agreement on Trade in Services (GATS), the multilateral rules for trade in services that were part of the Uruguay Round of trade talks. The world has changed radically in the intervening years as a result of technological advances, global data flows, global value chains, innovative business practices, and the widespread use of the Internet by nearly everyone (approximately three billion Internet users at last count).³

The international rules and provisions governing trade in services and digital trade have not kept up with these developments. They urgently need to be updated and brought into line with the realities of today’s digitally connected world.

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THE IMPLICATIONS OF THE DIGITAL REVOLUTION

Traditional goods providers that market books, journals, magazines, newspapers, films, music, games, software, etc. know that the digital revolution has changed their businesses forever. Digital trade distributes what we think of as a good in a manner more typical of a service. While cross-border marketing costs may be lower, issues related to taxation, as well as piracy and other malicious activity, abound. Traditional goods providers must not only adapt their business model to deal with the digital revolution, to the extent that they deal with the delivery of traditional goods, they must now seek to improve marketing and delivery by taking advantage of progress (and even evolution) in the services sector. They must also realise that the digital age may still pose unforeseen challenges to their business model, and that the line between delivery of a good and a service may become increasingly blurry in some sectors. The delivery of a good has always involved a service sector component (advertising, distribution, professional services, etc.). Now, with increased service sector competition and efficiency, management of service providers has become even more important.

1.3 How Services are Traded Internationally

The Services Revolution is a genuine international revolution. Not only is it occurring in all countries, it is occurring increasingly in trade among countries. Businesses need to understand how services are traded internationally. There are four ways in which services can be traded, known in international agreements as the four “modes of supply”. These are:

1. Providing services across a border, such as an architectural drawing or medical diagnosis transmitted via the Internet or by mail (Mode 1 – Cross- Border Supply);
2. Having the customer come to the host country to receive the service, e.g., tourism or going abroad for an operation (Mode 2 – Consumption Abroad);
3. Establishing an affiliate or branch or partnership in a foreign country, e.g., opening a fast food restaurant or operating a bank branch (Mode 3 – Commercial Presence); and
4. Sending an employee temporarily to the customer in a foreign country, e.g., repairing sophisticated machinery or operating an off-shore oil drilling platform (Mode 4 – Presence of Natural Persons).⁴

According to the World Trade Organization (WTO), cross-border exports of services supplied in Modes 1, 2 and 4 reached US$4.9 trillion in 2014.⁵The WTO estimates that the distribution of modes of supply is: 30% for Mode 1; 10% for Mode 2; 55% for Mode 3; and less than 5% for Mode 4. But because services are imbedded in all manufactured goods and agricultural products, the current international trade accounting vastly understates the value of cross-border services. For example, the entire value of an automobile is recorded as a manufactured good import, even though it is a combined manufacture and services import. The WTO has estimated that international trade in services amounts to 45% of international trade, rather than the 23% of trade indicated by the traditional trade statistics.⁶

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MUCH SERVICE TRADE GOES BY UNNOTICED AND AS A RESULT UNREGULATED

Although the international and regional rules governing service trade are important, much service trade operates below the radar screen. For example, if an attorney provides a foreign client with legal advice by phone or email (Mode 1), there is little that the authorities on either side of the border can do to regulate or prevent it. If a Swiss resident crosses the border into France, Italy or Germany for a haircut (Mode 2), there is also little that the authorities can do to limit such transactions (assuming they wanted to). Much service trade goes unnoticed and unregulated (particularly in Modes 1 and 2), regardless of international and regional commitments.

1.4 The Multilateral Services Regime: the General Agreement on Trade in Services (GATS)

Services trade was not important in 1947, when the General Agreement on Trade in Goods was negotiated, and there was no attempt to develop rules covering services. However by the 1980s, as a result of improved and cheaper telecommunications and travel opportunities, services trade was growing quickly around the world, providing new opportunities for developed and developing countries. A number of countries, led by the United States and the EU, pushed for inclusion of services in the Uruguay Round, one of whose most significant achievements was the negotiation of the GATS, the first international trade agreement to focus exclusively on services trade. Although developed countries have tended to benefit more from international services trade, many developing country businesses are beginning to reap enormous benefits as increased competition between international and domestic service providers reduces costs and improves quality, thereby benefitting consumers and businesses worldwide.

As discussed in more detail later in this chapter, the GATS gives WTO Members great flexibility in terms of the extent to which they open their service sectors. They can decide which sectors and modes of supply they wish to open, they can impose restrictions on the degree and timing of the opening, and, in contrast to the GATT, the GATS does not require national treatment to be given to foreign service suppliers. Under the GATS, Members make “commitments” as to which service sectors and subsectors they want to open, and have the ability to specify limitations they wish to place on such liberalisation. They also make commitments as to the extent to which they are prepared to give national treatment to foreign suppliers in the service sectors they have opened. The commitments and limitations are recorded in the Members’ schedules.

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In order for a business to assess opportunities to provide services to foreign markets, a business must look at both “the border” (i.e., permission to provide a service) and “behind the border” (the myriad regulations that set the rules for providing the service). Businesses must also look at the market access schedules for specific services in a given country, as well as the general (“Horizontal”) rules governing the conduct of services in the importing market (see Section 4 below). The service schedules of all WTO Members are available on the services section of the WTO website: See http://i-tip.wto.org/services/default.aspx “Behind the border” legal and regulatory information is often available on domestic websites. However, businesses usually find it necessary to visit target markets, and even to hire local legal and economic consultants to assess practices that may affect their market access and eventual performance.

1.5 Coverage

GATS is comprehensive in its coverage of service sectors. The only sector-specific exclusion is air traffic rights, which are governed by bilateral or other non-WTO agreements.⁷The GATS covers all measures, “whether in the form of a law, regulation, rule, procedure, decision, administrative action, or any other form”.⁸This includes measures at all levels of government (i.e., central, regional or local, as well as any non-governmental bodies that are exercising powers delegated by a government, such as a bar association or medical council).

As discussed below, the key provisions of the General Agreement on Trade in Services are:

1. General Obligations

1. Regulations to which all WTO Members must adhere

2. Specific (negotiated) Commitments (Market Access Schedules)

1. Market Access
2. National Treatment
3. Additional Commitments
4. Other types of commitments

3. Exceptions

1. Services or measures that Members can exempt from GATS rules and regulations

4. Annexes

1. Details and clarifications on GATS articles, including more information on exemptions.

2.0 General Obligations

GATS stipulates both unconditional and conditional general obligations that each Member takes on when accepting the agreement. Unconditional general obligations refer to the rules which WTO Members must apply to all sectors, whether or not they have agreed to open them. These obligations include most-favoured-nation (MFN) treatment, obligations affecting domestic regulations and transparency. Conditional general obligations refer to obligations that apply only to sectors that a Member has agreed to open and are therefore listed in the Member’s schedule of commitments. In GATS, conditional general obligations relate to certain domestic regulations, monopolies and payments and transfers.

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2.1 Unconditional General Obligations

2.1.1 Most-Favoured-Nation (MFN) Treatment (Article II)

Most-favoured-nation (MFN) treatment ensures that WTO Members do not discriminate among other WTO Members. In other words, one Member cannot provide another Member with an offer or special preference without providing the same offer or preference to all Members. However, at the conclusion of the Uruguay Round, or upon a new Member’s accession to the WTO, a Member could list in its schedule exceptions to the MFN obligation. In principle, these exemptions are meant to expire in no more than 10 years, but in fact there is no effective means of enforcing their termination. Therefore, one must consult a Member’s schedule to determine the extent to which an MFN exemption exists.

The business community should be aware that as described in Section 10 below, Article V of GATS provides an important exception to MFN between Members who are also parties to bilateral or plurilateral free trade agreements (or customs unions) covering services. This exception applies if the regional trade agreement has substantial sectoral coverage and eliminates substantially all discrimination among the parties to that agreement.

Businesses contemplating service transactions should first ascertain whether there is a bilateral or plurilateral trade agreement in place that may give their service exports preferential market access.

2.1.2 Transparency (Article III)

All WTO Members are required to “promptly publish all relevant measures of general application” that affect the operation of the GATS. Members are required to notify the WTO Council for Trade in Services of new or changed laws, regulations, or administrative guidelines that will affect trade in any services subject to specific commitments. This allows businesses to have time to prepare for any changes that need to be made. Members are also required to establish “Enquiry points” to respond to requests from other Members.

Businesses can consult service sector notifications of WTO Members on the I-Tip Services website,9 although the website warns that the list may not be complete. Businesses can find the contact information of each Member’s GATS Enquiry Points on the WTO Website.10

2.1.3 Domestic Regulation (Article VI)

The domestic regulation obligation applicable to all service sectors, whether or not market opening commitments have been made, allows individual service suppliers to access domestic mechanisms to seek legal redress, including objective and impartial review by “judicial, arbitral or administrative tribunals or procedures” in the Member where they are supplying a service. If a service supplier seeks legal action in a particular domestic market, the affected Member is obligated to provide a legal mechanism to review promptly, and where justified, provide appropriate remedies for administrative decisions affecting trade in services. Domestic regulation is also treated below under “Conditional General Obligations” (Section 2.2).

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2.1.4 Subsidies (Article XV)

While the GATS, unlike the GATT, does not discipline subsidies, a Member granting a subsidy is supposed to give “sympathetic consideration” to a request for consultations by another Member that considers itself adversely affected by the subsidy.

Since WTO subsidy disciplines only apply to goods, a business contemplating entry into a particular service sector may find it useful to petition its government for financial assistance. Several governments have given consideration to the provision of financial support to potential service suppliers to facilitate entry of their goods sectors into global value chains.

2.2 Conditional General Obligations

2.2.1 Domestic Regulations (Article VI)

In sectors where a Member has made market access commitments, regulatory requirements must be based on objective and transparent criteria and must not be more burdensome than necessary to ensure the quality of the service. Also, applications for the supply of a service must be acted on within a reasonable time. Regulatory requirements include licensing and qualification requirements, along with technical standards. This obligation ensures that any specific commitments that Members take are not undermined by requirements or technical standards that could not reasonably have been expected at the time that the specific commitments were made.

Service sectors that appear to open as a result of specific market-opening commitments may not be as open as first appears. WTO Members sometimes use licensing and qualification requirements as a means to limit access to service sectors. Service sector professionals contemplating work abroad under Mode 4 are advised to check whether there are foreign national licensing or qualification requirements that may limit the exercise of their profession (for example lawyers might be subject to local bar admittance requirements). Conversely, service sector professionals seeking to prevent foreign encroachment may try to maintain or erect licensing and qualification barriers. Although such barriers are supposed to be subject to WTO disciplines, negotiations to develop such disciplines have been slow.

Professional service providers should be aware that domestic regulations often pose a very important barrier to market access. The GATS Agreement limits the types of domestic regulations that a Member can impose in sectors in which they have made commitments, and provides an avenue of legal recourse in the event that a Member exceeds permissible limits. Nevertheless the present disciplines are weak.

2.2.2 Recognition of Professional Qualifications (Article VII)

Article VII provides the framework for a Member to recognise the educational qualifications or professional certifications granted by another Member. Such recognition may be the result of an agreement between the Members or granted autonomously by one Member to another. The criteria or standard for the recognition should be based on multilateral standards, and the arrangement or autonomous recognition should be available to other Members on a non-discriminatory basis.

2.2.3 Payments and Transfers (Article XI)

Article XI of the GATS requires Members to allow “international transfers and[Page239:]payments for current transactions relating to specific commitments.” This means that a Member cannot restrict payments and transfers (inward or outward) on transactions related to its specific services commitments except in the event of a balance of payments emergency. Moreover, any restrictions to safeguard the balance of payments must be consistent with the criteria in Article XII, which include nondiscrimination among Members, consistency with the IMF Articles of Agreement, temporary and progressive phase out, and avoidance of unnecessary damage to the commercial, economic and financial interests of any other Member.

2.2.4 Monopolies and Exclusive Service Suppliers (Article VIII)

GATS Members are permitted to maintain monopoly suppliers of services, provided they adhere to the MFN obligation and any relevant specific market access commitments in their schedule. Monopolies may not abuse their monopoly position in the provision of services outside the scope of their monopoly rights.

3.0 Specific Commitments

As explained above, the GATS gives WTO Members great flexibility in terms of opening their services markets to foreign competition. Where a Member decides to open a particular sector (in technical terms, makes a “commitment”), this is recorded in a schedule, which also lists any limitations on the degree of opening as well as any National Treatment limitations. Members’ schedules are provided to the WTO, and are available on the WTO website.¹¹

During the Uruguay Round negotiations, countries agreed to make commitments in 12 broad service sectors, such as Business Services and Transportation Services, plus a catchall “Other” category.12 These broad sectors are broken down into 160 subsectors. Developed countries, and countries that recently acceded to the WTO (such as China) were often required by Members to make extensive commitments. Developing countries that are among the founding WTO

Members tended to make fewer commitments. Members made three types of commitment, which are reflected in different columns in their schedules: Market Access Commitments, National Treatment Commitments and Additional Commitments. These are explained below.

3.1 Market Access Commitments (Article XVI)

Market access for services is very different than market access for goods, for which the only permissible restrictions are tariffs (and regulations that have a legitimate purpose, such as safety). A Member may impose the following limitations on market access for foreign service suppliers, so long as those limitations are recorded in the Member’s Schedule:

• Limitations on the number of service suppliers;
• Limitations on the total value of service transactions or assets;
• Limitations on the total number of service operations or the total quantity of services output;
• Limitations on the total number of natural persons employed in a particular service sector;
• Restrictions or requirements on the type of legal entity (e.g., subsidiary or branch) through which a service is supplied; and
• Limitations on the participation of foreign capital in terms of a maximum percentage limit on foreign shareholding or the total value of aggregate foreign investment.

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To give an example, a Member might decide to open its banking sector, but to limit the number of foreign banks to five, to limit the combined value of their business to US$10 billion, to require them to operate as branches rather than subsidiaries, and to limit the foreign employees to a specific number of senior managers and technical specialists for a specified length of time.

3.2 National Treatment (Article XVII)

In contrast to the GATT, the GATS does not require Members to provide unrestricted national treatment to foreign service suppliers, even in sectors where a Member has granted market access. However, any limitations on national treatment must be recorded in the Member’s Schedule. A Member may choose to give no national treatment at all, or it may limit national treatment. For example, some Members impose restrictions on foreign ownership of land (e.g., leasing only and not outright ownership), which can obviously have an impact on Mode 3 investment.

3.3 Additional Commitments (Article XVIII)

Many Members also scheduled additional commitments in the last column of their GATS schedules. Often these commitments deal with standards, qualifications and licenses. They are particularly common in the telecommunications sector.

3.4 Other Types of Commitments

3.4.1 The Understanding on Commitments in Financial Services

The Understanding on Commitments in Financial Services is a set of voluntary commitments that individual Members may schedule as additional liberalisation. It reflects the fact that some WTO Members were prepared to go further in liberalising their services regime than was acceptable to the overall WTO membership. The Understanding lists a “menu” of commitments for Members to choose, so the precise commitments scheduled vary from Member to Member. Among the commitments are: an agreement not to add non-conforming measures (i.e., measures that are excluded from coverage); most-favoured-nation treatment and national treatment on the purchase of financial services by public entities; permission to supply new services; and certain conditions of temporary entry for senior financial services managerial personnel or specialists (e.g., actuarial, legal, computer and telecommunications).

3.4.2 The Telecommunications Reference Paper

The Telecommunications Reference Paper, like the Financial Services Understanding, is a voluntary, legally binding list of definitions and principles applying to basic telecommunications services regulatory practices that a Member may include in its schedule, in whole or in part. Six areas of regulatory practice are covered: (1) prevention of anti-competitive practices by the telecommunications network provider; (2) interconnection arrangements and safeguards; (3) universal service provisions; (4) transparency in licensing; (5) independence of telecommunications regulatory bodies; and (6) procedures for the allocation and use of scarce resources such as frequencies.

4.0 How to Read a GATS Schedule

4.1 Scheduled Commitments

At first glance, services schedules are rather intimidating documents, but learning to read a GATS schedule is not only important for service providers, it is important for investors that may need services supplied by foreign service providers. Most Members’ schedules begin with the so-called Horizontal Commitments. These record commitments (and limitations) that are applicable to all service sectors and[Page241:]subsectors for which market access commitments have been made, and are simply designed to avoid having to repeat the same information on each of the sector specific schedules. Typically they define the types of individual who may enter under Mode 4 in connection with a Mode 3 investment, e.g., senior management or technical specialists. They also sometimes involve restrictions on land ownership by foreigners (relevant to Mode 3 investments).

The Horizontal Commitments are followed by Sectoral Commitments listing the commitments (and restrictions) mode-by-mode for each service sector and subsector in which a Member has granted market access. There are 12 sectors and 160 subsectors that a Member could schedule. No listing is provided for sectors where a Member has not made a commitment.

4.2 Terminology

It is also necessary to understand the terminology used in service schedules. None means that a Member is opening a particular service sector in the designated Mode of Supply with no restriction whatever. Unbound means that a Member has made no market access or national treatment commitment. From the business perspective this means that the Member is not taking a legal obligation to allow market access or to grant national treatment. Market access may be permitted, but the Member has the legal right to withdraw such permission. Unbound* means that supply of the service through the mode in question is not technically feasible. For example, it is not possible to provide a haircut via the Internet or any other Mode 1 method.¹³

READING A SERVICES SCHEDULE

Looking at a particular service schedule may help to clarify the subject. Appendix A consists of extracts from Japan’s service schedule. Suppose that a US advertising company wishes to establish a subsidiary in Japan. It will learn from the relevant Sectoral schedule that there are no Mode 3 restrictions with respect to advertising services. However, the Horizontal Schedule indicates that Mode 4 restrictions exist. There we find that a foreign person may be transferred to Japan for a period of no longer than five years in order to perform a number of specified activities, such as branch director, auditor, or engineer, provided he or she has been employed by the sponsoring enterprise for at least one year immediately preceding the assignment to Japan. The Horizontal Schedule also tells us that Japan is making no national treatment commitment with respect to the provision of research and development subsidies for foreign service suppliers via commercial presence (Mode 3) or temporary entry of natural persons (Mode 4). In other words, in the event that the Japanese Government decided to provide subsidies to its domestic advertising agencies, it would be under no obligation to do so for foreign-owned agencies.

4.3 How Schedules Are Negotiated (Request-Offer)

Market access schedules are negotiated bilaterally through an iterative request-offer process, with the results applying to all Members. At the beginning of the market access negotiations, each party presents an “offer” listing the sectors that it is willing to open, including specification of which modes of supply the offer covers and any restrictions it is placing on the degree of opening. Each party also submits a “request” to each of the other parties, identifying the sectors and modes of supply that it would like each party to open. There follows rounds of separate bilateral negotiations as each party modifies its offers and requests (improving or reducing them) until a bilateral agreement is reached with each party (actually with each of the Member’s major[Page242:]trading partners). The sum of a party’s final offers is made available to all Members of the negotiation, i.e., the bilateral offers are “multilateralised” in their application.

4.4 “Water”

A Member’s GATS schedule only indicates the degree to which the Member is legally obliged to open a particular sector. Many Members have opened up their service markets to a considerable degree since the Uruguay Round, without altering their schedules, so that the markets are in fact more open than schedules suggest. The difference between the committed and actual degrees of openness is known as “water”.

A service business wishing to invest in another country that finds that either the country has made no market access commitments in the sector in question or that it has placed limitations on its commitments that would make it difficult for the business to operate effectively should investigate whether the market is in fact more open than indicated in the schedule. But it must keep in mind that the country is under no obligation to maintain that additional degree of openness, and could revert to its more restricted scheduled commitment (on an MFN basis) in the future.

5.0 Protocols

At the initiation of the World Trade Organization, it was recognised that in certain services areas the specific market access commitments were inadequate. It was agreed that subsequent negotiations should occur to provide additional time for Members to improve their commitments. The additional commitments, negotiated between 1995 and 1997, were recorded in protocols that became integral parts of the GATS. There were four protocols: the second and fifth protocols on financial services, the third protocol on movement of natural persons, and the fourth protocol on access to basic telecommunications services. There is no first protocol.¹⁴

6.0 Positive List vs. Negative List

The GATS and some free trade agreements (particularly those involving developing countries) use the so-called “positive list” method for scheduling a Member’s market access and national treatment commitments, with the rule being that no commitments have been made in sectors that are not listed in the schedule. Other bilateral and plurilateral free trade agreements (FTAs), including all of those negotiated by the United States, use a “negative list” approach, in which full market access and national treatment is given except where exclusions are listed.

ADVANTAGES OF THE NEGATIVE LIST APPROACH

The negative list approach, which assumes that everything is covered unless explicitly excluded, is preferable from a market-opening standpoint because it provides more comprehensive coverage and better clarity on market access restrictions. It also means that new services, or services delivered in a new manner, automatically receive market access and national treatment because they were not specified in the original negative list.

US FTAs are structured quite differently from the GATS and positive list FTAs. Typically, they have separate chapters covering cross-border trade in services, financial services, and telecommunications. Some, but not all, contain a chapter on[Page243:]temporary entry for business persons. All have a separate chapter on investment, which covers all types of investment, not just investment in services. Such investment provisions will be discussed in Volume Two of this series.

7.0 Exceptions

7.1 General Exceptions (Article XIV)

The GATS sets forth several important general exceptions applicable to service sector rules that largely parallel the exceptions present in the GATT 1994 (which is applicable to goods). These exceptions are limited by the strict requirement that they not be applied “in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where like conditions prevail, or a disguised restriction on trade in services”. The exceptions allow Members to adopt or enforce measures:

• Necessary to protect public morals or to maintain public order;
• Necessary to protect human, animal or plant life or health;
• Necessary to secure compliance with laws or regulations which are consistent with this agreement, including:
• prevention of deception of fraudulent practices;
• the protection of privacy of individuals in relation to the processing and dissemination of personal data and protection of confidentiality of individual records and accounts; and
• safety;
• Inconsistent with Article XVII (national treatment) as long as the difference in treatment is aimed at ensuring the equitable or effective imposition or collection of direct taxes in respect of services or services suppliers of other Members; and
• Inconsistent with Article II (most-favoured-nation treatment), as long as the difference in treatment is the result of an agreement on the avoidance of double taxation.

Businesses should be aware that no WTO dispute settlement proceeding has ever upheld a government trade measure applicable to service providers based on any of the above exceptions. Just as in cases applying similar language applicable to trade in goods, it is evident that the Appellate Body will interpret these exceptions narrowly.

7.2 Security Exceptions (Article XIVbis)

The GATS also contains limited exceptions whereby a Member can avoid GATS obligations in order to protect its national security. These exceptions are virtually identical to the exceptions set forth in GATT Article XXI, discussed in Chapter Two. No GATS dispute has ever interpreted these exceptions.

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8.0 Annexes (Article XXIX)

The GATS includes a number of Annexes that provide more detailed provisions relating to certain service sectors, as well as provisions relating to Mode 4.

8.1 Annex on Financial Services

The GATS Annex on Financial Services covers all financial services, which include insurance and insurance-related services (e.g., actuarial, risk assessment, claim settlement), and banking and other financial services. The Annex specifies that financial services supplied in the exercise of governmental authority (e.g., central bank, social security, public retirement plans) are not covered by GATS. The Annex also explicitly permits a country to take measures that would otherwise conflict with the GATS, for prudential reasons, including for the protection of investors, depositors, policyholders or persons to whom a fiduciary duty is owed by a financial services supplier, or to ensure the integrity and stability of the financial system. The prudential exception is drafted to provide wide latitude for regulators to protect the integrity and the stability of the financial system, provided that such measures are not designed simply to avoid a Member’s obligation under the GATS. Examples of such measures are higher reserve requirements for foreign banks and reinsurance collateral requirements.

8.2 Annex on Movement of Natural Persons Supplying Services

The Annex on Movement of Natural Persons Supplying Services confirms that the agreement does not apply to measures regarding citizenship, residence, employment on a permanent basis, or natural persons seeking access to the employment market of another country, i.e., who do not already have jobs. It also makes clear that maintaining a visa system is not in itself inconsistent with market access commitments or national treatment or MFN obligations.

8.3 Annex on Telecommunications

The Annex on Telecommunications recognises that service suppliers in all areas depend on access to telecommunications networks on reasonable and nondiscriminatory terms, which the Annex requires and spells out in some detail. This Annex also acknowledges a Member’s rights to impose regulations to protect the technical integrity of networks and to safeguard their public service responsibilities, such as making networks available to the public generally. The treatment prescribed in the Annex, however, applies only to those (telecom-using) services that are contained in the Member’s schedule of market access commitments.

8.4 Annex on Air Transport Services

The Annex on Air Transport Services excludes from coverage measures affecting air traffic rights or services directly related to the exercise of those rights. It does specify, however, that the agreement applies to measures affecting aircraft repair and maintenance services, sales and marketing of air transport services, and computer reservations systems services, to the extent that they are scheduled on a country’s positive list.

9.0 Dispute Settlement (Article XXIII)

GATS provides access to the WTO dispute settlement process, which is discussed in Chapter Twelve. Relatively few WTO dispute settlement cases involving services have been concluded. The most significant cases include: (1) A US case against Mexico on telecommunications services;¹⁵(2) A case against the United States on gambling services;¹⁶(3) A US case against China on publications and audio-visual services;¹⁷and (4) A US case against China on electronic payment services.¹⁸While different GATS articles were in play in these disputes, in both cases involving China the panels and[Page245:]the Appellate Body found some form of discrimination between domestic and foreign suppliers of the relevant services or that foreign service suppliers had to conduct a crucial part of their business through a government-designated monopoly. The Mexican case found discriminatory regulatory practices, including with respect to excessive interconnection charges, and with respect to service suppliers’ access to telecommunications networks.

As only WTO Members are parties to WTO dispute settlement, companies with grievances must work through a friendly government that is willing to take their cause to WTO dispute settlement.

9.1 Case Study: China Electronic Payment Services19

In September 2010 the United States initiated a case claiming that China had imposed WTO-illegal restrictions and requirements pertaining to electronic payment services (EPS) for payment card transactions, and against the suppliers of those services. Among other things, the United States alleged that China had given a Chinese entity a monopoly in the processing of all domestic Renminbi transactions.

The WTO panel issued its decision in July 2012. While it did not accept all of the US claims, it did find that the establishment of the Chinese company as the sole supplier for the clearing of certain types of card transactions violated China’s Market Access commitments, and that certain requirements with respect to all payment cards issued in China, including that they bear the logo of the Chinese clearing company, were inconsistent with China’s national treatment obligations.

China did not appeal the Panel’s decision. While China and the United States agreed in August 2013 on procedures for compliance with the panel ruling, the United States maintained through early 2017 that China had not brought its measure into compliance with the Panel’s recommendations. In May 2017, however, China agreed to provide full market access to US electronic payment service companies by July 2017.

10.0 Bilateral and Plurilateral Agreements

10.1 GATS Article V

GATS Article V recognises the right of WTO Members to negotiate service sector bilateral or plurilateral free trade agreements (called “Economic Integration Agreements”) provided: (1) the agreement has “substantial sectoral coverage”, as measured by number of sectors, volume of trade, and modes of supply; (2) the members of the bilateral/plurilateral eliminate “substantially all discrimination between or among the parties” in those sectors; and (3) the members do not raise the level of barriers in the covered sectors to those outside the agreement higher than the level existing prior to the free trade agreement. While most early free trade agreements covered goods only, virtually all modern agreements include services, and services provisions are being added to some of the early free trade agreements.

10.2 Trade in Services Agreement (TiSA)

Since the inception of the WTO in 1995, technological advancement and the wide use of the Internet by businesses and consumers have dramatically changed the global services market. But the trading system has not kept up. Trade negotiators need to address issues created by the digital revolution and cross-border data transfer, supply chains, state entities competing in commercial services, clustering and integrating services across sectors, and the integration of services with all other segments of the economy, including agriculture, manufacturing and energy.

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The Trade in Services Agreement (TiSA) is the first trade agreement since the GATS was negotiated more than 20 years ago, that focuses exclusively on updating the standards for international trade in services. Not all WTO Members are participating in the TiSA negotiations, which involve 50 countries (including the 28 EU members), mostly developed, accounting for 70% of the world services market. China has expressed an interest in joining the negotiations, but there has not been a consensus to admit China. Some parties have expressed concern that China’s record in services does not correspond to the level of liberalisation contemplated for TiSA.

The critical mass of participants means that the standards and level of ambition in this agreement are likely to become the template and standard for the global system. The world urgently needs TiSA. In the absence of such an agreement, countries are imposing many kinds of restrictions on service suppliers. The negotiations are taking place in Geneva but are not part of the Doha Round or any other WTO negotiation. However, the results will be legal in terms of the parties’ WTO obligations, assuming TiSA meets the requirements of GATS Article V.

11.0 The Post-GATS Landscape and the Forward Agenda

11.1 The Digital Revolution: A Business Perspective

Cross-border commercial data flows are the real backbone of the digital economy and are crucial to boosting growth in all sectors of the economy, including small and medium-size enterprises. Many business leaders believe that trade agreements should allow cross-border data flows and data-processing (cloud computing), and should prohibit requirements to use local network infrastructure or local servers. They assert that these commitments should be applied across all services sectors, including financial services. Any exceptions to these provisions should be limited to legitimate public policy objectives and only in full compliance with the provisions of GATS Article XIV (General Exceptions).

Many countries are imposing limits on businesses’ ability to conduct their operations in the most efficient ways possible. Governments increasingly and routinely impose legal restrictions on the ability of a firm to manage and move its own data across borders, or they impose requirements to store data on local servers. A common requirement is for a government to require that foreign firms establish facilities for storing and processing their data in the jurisdiction they are serving. This tendency is particularly pronounced in regulated sectors such as banking, insurance and telecommunications. Localisation requirements essentially make cloud computing services impossible. Examples of local data storage and processing requirements abound. For example, Canada, China, Greece, India, Indonesia, Malaysia and Russia all require that data generated within the country be stored on servers within the country.

From a global business perspective, it is essential that governments resist attempts to impose localisation requirements on service sector providers. The opportunity to do so lies in the current trade negotiations – various free trade agreements and the TiSA negotiations, which could be stepping stones ultimately to multilateral provisions in the WTO.

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These negotiations should set the standard for digital trade by:

• Ensuring that parties can transfer, access, process, and store data across borders and prohibiting parties from requiring the establishment or use of local servers;
• Ensuring non-discriminatory treatment of digital products and services from other parties; and
• Allowing parties to regulate cross-border data flows for legitimate policy reasons only within accepted standards under one of the exceptions set forth in GATS Article XIV.

11.2 The Digital Revolution and the Trans-Pacific Partnership

The Trans-Pacific Partnership (TPP),concluded in February 2016 among 12 Asia-Pacific countries,²⁰addressed the digital revolution explicitly in the form of a separate chapter on e-commerce. The text includes a number of ground-breaking provisions vital for supporting services trade in the digital age. Importantly, the TPP assures that a Member’s service sector market access commitments apply equally to services delivered or performed electronically and services delivered conventionally. Furthermore, Members may not require service firms to establish a local presence as a condition for supplying services – a vital requirement for ensuring the ability to offer cloud computing and other Internet-based services. The TPP also ensures that digital products, such as software and video products, remain duty free if transmitted online. For the first time in a trade agreement, TPP calls for Member countries to cooperate on cyber-security – an increasingly important priority for almost every economy.

The negotiations have made important progress in advancing the objective of freedom for cross-border data flows and prohibitions on localisation requirements. TPP provides that each Party shall allow the cross-border transfer of information by electronic means. In addition, the agreement prohibits localisation requirements. However, despite the advantages that TPP would appear to offer for services trade, the United States withdrew from the Agreement in January 2017 and it is uncertain whether the 11 other signatories will ratify it, at least in the near future.

FINANCIAL SERVICES AND TPP

From the business perspective, the TPP includes a very disturbing exception to the prohibition of localisation requirements. The financial services chapter of the TPP, which includes banking, securities, insurance, electronic payment service providers, and any other non-traditional financial services suppliers, does not contain a provision on the prohibition of localisation requirements present for all other businesses in the e-commerce chapter. By this exclusion, financial services are denied the cost and efficiency benefits of lowered trade barriers, and are also exposed to the considerable risks that derive from data localisation laws, thus limiting the parties’ ability to manage secure, well-functioning global information systems.

The financial services chapter also states that each party shall allow the cross-border supply of electronic payment services for payment card transactions, but it does not guarantee national treatment or the ability to conduct the full range of business activities related to electronic payments (i.e., beyond cross-border processing of payments transactions). From the business perspective, this is a significant omission, and business should be on guard that it is not repeated in future negotiations.

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11.3 State-Owned and State-Sponsored Enterprises

Businesses are finding that unfair competition from government-subsidised, supported, or owned/controlled enterprises is a rapidly increasing barrier to the provision of services by commercial suppliers in many markets. The preferential treatment granted by governments to state-owned enterprises (SOEs) takes many forms:

• Exemptions, in whole or in part, from laws and regulations applicable to privately owned enterprises, in particular foreign enterprises;
• Subsidies or monopoly rights to provide a particular service granted by governments to an SOE; and
• Imposition of harsher financial and regulatory requirements, and/or stricter supervisory enforcement on private and foreign firms.

The business community will benefit if TiSA and other services agreements establish appropriate globally relevant disciplines on state trading enterprises, state-owned enterprises, and designated monopolies that are engaged in commercial activities.

The TPP marks an initial effort to establish disciplines on anti-competitive behaviour with respect to services by SOEs. The disciplines are confined to those SOEs (as defined by the TPP) that affect trade or investment among the TPP parties within the 12 TPP jurisdictions. This, obviously, is one of the limitations resulting from a purely plurilateral agreement, but it is an important first step. The significance of the disciplines is also limited by the narrow definition of an SOE. To qualify as an SOE in the TPP, the entity must be directly owned at least 50% by the government (or the government exercises more than 50% of the voting rights or the power to appoint a majority of the board of directors). Business would benefit if this narrow definition does not become the model for defining SOEs in future agreements.

The TPP requires member governments to ensure that their SOEs provide commercial services in accordance with commercial considerations, and do not discriminate in their sale or purchase of goods or services. In addition, TPP parties are enjoined from providing non-commercial assistance to their SOEs, subject to a finding of adverse effects or injury to the interests of another TPP party or that party’s industry. The test for adverse effects is tightly drawn, with the result that the burden of proof on the complaining party is substantial. Moreover, the agreement does not recognise that adverse effects can result from an SOE’s behaviour in its own country – an inexplicable assumption. Nevertheless, if the TPP ever enters into force, businesses will find that the value of its SOE provisions lie in their impact on the terms of competition in TPP markets, and as a basis on which to build future agreements.

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11.4 Regulatory Cooperation and Coordination

REGULATORY COOPERATION: BENEFITS FOR SERVICE PROVIDERS

In many markets services companies have identified regulatory cooperation as the primary benefit from entering an FTA. Regulatory cooperation results in processes and mechanisms that reduce costs associated with regulatory differences and that promote greater compatibility in dealing with common issues. Regulatory dialogues that are taking place in many sectors, for example insurance, help to create mutual confidence with respect to the application of foreign and domestic regulations.

In order to increase the benefits of regulatory cooperation, businesses should take steps to ensure that trade agreements leverage the results of these dialogues in order to advance commonality and cooperation, and to promote competitive fairness, equal application for all market participants, and the rule of law. Negotiators and services regulators should work toward establishing meaningful, outcome-driven regulatory coherence where appropriate. One of the principal objectives for many businesses in the Trans-Atlantic Trade and Investment Partnership (TTIP) under negotiation between the United States and the EU has been much more robust and accountable regulatory coherence. To date, however, progress has been negligible, owing in part to regulators’ fears of encroachment upon their independence by trade agreements.

Regulatory cooperation is especially important in the area of financial services, where the industry has called for the inclusion of mechanisms to strengthen coordination and cooperation between financial regulators to ensure that financial sector reforms in different countries are implemented in compatible ways. Such provisions are not intended to take decisions about appropriate prudential regulation out of the hands of regulators, but to encourage them to work together to ensure that regulatory environments in different countries operate in a coherent manner that is supportive of cross-border business development.

11.5 Transparency and Due Process in Regulations

In sectors subject to regulation, businesses stand to gain if the agreements subject regulators to horizontal disciplines, regulatory principles and best practices. Principles such as regulatory transparency, consultation with stakeholders before adoption of new or revised rules, impartiality and due process with regard to licensing and qualification requirements and procedures, right of appeal, etc. are already normal practice in many jurisdictions.

11.6 Mobility of Persons

Mobility of highly skilled personnel (Mode 4) is a key component of the daily activities of international goods and service providers. Commitments to facilitate mobility and expedite business visas and temporary work permits are a matter of great importance to services providers. However, it is necessary for business to recognise that mobility of persons refers only to temporary activities, such as training, sales, after-sales service and maintenance. It does not include permanent employment or an unfettered right to a work permit or residence permit, such as a US green card.

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Businesses contemplating a foreign investment in Mode 3 (Commercial Presence) should not only evaluate the market access and national treatment commitments of the host state in Mode 3, they should examine whether they may need to move key personnel temporarily from the home state, and if so whether the host state’s Mode 4 commitments (Temporary Movement of Natural Persons) would allow such movement. Likewise, host state businesses should examine whether they would benefit from the presence of foreign competition and foreign service providers.

11.7 Investor-State Dispute Settlement

Many free trade agreements and bilateral investment treaties (BITs) contain provisions for investor-state dispute settlement (ISDS), which enables an individual investor to initiate an arbitration process with a host government that has expropriated an investment or caused other harm to an investor. ISDS does not require the consent of the investor’s home government. Governments often are reluctant to initiate WTO dispute settlement based on the allegations of a single investor, so ISDS offers a private investor an avenue for pursuing its claim against the host government. The arbitration process frequently is handled by the International Centre for the Settlement of Investment Disputes (ICSID), as well as other institutions, including to a lesser extent the International Chamber of Commerce. (See Volume Two of this series).

12.0 Conclusion

Services are no longer the red-headed stepchild of the international trading system, but are integral to its functioning. In the 25 years since services initially were incorporated into the multilateral trade rules, the global economy has undergone revolutionary change, in large measure due to the digital revolution. Service sector businesses have been among the most active and successful in exploiting the opportunities created by the digital economy. All businesses have a stake in advocating updated multilateral rules for services, and all governments must recognise that their economies depend on access to efficient services for their citizens’ competitiveness, prosperity and economic growth.

Because the importance of the service sector will only grow over time, businesses should recognise that they are working in an environment where regulations and disciplines are subject to change. They should factor in the risk of change when they consider service sector investments.

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