International trade body turns to financial services COMPETITION

It is becoming increasingly clear the importance of the financial services sector on the global stage. The recent drive toward globalization of business — coupled with new information technology and the formation of geo-economic and political alliances — have allowed financial institutions to follow their clients around the globe. However, the growing importance of financial services at the international level has drawn the attention of such bodies as the World Trade Organization (WTO) in establishing “fair play” rules to who and how the players can compete. The latest round of WTO “GATS” discussions on financial services concluded this year should broaden international competition significantly. That said, Canadian property and casualty insurers and their life counterparts are unlikely to be affected by the agreement due to the intense competition already existing in the market.

According to the World Trade Organization (WTO), there has been dramatic growth over recent years in the number of foreign banks, insurance companies and securities houses either operating outside their home countries or providing services to foreign customers.

A study released in the second quarter of 1997 by economists from the WTO Secretariat discussed the benefits and challenges related to the liberalization of financial services trade in both developing and developed countries. The paper highlighted the importance of international competition in banking, securities and insurance markets while acknowledging the critical need for preserving prudential policies to safeguard financial systems for the benefit of investors and consumers.

The study, “Open Markets in Financial Services and the Role of the GATS”, says trade liberalization in financial services will enhance competition and improve sector efficiency, which in turn will lead to lower costs, better quality, and greater choice. The study also suggests that opening up competition will improve financial intermediation and increase investment opportunities through better resource allocation across all the sectors, countries and time, and through better means of managing risks and absorbing shocks. This, the study points out, will induce governments to improve macroeconomic management, domestic policy interventions in credit markets, and financial sector regulation and supervision.

The financial services sector has expanded rapidly in recent years. The study notes that employment increased by 25% to 50% in a number of industrialized countries since 1970 and now represents 3% to 5% of total employment. Value-added in the financial service sector has also grown considerably over the past 25 years and now reaches between 7% and 13% of GDP in Hong Kong (China), Singapore, Switzerland, and the U.S. Furthermore, cross-border trade in financial services more than tripled between 1985 and 1995 and now exceeds US$50 billion for the most important trading countries.

Insurers rise internationally

The upward spiral in capital flowing to financial service-oriented companies is certainly not limited to banking and securities, but is easily recognized in the insurance sector as well. In 1995 insurance premium volume amounted to US$2,143.4 billion — surpassing the US$2 trillion mark for the first time in history. More than 90% of this amount, says Swiss Re (sigma issue 4/97), was attributed to markets in industrialized countries. In the life insurance sector, premium volume reached US$1.2 trillion — 57.7% of total direct insurance business written worldwide. Life insurance, Swiss Re says, reached particularly high levels in Asian countries, especially in Japan and South Korea. Similarly, property and casualty insurance achieved a turnover of US$906.8 billion. The lion’s share of this business was written in the industrialized countries of North America and Western Europe with world market stakes of 41.9% and 33.5% respectively. Japan accounts for 14% of global market volume.

The impact of GATS

The General Agreement on Trade in Services (GATS) is the first multilateral agreement to provide legally enforceable rights to trade in all services. It has a built-in commitment to continuous liberalization through periodic negotiations. It is the world’s first multilateral agreement on investment, since it covers not just cross-border trade but every possible means of supplying a service, including the right to set up a commercial presence in the export market.

The GATS has three basic principles: it covers all services except those provided in the exercise of governmental authority, secondly, there should be no discrimination in favor of national providers — the national treatment principle, and thirdly, there should be no discrimination between other members of the agreement — the most-favored-nation (MFN) principle. The agreement provides important exceptions to all three of these principles. In the first instance, governments can choose the services in which they make market access and national treatment commitments, and secondly, they can limit the degree of market access and national treatment they provide. They can also take exceptions even from the MFN obligation, in principle only for ten years, in order to give more favorable treatment to some countries than to the generality.

The beginning of GATS

At the end of the Uruguay Round of trade negotiations in 1993, discussion concerning financial services, along with those on basic telecommunications and maritime transport, remained unfinished. Specific commitments to provide market access and national treatment were made in the sector, but they were not considered enough to conclude the negotiations. Broad most-favored nation (MFN) exemptions based on reciprocity remained (eg. you can enter my market if I can enter yours). The second annex on “Financial Services to the General Agreement on Trade in Services” and the “Decision on Financial Services” adopted at the end of the round provided for extended negotiations in this sector. The negotiations were to be held during a six-month period following the entry into force of the GATS (i.e. until the end of June 1995). At the conclusion of this period, members of the WTO had the possibility to improve, modify or withdraw all or part of their commitments. They were also able to introduce additional MFN exemptions. Until the end of this period, existing broad MFN exemptions based on reciprocity were not applied.

The interim agreement of 1995

The 1995 negotiations were actually concluded in July of that year rather than June 30 as initially planned. The agreement was called the “Interim Agreement”, as negotiators again decided that the results of the talks were not satisfactory and envisaged further negotiations in two-years’ time (i.e. in 1997). As a result of the 1995 negotiations, 29 WTO members (counting the EU as one) improved their schedules of specific commitments and/or removed, suspended or reduced the scope of their MFN exemption in financial services.

Those improved commitments were annexed to the Second Protocol to the GATS. Three other countries — Colombia, Mauritius and the U.S. — decided not to improve their commitments, and took broad MFN exemptions based on reciprocity. As a result of those extended negotiations, and with new accessions to the WTO, 97 members of the WTO (again, counting the EU individually) had commitments in financial services by mid-1997, compared to some 76 countries at the end of the round. The Second Protocol and the commitments annexed to it entered into force beginning of September 1996, except for a small number of countries which were unable to complete their internal ratification procedures and formally accept the protocol before July 1, 1996. For those remaining countries, the commitments entered into force 30 days after acceptance.

The 1997 negotiations

The negotiations were reopened in April 1997, where members again had an opportunity to improve, modify or withdraw their commitments in financial services and to take MFN exemptions in the sector from November 1 until December 12, 1997 . A new set of commitments in financial services under the GATS was agreed on in December of that year. A total of 56 schedules of commitments representing 70 WTO member governments and 16 lists of MFN exemptions (or amendments thereof) were annexed to the Fifth Protocol to the GATS, which was open for ratification and acceptance by members until January 29, 1999. Fifty-two Member governments accepted the protocol by the due date, and those members decided to put it into force on March 1, 1999 in accordance with the terms of the protocol. It was also decided by the Council for Trade in Services that the protocol would be kept open for acceptance until June 15, 1999 for the remaining 18 members. For those members accepting after March 1, the protocol would enter into force upon acceptance.

With five countries making commitments in financial services for the first time, the total number of WTO members with commitments in financial services will increase to 104 upon the entry into force of the Fifth Protocol.

As a result of the negotiations, the U.S., India and Thailand decided to withdraw their broad MFN exemptions based on reciprocity (only a small number of countries submitted limited MFN exemptions or maintained existing broad MFN exemptions). Several countries, including Hungary, Mauritius, the Philippines and Venezuela reduced the scope of their MFN exemptions. The U.S. submitted a limited MFN exemption in insurance, applicable in a circumstance of forced divestiture of U.S. ownership in insurance service providers operating in WTO member countries.

The new commitments contain significant improvements allowing commercial presence of foreign financial service suppliers by eliminating or relaxing limitations on foreign ownership of local financial institutions, limitations on the juridical form of commercial presence (branches, subsidiaries, agencies, representative offices, etc.) and limitations on the expansion of existing operations. Important progress was also made in “grandfathering” existing branches and subsidiaries of foreign financial institutions that are wholly or majority-owned by foreigners. Improvements were made in all of the three major financial service sectors — banking, securities and insurance, as well as in other services such as asset management and provision and transfer of financial information.

1999 deadline confirmation

Governments which account for more than 90% of the global financial services market agreed in February this year that the landmark WTO financial services agreement will enter into force on March 1. At a meeting, representatives from 52 governments decided that the March 1 date would not be changed and requested the WTO’s Council for Trade in Services to extend the deadline for accepting the protocol in order to allow another 18 governments more time to complete their domestic ratification procedures. The decision to extend the deadline for accepting the protocol to June 15, 1999 was later adopted by the Council for Trade in Services.

What GATS means for Canadian p&c insurers

According to the Insurance Council of Canada’s 1998 Facts Book (Facts of the General Insurance industry in Canada) in 1905 there were 40 companies offering fire insurance in Canada. Of these, 17 were British, 13 Canadian and 10 American. Today, there are more than 200 companies across Canada offering general insurance and reinsurance. And there is still a strong presence of foreign owned carriers in the country (more than half, with parent companies from the U.S. and Europe playing the strongest role). In short, there is no shortage of p&c companies in Canada, and the sector could not possibly be accused of being closed and protective. It is therefore anticipated that the WTO GATS will have little impact on Canada’s non-life insurance sector.

Non-life insurance in Canada is one of the most regulated sectors in the country. All insurers and reinsurers must be licensed for each class of business they insure in each of the ten provinces and two territories. They must also be either federally registered or registered in each province in which they conduct business. Canadian branches of a foreign company must be federally registered.

Insurance companies incorporated under provincial legislation are subject to provincial supervision. Provincial legislation deals with insurance contract matters, the protection of policyholders, and the licensing of agents, brokers, claims adjusters, and other intermediaries. Although branches of foreign companies must be registered federally, a foreign company may choose to register a Canadian subsidiary company separately in each province in which it carries on business.

If the GATS financial services deal has any affect on Canada at all, it may take the form of an unofficial moratorium on new insurance industry regulation that could be perceived by foreign companies as barriers to market entry. In other words, though the GATS may not drive widespread liberalization of industry rules and regulations, it probably won’t tighten up industry regulations, either (i.e. see industry legislation get more stringent). If any insurance regulations are liberalized, it could be in the area of tax (where current guidelines are quite complicated — especially for foreign company/branches operating in Canada) and jurisdiction, where there has been talk lately of creating single provincial regulators to watch-over the securities, mutual fund and insurance industries together.

While the GATS isn’t expected to shakeup the country’s p&c industry to any great degree (and, perhaps, to no degree at all), the real interest may lie in the fact that the agreement reinforces the theory that business of every kind is becoming more global and that geographic borders are slowly disappearing. The fact that 104 nations signed on to the financial services section of the GATS deal could be considered a clear indication of this trend.

Compiled with extensive use of World Trade Organization documents. Thank you to the WTO for permission to use their material in writing this article.