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Brexit: Prospects for EU-UK Trade Negotiations

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Now that the UK Government has a majority in Parliament to pass the EU (Withdrawal) Act before its invocation of Article 50 of the Treaty of European Union expires on 31 January 2020, the threat of the UK leaving the EU without a new trade agreement (a “no deal” outcome) is no longer imminent.

Passage of the EU (Withdrawal) Act will trigger the start of a transition period, during which:

  • The current EU-UK trade relationship will not change – the UK will remain part of the EU Customs Union and Single Market, subject to all EU trade law.
  • The EU and the UK will negotiate their new economic and security relationship, including a new agreement on trade, based on the mandate contained in the Political Declaration on the EU-UK future relationship.1

The transition will last until 31 December 2020. Under the Withdrawal Agreement, it can be extended for up to two years if the EU and the UK agree to do so. However, at present, the UK Government’s stated intention is not to seek or agree to an extension.

A “no deal” outcome on trade remains a possibility if the EU and the UK fail to conclude a new trade agreement before 31 December 2020 and the transition period is not extended. In that case, with effect from 1 January 2021, the basis for EU-UK trade would automatically default to WTO terms.

The UK Government is expressing its confidence that it will be possible to reach a new trade agreement and avoid a “no deal” by the end of the transition period. However, the short deadline for doing so if the transition is not extended has led senior EU officials to express concern that the agreement may be less meaningful than if negotiations were to be given more time.

The Political Declaration on the EU-UK future relationship on which trade negotiations will be based is an aspirational document setting out general principles and objectives that could produce a wide range of outcomes. It envisages “an ambitious trading relationship on goods” and “ambitious, comprehensive and balanced arrangements in services and investment”. Recently, however, the EU and the UK have dampened expectations of the scale of ambition that will be possible. The UK has ruled out its earlier support for a single customs territory with the EU, and the accompanying close regulatory alignment. The EU has said the depth of the trade agreement possible will depend on the degree of regulatory convergence with the EU that the UK is prepared to accept. The EU’s stated focus is on maintaining a “level playing-field” through UK commitments not to seek an unfair competitive advantage by deregulating its laws on the environment, labour, taxation or state aid – “The more divergence there is, the more distant the partnership has to be” (EU Commission President Ursula von der Leyen, 8 January 2020).

A new EU-UK trade agreement that lacks depth or breadth could place businesses that depend heavily today on frictionless trade within the Customs Union and the Single Market in a position that is barely less challenging than a “no deal” outcome. Even if agreement can be reached that trade will take place tariff- and quota-free, the transaction costs of getting goods both ways across EU-UK borders could rise substantially because of customs controls, the need to fulfil rules of origin and regulatory divergence.

Negotiations on the EU-UK future relationship will take place in parallel with UK trade negotiations with other partner countries, notably the United States. These are linked. Other partner countries are likely to prefer to wait to find out what the EU-UK trade agreement contains before concluding their own trade negotiations with the UK. The closer the UK remains aligned to the EU regulatory model, for example, the less room it has to manoeuvre and strike a close trade deal with the United States.2

 

Importance of the Transition Period

The transition period will begin on 1 February 2020, after ratification of the EU (Withdrawal) Act in the UK. It will last until 31 December 2020. The UK and the EU may extend the transition period once for up to two years. To trigger the extension they must agree that one is needed by 1 July 2020, and agree on the financial contribution that the UK will make to the EU budget for as long as the transition lasts.

  • UK Prime Minister Boris Johnson has stated that he will not seek an extension of the transition.  To reinforce that, Clause 33 of the UK Withdrawal Agreement Bill, which implements the EU (Withdrawal) Act in UK law, would prevent a government minister from agreeing any extension to the transition period; instead, primary legislation would be required to approve an extension. If an agreement on the future EU-UK trade relationship is not reached by 31 December 2020 and the transition is not extended, the UK would have to leave the EU on a “no deal” basis and start trading with the EU as a third country on WTO terms.

During the transition, “Union law shall be applicable to and in the United Kingdom”. That covers all EU trade law, including tariffs, customs and regulations as well as trade remedies, state aid and government procurement. It means that the UK will remain part of the EU Customs Union and Single Market throughout the transition period. New EU trade regulations and directives that enter into force during the transition period will also apply to the UK, although the UK will no longer have a voice in their adoption or judges in the European Court to rule on their interpretation.

  • The transition period provides reassurance to business that the terms of EU-UK trade will not alter before end-2020, but it does not reduce uncertainty about the basis on which future trade will take place nor does it eliminate the possibility of a “no deal” result. The outcome of negotiations may not be known until shortly before the transition period ends, too late for businesses to adjust their production and investment decisions for 2021. Once again, planning for a “no deal” outcome, or, at best, for considerably more complicated trading conditions, may be the most prudent choice.

During the transition period, the UK and the EU have agreed that the UK will continue to be bound by the EU’s FTAs with third countries.The EU has notified the parties to these FTAs that during the transition period the United Kingdom is to be treated as an EU member state for the purposes of the agreements, but third countries do not have to accept that.4 These FTAs account for 11 per cent of UK exports and individually, several of them are of considerable commercial value to UK and UK-based business. The UK has negotiated Trade Continuity Agreements that will preserve some of the trade benefits of some of these FTAs and it is negotiating to rollover most of the others.5 They will enter into force in the event of a “no deal” outcome from the EU-UK trade negotiations at the end of the transition period. More than the continuity agreements will be needed, however, to replicate the kind of preferential access enjoyed today by UK exporters to important markets such as Canada and Japan and to match the market access in services that UK business has in Norway and Switzerland.

  • Countries that have FTAs with the EU are expected (but are not obliged legally) to continue to treat the UK as a party to the FTAs during the transition so that the UK will continue to be able to take advantage of preferential trade with them. Trade continuity agreements with these countries will help to remove some of the risk for business of a “no deal” outcome from the EU-UK trade negotiations, but those that have been concluded so far cover only 8 per cent of UK exports and they are not comprehensive replicas of the EU FTAs. Long term, the UK will need to negotiate new FTAs with these countries.

During the transition period, the Withdrawal Agreement permits the UK to negotiate trade agreements with third countries, although these cannot enter into force until the transition ends.

  • In its manifesto for the General Election in December 2019, Prime Minister Johnson’s Conservative Party stated that: “…we aim to have 80% of UK trade covered by free trade agreements within the next three years, starting with the USA, Australia, New Zealand and Japan”. These FTAs “…will be negotiated in parallel with our EU deal”.

The UK will become a separate WTO Member from 1 February 2020, after ratification of the EU (Withdrawal) Act. It will be held to account to implement its independent WTO obligations during the transition period while it is still applying EU trade law. This could give rise to a number of complications if the UK’s application of EU trade law were to be viewed by other WTO Members as being inconsistent with its WTO obligations in certain areas, such as the level of UK tariff rate quotas on certain agricultural products and the imposition of anti-dumping duties and countervailing measures without proof of material injury to UK business.

  • As long as other WTO Members view the transition arrangements as short-lived and temporary, the risk of dispute settlement against the UK in the WTO is likely to be low. However, a maximum extension of the transition period until end-December 2022 might attract a more critical attitude.

 

A new EU-UK trade agreement

The Political Declaration on the framework for the EU-UK future relationship contains general principles and objectives for negotiations on long-term economic and security partnerships, including a new trade agreement. It is a broad-brush document that could lead to a wide range of outcomes.

In the past, the EU has cited its Comprehensive Economic and Trade Agreement with Canada (CETA) as a potential model for a future UK-EU trade agreement, and expressed its willingness to go significantly further than the CETA if negotiations with the UK permit. The UK Government appeared to endorse that objective in its “Chequers plan” of July 2018, aiming to conclude an association agreement with the EU that would be “broader in scope than any other that exists between the EU and a third country” and that would make post-Brexit trade with the EU as frictionless as possible.

Since then, however, the UK has agreed with the EU to revise the trade objectives in the Political Declaration. It no longer mentions the aim of a single customs territory to avoid the need for customs controls, including customs declarations and rules of origin. Nor is there mention of the UK aligning with EU rules in relevant areas on a “common rulebook” to eliminate the need for regulatory controls at the border. This implies a considerably looser trade relationship. The changes reflect the importance the UK has attached to having more flexibility to negotiate new trade deals with third countries, in particular the United States, which the UK considers could be more difficult if it remains closely aligned to EU regulatory standards, customs tariffs and trade regulations.

The mandate for a new EU-UK trade agreement in the Political Declaration is cast in aspirational terms.

With regard to trade in goods, the UK and the EU envisage “a free trade area, combining deep regulatory and customs cooperation, underpinned by provisions ensuring a level playing field for open and fair competition”. Trade in goods should be tariff- and quota-free across all sectors, with “appropriate and modern” rules of origin. The Parties will have regulatory autonomy, but efforts will be made to avoid unnecessary trade barriers from TBT and SPS measures. The possibility for regulatory cooperation on medicines, chemicals and aviation will be explored. Customs checks and controls will be needed – their extent will depend on the UK’s commitments on customs and regulatory cooperation. Maximum use will be made of customs facilitation measures, including facilitative arrangements and technologies to try to ensure the absence of a hard Irish border.

The reference to a “level playing field for open and fair competition” in goods trade reflects EU concerns about the possibility of having to compete in the future with a deregulated UK economy. It brings into play other elements of the future relationship, notably negotiations on environment and labour standards, taxation, and state aid, all of which will need to feed into the new trade agreement.

The Political Declaration is similarly vague with respect to trade in services and investment. The agreement should be “ambitious, comprehensive and balanced” and respect each Party’s right to regulate. Liberalisation should go well beyond WTO commitments and build on recent EU FTAs. Sectoral coverage should be substantial and cover all modes of supply. Provisions on market access and national treatment under host state rules should be included, and performance requirements imposed on investors should be addressed. Unnecessary regulatory requirements should be avoided, inter alia, through disciplines on domestic regulation. Assessments to recognise regulatory equivalence will be pursued as a priority for financial services, with the aim of concluding them by June 2020. Electronic commerce should be facilitated.

These kinds of generalities are of limited real value to businesses that are looking for guidance on their operational, production and investment decisions for 2021 and beyond. It is the precise and detailed trade rules that will apply in these areas that matter, and on that, for the time being, there is no indication available. Of particular interest to trade in goods will be:

  • Tariffs and quotas: The commitment to tariff- and quota-free trade in goods may be challenging to deliver for farming, fish and food products once the UK is no longer part of the EU Common Agricultural Policy or the Common Fisheries Policy. It could also run into conflict with the EU’s “level playing field” concerns about UK deregulation and unfair competition.
  • Rules of Origin: Since the UK and the EU will no longer be in a customs union, bilateral trade in goods will be subject to rules of origin to ensure that duty preferences are administered correctly. Compliance with rules of origin can be costly for business, depending on how they are formulated.6
  • Customs requirements and controls: Customs arrangements will be key to keeping transaction costs at the border to a minimum. Even with the most up-to-date and technologically advanced facilitation arrangements, traders will face new administrative requirements and potential border delays. This could be of particular concern for Northern Ireland’s businesses.
  • Regulatory divergence: Coping with regulatory divergence could be the most costly area for business, in goods and services, both because of the need to adjust production to meet different regulations in different markets and the associated costs of testing, conformity assessment and border controls.

…and for trade in services:

  • Sectoral coverage: Not all service sectors will automatically be covered by the new trade agreement. Audio-visual and media services are regularly excluded by the EU from its FTAs, aviation and other transport services are typically treated separately, and certain public services, such as health services, could be sensitive. Financial Services are also often excluded
  • Market access and national treatment: Negotiations based on a negative list approach to scheduling would probably produce a more liberal outcome than a positive list. Even so, EU and UK service suppliers will go from unrestricted access to each other’s markets today to something closer to the level of WTO commitments. There is a huge gap between the two. Where exactly new deals will be struck is likely to vary from sector to sector, and working that out could take considerably more time than the transition period currently allows for.
  • Temporary labour mobility: This is of great importance for the cross-border delivery of professional services. Current freedoms are likely to be curtailed and new conditionality may be introduced, but it is not known yet by how much.

 

Three priorities

The Political Declaration assigns priority to three issues by setting specific target dates for reaching agreements.

Financial Services. The EU and the UK will “endeavour” to complete their respective assessments of the equivalence of each other’s regulatory and supervisory frameworks for financial services by 30 June 2020.7 This exercise should be facilitated by the starting position today that the UK’s framework conforms in all 27 areas in which equivalence is judged against EU Directives and Regulations on financial services.8 That could change, however, if UK regulations diverge in future from those of the EU (and vice versa, bearing in mind that the UK will no longer have any role in setting EU Directives and Regulations on financial services). Recognition of equivalence can be withdrawn unilaterally, making it a less certain and predictable basis for trade to take place. Also, equivalence does not, in itself, guarantee market access or national treatment; e.g., there is no EU equivalence regime for core banking services, such as deposit taking and loan business. According to the Political Declaration, these are to be negotiated separately.

Fisheries. “A new fisheries agreement on, inter alia, access to waters and quota shares” is to be established by 1 July 2020.9 Although fisheries do not account for a significant share of bilateral trade, this is a highly charged issue and a political priority for several EU member states, which have stated that it will influence their attitude towards negotiations on the new trade agreement with the UK. Broadly speaking, the less access these countries have to UK fisheries resources, the less access the UK can expect to have to the EU market for goods and services.

Data protection. The EU and the UK will “endeavour” to complete their respective assessments of each other’s data protection standards by end-2020 in order to facilitate bilateral data flows.10 The freedom of data flows and exchanges is of considerable importance for digital trade in goods and services. The UK’s Data Protection Act 2018 complements the EU’s General Data Protection Regulation (2016) (GDPR) and provides for the GDPR to apply in the UK, but it will nonetheless require an “adequacy decision” from the EU before the current level of data flows can continue.

 

Conclusion

Brexit has entered a new phase, but most of the concerns of business have not gone away.

Trade negotiations between the EU and the UK have been placed on an accelerated track by the UK Government, which would/could appear to limit the level of ambition for a new EU-UK trade relationship that can be achieved in the time available. A “no deal” outcome by end-2020 cannot be ruled out, and business might consider it prudent to continue to plan for such an eventuality. The alternative, given the tight schedule for trade negotiations, may be a “narrow and shallow” trade agreement that would not differ greatly in effect from “no deal”: for trade in goods, the introduction of rules of origin, increased customs checks and controls, more costs associated with regulatory divergence, and the possibility of tariffs or quotas being applied to certain bilateral trade flows; for trade in services, exclusion from the Single Market until new equivalence assessments have been carried out, and even then no guarantees of retaining current market access or national treatment. The Brexit, which will happen on January 31, 2020, is simply step 1 and does not negate the risk of the “cliff edge” occurring on December 31, 2020.

For the UK Government, the quid pro quo of reduced access to the EU market for UK business is the opportunities that may lie in securing preferential access to other markets, in particular the United States. For the time being, that proposition remains unproven.

 

1 Political Declaration setting out the framework for the future relationship between the European Union and the United Kingdom, 19 October 2019: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/ attachment_data/file/840656/Political_Declaration_setting_out_the_framework_for_the_future_relationship_between_the_European_Union_and_the_United_Kingdom.pdf
2 The EU model incorporates the “precautionary principle” to assess risk. The US model relies on science-based risk-assessment.
3 EU Free Trade Agreements, Association Agreements, Stabilisation Agreements and Economic Partnership Agreements.
4 Article 129 of the Withdrawal Agreement.
5 The status of the negotiation of trade continuity agreements can be found here: https://www.gov.uk/government/publications/uk-trade-agreement-continuity-statistics-and-analysis/uk-trade-with-trade-agreement-continuity-tac-countries-statistical-ad-hoc-release.
6 For more on the issue of rules of origin, see https://www.whitecase.com/publications/alert/hard-or-soft-brexit-does-it-matter-origin-goods.
7 Paragraph 36 of the Political Declaration.
8 Decisions on equivalence with third countries in this area are shown here: https://ec.europa.eu/info/files/overview-table-equivalence-decisions_en. Equivalence with the United States has been recognised in 21 of the 27 areas, followed by Japan (20), Canada (19) and Australia (18).
9 Paragraph 74 of the Political Declaration.
10 Paragraph 9 of the Political Declaration.

 

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