Trade in services: Parting with the EU?

Leaving the EU will change how UK service businesses like law firms, banks, insurers, architects and tour operators trade with the EU. Whatever choice the UK makes, departing from Single Market rules will inevitably mean more barriers to trade. As the Confederation of British Industry has stressed, “an agreement of unprecedented depth” would be required to ensure trade between the UK and the EU remains as frictionless as possible.

Why is trade in services important?

In 2018, services made up around 80% of the UK economy. Service industries accounted for 46% of UK exports and 28% of imports. The UK is the world’s second largest exporter of services, selling more than £297 billion worth in 2018, an increase of more than two thirds since 2008. And this data does not include the significant amount of services sold through foreign branches of UK companies.

The US is the UK’s largest single national trading partner, accounting for 21% of the UK’s total trade in services in 2018. However, taken as a bloc, the EU is much larger, accounting for 43%. Financial services, together with business services (including accounting, engineering and legal), account for about half of UK services exports. But services are sold across country borders in many other sectors, like travel, transport, telecoms, IT, film, culture and education.

Trade in services is complex

Trade in services is more complex than goods because consumers, suppliers and services themselves can cross borders. For example, tourists, foreign students and medical patients travel abroad to buy services. When a German architecture firm has a branch in London, it has established a ‘commercial presence’ in the UK. A UK accountant travelling to advise their client in Japan moves temporarily to provide a service. A service itself crosses a border when, for example, a call centre in Slovenia provides support to UK consumers.

Trade in each sector is governed by a huge number of rules. Services are not affected by tariff barriers and physical border checks. Instead, they face non-tariff barriers such as national regulations on company licensing, professional qualifications and immigration. These rules determine who can enter a foreign market and how they are treated.

To boost trade in services, countries remove restrictions or align regulations. Often, governments have to accept that their freedom to set rules may be restricted as a result. This can complicate the negotiation of trade agreements.

How free is UK and EU trade now?

The Organisation for Economic Co-operation and Development has shown that trade in services inside the EU Single Market is considerably freer than trade with partners outside.

Within the EU, businesses have the freedom to provide services and establish themselves in any Member State. This is possible due to a combination of common EU rules for various types of services, including financial services, and the principle of mutual recognition. As a result, a business that follows UK rules and standards is considered compliant across the EU and vice versa.

What is mutual recognition?
Mutual recognition of rules involves countries recognising each other’s standards or regulatory regimes as equivalent. Their rules may be different, but they achieve comparable outcomes. These rules are generally managed by shared processes or institutions. In the case of the Single Market, the term is also used to refer to automatic mutual recognition

Other cross-cutting EU rules also facilitate trade in services. For example, the rules on freedom of movement make it easier for people to work across the EU. The directives on the recognition of qualifications mean that professionals like nurses, vets and engineers can practise in other EU states. Common data protection rules cover all Member States and support many services that rely on the free flow of personal data.

However, it’s widely recognised that the Single Market for services needs improving: there are still many unnecessary or opaque rules and restrictions.

Financial services: From passporting to equivalence?

Financial services accounted for 6.9% of the UK’s economic output in 2018. Much of this depended directly or indirectly on the freedom to operate within the Single Market.

In the financial services sector, ‘passporting’ describes the automatic freedom to operate across the Single Market. A financial institution that is established in one European Economic Area state may carry out a range of activities set out in EU legislation in any other EEA state. The UK and the EU agree that if the UK leaves the Single Market, these passporting arrangements will end.

The main focus for future UK-EU financial services trade has been establishing ‘equivalence regimes’. An equivalence regime establishes mutual recognition for a specific area or type of service. To achieve this, trading partners will need to review each other’s regulatory arrangements and agree that the ‘regulatory outcomes’ are comparable.

But there are drawbacks:

• Equivalence regimes can be unilaterally withdrawn by either party for any reason. The EU withdrew recognition from a range of partners in 2019.
• Under current arrangements, it is not possible to establish a general equivalence regime with the EU that covers financial services as a whole. EU law limits equivalence agreements to a limited number of specified areas.
• Equivalence assumes strong regulatory alignment. If the parties’ regulations diverge, the equivalence regimes are likely to collapse.

For now, the UK has established temporary permissions regimes that would allow EEA financial institutions currently operating in the UK to continue to do so for a limited time after Brexit. But these are unilateral, and the adoption of reciprocal arrangements by other EEA states has been piecemeal.

Further reading

• Trade in services and Brexit, House of Commons Library.
• Brexit and financial services, House of Commons Library.
• Financial services: contribution to the UK economy, House of Commons Library.