As the European Union (‘EU’) and the United Kingdom begin to negotiate their future trading relationship, constraints arising from the EU’s existing free trade agreements (‘FTAs’) will come to the fore. The Most Favoured Nation (‘MFN’) provisions of the EU’s existing FTAs pose a particular problem, since existing FTAs, including those concluded with Canada, Korea, Singapore, and most recently Japan all confer MFN rights on these counterparts. This means that any advantages the EU may seek to accord to the UK under a UK-EU FTA may also need to be extended to these other States. The MFN constraint therefore will place definite strictures on the benefits the EU is willing to extent to the UK. Otherwise, FTA members will gain significantly enhanced access to the EU market, access to the benefits of the EU “club”, through the back door of the EU-UK negotiations.

FTAs are negotiated between two economies that are considering steps to enhance the fluidity and intensity of their reciprocal economic exchange. The most obvious of achievement, in terms of trade in goods, is to reduce and to eliminate existing import tariffs. For trade in services, enhancement in trade conditions starts by eliminating expressly discriminatory provisions in national legislation – for example, laws or regulations limiting access to a particular services sector to State nationals. Beyond this, partner economies can seek to further enhance fluidity in their mutual goods and services exchange through mutual recognition of regulatory standards, among other things. Mutual recognition can streamline processes for the entry of goods and for the provision of services across borders.

Indeed, the Canada-EU Comprehensive Economic and Trade Agreement (CETA) goes beyond removal of express barriers between the EU and Canada. It seeks better regulatory cooperation between Canada and the EU, in a manner that over time will make trade in goods and services more fluid.

Yet provisions such as those in CETA or other modern free trade agreements are a far cry from the deep regulatory integration and common rules-making that distinguish the EU’s Single Market. The rules of the Single Market amount to membership of a select club, whose benefits flow only to members. It is precisely that kind of fluid EU access – based on participation in a common regulatory space – that the UK is seeking to maintain, albeit as a non-member of the EU.

To the extent the UK seeks the benefits of EU membership without actually being a member, MFN issues will arise. The EU and UK largely are insulated from MFN concerns in the context of the World Trade Organisation (WTO). For example, the General Agreement on Tariffs and Trade (‘GATT’) expressly reserves against MFN applying to agreements affecting “substantially all trade”.[1] The EU and UK would be unable to enter into stand-alone sectoral agreements relating to, for example, financial services or automotive industry trade, without extending the same benefits to other WTO Members. But they are insulated from MFN implications to the extent that coverage of these sectors is folded into a broader trade agreement, of the kind the EU and UK will be seeking to achieve.

The issue is different for the EU’s current FTA partners. Typically, modern FTAs provide for “forward” MFN – that is, the parties to the agreement agree that they have granted each other the highest level of liberalisation they currently may offer. But they also undertake to extend to the FTA partner any better level of liberalisation they may offer in any future negotiations. This is subject only to express MFN reservations in the FTA, allowing a party to extend specific rights to a future counterpart on an isolated basis.

This is the source of the dilemma for the EU vis-a-vis the UK. As a member of the EU, the UK enjoys unfettered access to the EU Single Market, premised upon regulatory integration, common supervision under the European Court of Justice (ECJ) and related freedoms of movement. These are all rules of the club that all Members States are bound to accept. The EU has never extended the benefits of EU Membership to third party States, without such States accepting EU rules.

In taking reservations in agreements like CETA, the EU did not bother negotiating MFN reservations against many rights extended to EU members only. The EU only took reservations for a variety of EU benefits on a “National Treatment” basis. That is, these were benefits extended to EU Member States only. They would never be extended beyond the club, and so no MFN reservation was necessary.

This means that a broad range of rights the EU exclusively reserved for its Member States – rights set out and reserved in various annexes to the CETA – will be open to Canada should the EU ever agree to extend them to the UK as a third party. The specific impacts are complex and raise a myriad of issues.

To give just a few examples, in the CETA the EU:

  • reserves the right to treat only EU-registered companies as equivalent to natural persons, for purposes of freedom of movement across the EU. If the EU extends this benefit to UK companies, it will also extend to Canadian companies;
  • reserves the right to offer access to publicly funded research support to EU nationals or juridical persons only. If the EU extends this benefit to UK natural and legal persons, it will also extend to Canadians; and
  • reserves the right to restrict access to ownership of water treatment facilities to EU nationals only. If the EU extends this benefit to UK natural or legal persons, Canadians may also have rights to invest in this sector.

The list goes on and covers a broad range of specific EU and Member State rights. If the UK succeeds and the EU extends these benefits to it as a non-EU Member State, much of the “exclusivity” of the EU’s current structure will fall away. Indeed, it will fall away not only for Canada, but to all other States with whom the EU has negotiated similar MFN provisions.

There is one way that the UK and EU could insulate their future agreement against this result. The MFN issue largely disappear if the UK opts for a “Norway” style, European Economic Area (‘EEA’) arrangement with the EU. Under the EEA a State gains access to most of the enhance access of EU “club” membership, but that access comes at the cost of compliance with EU rule-making. The CETA provides an express reservation against MFN for future EEA-type arrangements. This again reflected EU thinking – it contemplated that States in future might want to “join” the EU, through this alternative option.

It is an open question whether the UK Government will be open to this solution. By adopting the “Norway” option, the UK will maintain most of the access it currently enjoys with the rest of the EU. But it will have only limited ability to influence the rules applicable to it across a broad sectoral and functional range. It is difficult to square this outcome with Brexit purportedly repatriating some of the UK’s sovereign rights.

To the extent the UK wants to enjoy EU club benefits without full EU membership, MFN provisions in the EU’s current FTAs likely will pose a significant problem. The impact of MFN and related reservations in the EU’s existing free trade agreements is complex and requires specific industry-by-industry consideration.