Despite the tortuous path ahead for the US election campaigns and the trials and tribulations of 2020, the US-China Phase One Trade Deal remains in place.(1)
Although commitments under the Phase One Deal are between China and the United States only, international trade law limits the extent to which benefits under such agreements can be strictly bilateral.
In particular, the most-favoured nation (MFN) obligation requires World Trade Organisation (WTO) members (eg, China and the United States) to give all WTO members the same benefits that they give to preferential trading partners.
This might leave some non-US entities with business in China wondering whether the Phase One Deal is beneficial only for US entities or whether other foreign entities can also benefit.
As China begins to further open its financial market, foreign insurance institutions (FIIs) may be wondering whether non-US FIIs have any chance of benefiting from China's treatment of US insurers, specifically under the insurance heading of the Phase One Deal's financial services chapter (Article 4.6). If only US insurers benefit, would that be a Global Agreement on Trade in Services (GATS) violation or would it be GATS compliant?
These are thorny legal questions which this article answers by examining China's commitments under:
- the GATS;
- Article 4.6 of the Phase One Deal; and
- the MFN obligation under the GATS.
China has already voluntarily passed GATS-compliant legislation, extending one bilateral commitment in Article 4.6 to all foreign investors. China may follow a similar course of action with its other bilateral insurance commitments to the United States. However, as is often the case with international trade law, whether China decides to do so will depend on both legal and diplomatic concerns rather than solely on legal considerations.
China's Phase One Deal insurance commitments align with prior plans
Modernising and improving China's insurance sector has been a strategic state goal since as early as 2014, when the Several Opinions of the State Council on Accelerating the Development of the Modern Insurance Service Industry were passed. Among the goals contained in the opinions is that by 2020, insurance will become an essential means of risk and financial management for the government, enterprises and residents, with specific targets for greater insurance penetration (5%) and density (Rmb3,500 per person).(2)
Aligned with these objectives, at the start of the 2020 two sessions (the 2020 lianghui) Premier Li Keqiang announced "higher government subsidies for basic medical insurance for rural and non-working urban residents" (third session of the 13th National People's Congress). After the end of the 2020 lianghui, the State Council also encouraged insurers to increase coverage for Chinese exporters and small to medium enterprises affected by COVID-19 in its Guidelines about Further Strengthening Financial Services for SMEs and Micro Enterprises (Yin Fa 2020 120).
Like these more recent measures, many Chinese commitments to US insurers in the Phase One Deal also dovetail with earlier Chinese reform plans. Article 4.6 of the Phase One Deal reads as follows:
Article 4.6: Insurance Services
1. No later than April 1, 2020, China shall remove the foreign equity cap in the life, pension, and health insurance sectors and allow wholly U.S.-owned insurance companies to participate in these sectors. China affirms that there are no restrictions on the ability of U.S.-owned insurance companies established in China to wholly own insurance asset management companies in China.
2. No later than April 1, 2020, China shall remove any business scope limitations, discriminatory regulatory processes and requirements, and overly burdensome licensing and operating requirements for all insurance sectors (including insurance intermediation), and shall thereafter review and approve expeditiously any application by U.S. financial services suppliers for licenses to supply insurance services. In accordance with this commitment, China affirms that it has eliminated the requirement of thirty-years of insurance business operations for establishment of new foreign insurance companies.
3. The United States acknowledges current pending requests by Chinese institutions, including by China Reinsurance Group, and affirms that such requests will be considered expeditiously. (Emphasis added.)
Prior to the conclusion of the Phase One Deal, the concession outlined in Article 4.6.1 was already scheduled to be passed. To this end, on 6 December 2019 the China Banking and Insurance Regulatory Commission issued the Detailed Rules for Implementing the Regulations Administering Foreign-Invested Insurance Companies in China together with the Notice Clarifying the Timeline to Cancel Foreign Equity Ratio Restrictions in Joint Venture Life Insurance Companies. Notably, the concession in Article 4.6.1 was not granted solely to US enterprises (which would be a GATS violation, as discussed below), but rather to all foreign investors in China.
The United States' acknowledgement of "pending requests by Chinese institutions" in Article 4.6.3 relates to applications from Citic Group, China Re and China International Capital Corp (CICC) for licensing in the United States.
The only possible friction between China's insurance sector Phase One Deal and GATS commitments is Article 4.6.2, in which China singles out US firms for what appears to be preferential treatment: "review and approve expeditiously any application by U.S. financial services suppliers for licenses to supply insurance services."
Road to accession: China included insurance in its GATS schedules of commitments in 1994 and 2002
Could this friction result in a possible GATS violation? China's GATS commitments must first be examined. (For brevity, the particulars of these commitments are not listed in this article.)
China's first GATS commitments were published in 1994, prior to its accession to the WTO. A fundamental concept in understanding GATS commitments is the difference between positive and negative lists. WTO members use a positive list to indicate their specific commitments to provide market access and national treatment in a schedule of commitments (SOC). On the other hand, a blanket MFN commitment applies to all areas of the GATS, unless there is a negative reservation in the form of an exemption (discussed below, together with other exceptions). Regardless of whether a positive commitment is listed in the SOC, a WTO member cannot discriminate among its trading partners in terms of market access or national treatment.
When China made this SOC, foreign insurers had a minimal presence in China. The only FII in China in 1994 was AIA (a subsidiary of AIG), which established a branch in Shanghai in 1992 (becoming the first foreign-invested insurance entity in China). In 1996 Canadian insurer Manulife established China's first life insurance joint venture with Sinochem.
In 2001 China acceded to the WTO and in 2002 it issued another SOC under the GATS, leading to further liberalisation. The ensuing relaxation of market entry rules ushered in a series of new insurance players in the Chinese market. To better understand what this liberalisation entailed, China's commitments for its four modes of supply that took place should be examined. These modes refer to the four means for supplying services listed in the GATS (Article I:2 of the GATS). Mode 2 (consumption abroad) became open for all but brokerages (ie, China still reserves the right to restrict the consumption of insurance services from brokerages based abroad). Most significantly, Mode 3, which deals with commercial presence, was opened (but still subject to a number of restrictions). Modes 4 (presence of natural persons) and 1 (cross-border trade) remained 'unbounded' (ie, China made no commitment to liberalise them), with some exceptions for Mode 1.
GATS MFN applies to Phase One Deal and no exemptions or exceptions apply
Under the GATS, there are two general, unconditional (with certain exceptions) obligations. The first is the MFN obligation and the second is the obligation of transparency. Only the first (MFN) is relevant to this analysis. The operative MFN provision for the GATS is:
GATS Article II.1 (Most Favoured Nation)
With respect to any measure covered by this Agreement, each Member shall accord immediately and unconditionally to services and service suppliers of any other Member treatment no less favourable than that it accords to like services and service suppliers of any other country.
The effect of the MFN obligation is to forbid discrimination among a member's trading partners. For example, if China gives special market access to a US bank, it cannot deny that same access to a Canadian bank (except with some exceptions, discussed below).
Under Article II of the GATS, the test to determine whether a measure violates China's MFN obligation is to ask whether it modifies "the conditions of competition to the detriment of like services or service suppliers of any other Member" (Appellate Body Report, Argentina – Financial Services, Paras 6.114 to 6.115). Such an analysis must begin "with careful scrutiny of the measure, including consideration of the design, structure, and expected operation of the measure at issue" (Appellate Body Report, Argentina – Financial Services, Para 6.127).
As a result, any favourable treatment afforded solely to the United States under the Phase One Deal is discriminatory and must also extend to other foreign investors under the MFN obligation. For any measure covered by the GATS (ie, falling under the definitions in Article I of the GATS), a WTO member cannot give favourable treatment to services and service suppliers of any country without immediately and unconditionally giving no less favourable treatment to all WTO members (Article II of the GATS). This applies irrespective of whether that measure is the subject of a specific commitment in the SOC.(3)
China's commitments to United States may engage GATS and extend to other WTO members
China has already voluntarily extended many of its Phase One Deal concessions to all foreigners (China already granted the concessions in Article 4.6.1 to all foreign insurers, making it GATS compliant). As of 1 January 2020, all foreign insurers (and not just US insurers) are allowed full ownership of Chinese life insurance companies. From 1 April 2020, this commitment also extends to the pension and health insurance markets. Under China's new Foreign Investment Law, all FIIs will also now be governed by the Company Law rather than ad hoc foreign investment laws.
However, it remains to be seen whether China's commitments under Article 4.6.2 of the Phase One Deal will violate the GATS. Article 4.6.2, which can be split into two parts, appears to signal an intent to give US firms special treatment. The first part commits China to remove:
any business scope limitations, discriminatory regulatory processes and requirements, and overly burdensome licensing and operating requirements for all insurance sectors (including insurance intermediation).
This part complies with the GATS. However, the second requires China to "thereafter review and approve expeditiously any application by U.S. financial services suppliers for licenses to supply insurance services". This second part strongly indicates an intent to grant preferential, discriminatory treatment for the benefit of US firms.
The question is whether China will:
- extend Article 4.6.2 commitments to all FIIs willingly, as it did with Article 4.6.1 commitments;
- overtly discriminate in favour of US insurers (de jure discrimination); or
- covertly discriminate in favour of US insurers (de facto discrimination).
In case of the first option, there is no MFN violation. This may happen and it is entirely possible for China to formulate regulations in its implementing measures which meet this Phase One Deal term while affording equal treatment to other WTO members.
In case of the second option (de jure discrimination), the MFN violation is straightforward and other WTO members may initiate dispute settlement proceedings under the auspices of the dispute resolution body (DSB) and would most likely obtain a favourable decision. Chinese authorities are well aware of this; thus, the second option is unlikely.
In case of the third option (de facto discrimination), the issue becomes much more complicated and guiding WTO case law becomes necessary. In EC — Bananas III, the European Communities argued that MFN under the GATS does not extend to de jure discrimination, only to de facto discrimination. This was rejected (Appellate Body Report, EC – Bananas III, Paras 231 to 234). Applying the above analysis from Argentina Financial Services, any treatment which modifies the "conditions of competition" against one member in favour of another falls foul of MFN. In its reasons for ruling against the European Community in EC — Bananas, the Appellate Body expressly applied this standard to de facto licensing discrimination: "various aspects of the EC licensing procedures at issue created less favourable conditions of competition for service suppliers of the complainants'" (Appellate Body Report, EC – Bananas III, Paras 240 to 248).
The standard for breaching the MFN obligation in this context is low, and there is no separate enquiry into the regulatory objective or concerns behind a measure's impact on the conditions of competition (Appellate Body Report, Argentina – Financial Services, Paras 6.105 to 6.106):
This legal standard does not contemplate a separate and additional inquiry into the regulatory objective of, or the regulatory concerns underlying, the contested measure. Indeed, in prior disputes, the fact that a measure modified the conditions of competition to the detriment of services or service suppliers of any other Member was, in itself, sufficient for a finding of less favourable treatment under Articles II:1 and XVII of the GATS.
As a result, if China visibly moves the needle in favour of licensing US insurers, it will breach the GATS, but if it does so inconspicuously, this will be insufficient to mount a GATS challenge. If China wishes to grant favourable licensing terms to US insurers in a way that does not lead to losing a GATS challenge, it must do so in a manner that is almost imperceptible and, at the least, non-provable. For example, any kind of quid pro quo that leads to a US firm being licensed in China shortly after the United States licenses a Chinese firm (eg, China Re, Citic Group or CICC) would appear transactional and arouse suspicion and could be challenged as an MFN violation. In challenging any discriminatory treatment, the fact that China's Article 4.6.2 commitment (to approve US insurers) immediately precedes the United States' Article 4.6.3 commitment (to acknowledge the pending requests of Chinese insurers) in the Phase One Deal may be used as a smoking gun to show discriminatory intent.
Legally under the GATS, Chinese concessions to the United States must be legislated in ways that do not discriminate between WTO members. If these concessions instead extend only to the United States, or if it is discovered that a government measure in fact discriminates against other WTO members, those members may initiate consultations. Failing consultations, those members may pursue dispute settlement under the auspices of the DSB.
So far all of China's measures implementing the Phase One Deal appear to have been GATS compliant and have not led to a challenge from another member.
However, what might possibly occur, and raise questions regarding compliance with the GATS, is a quid pro quo between the Chinese and US administrations – for example, licensing a US insurer in exchange for the United States licensing a Chinese insurer. This would be an MFN violation. However, as a form of de jure discrimination, such violations are notoriously difficult to prove.
This means that from an evidentiary standpoint, there is room – however narrow – for China to license US insurers on a preferential basis without demonstrably affecting the conditions of competition in the Chinese insurance market. Nevertheless, WTO precedent on the matter is clear and if such de jure discrimination were proven, it would not be difficult to show that such treatment adversely affects the conditions of competition in violation of the MFN obligation.(4)
Although preferential licensing of US insurers is an option available to China, diplomatic considerations will be taken into account in terms of whether to pursue it. China voluntarily extended the commitment in Article 4.6.1 to all FIIs and has been carefully planning this phase in its insurance reform since before the release of the 2014 policy. China may find that the economic benefits of greater competition and variety in the Chinese insurance market are more valuable to its long-term reform plans than the diplomatic points that it would gain through a licensing quid pro quo with the current US administration. If that is the case, it would be logical to then also voluntarily extend the commitment in Article 4.6.2 to all FIIs.
Endnotes
(1) Damaging floods and spiking corn prices have pushed Chinese importers to buy record volumes of US corn, which could help the government to fulfil a pledge under the Phase One Deal. See Hallie Gu and Dominique Patton, "Exclusive: China plans wheat, rice sales to tame surging corn prices - sources", Reuters, 21 July 2020.
(2) Zhen Jing, Chinese Insurance Contracts: Law and Practice, (Abingdon, Routledge 2017) at 23.
(3) There are a few exceptions to the MFN requirement in Article II, none of which apply to the Phase One Deal. For one, if the Phase One Deal was an economic integration agreement (EIA), China could give the United States preferential access under Article V of the GATS. However, in order for an agreement to qualify as an EIA, it must, among other requirements, have 'substantial sector coverage' under services (Article V of the GATS). The Phase One Deal cannot be characterised as having substantial sector coverage because, among other reasons, it does not liberalise all four GATS modes of supply (a key requirement for substantial sector coverage). It also cannot be characterised as a regional trade agreement, which like an EIA could spare China from Article II MFN commitments because the United States and China do not share a border (Article II.3). If either were the case, China could have claimed the right to liberalise its market solely for the benefit of US insurers under the Phase One Deal and not extend that same treatment to all other WTO members.
A couple of other exceptions are worth reviewing briefly, but also do not apply. The first is exemptions. A WTO member may enter reservations to its MFN obligation through MFN exemptions in its annex to the GATS. However, China's insurance commitments were not exempted in its annex. The only exempted industries are those relating to transport (maritime, international and freight and passengers). In other words, under the GATS, the Chinese insurance sector (including life, pension and health insurance) is not exempt from MFN treatment. The second exception concerns government procurement: direct purchases of insurance services by the Chinese government are not subject to the MFN obligation. However, it is unclear whether the obligation applies to purchases by state-owned enterprises.
(4) In 2020 should China continue to go through the motions of showing GATS compliance? The WTO has no teeth and cannot enforce any of its decisions. The WTO's dispute resolution platform also continues to face a crisis due to the United States blocking the appointment of Appellate Body panellists.
The answer is most likely yes. Unfavourable rulings do carry consequences. They sometimes lead to countermeasures from trading partners and continue to carry weight in international diplomacy. Members prefer to avoid unnecessary pressure from other members and it is unlikely that China will overtly ignore the GATS rules.
