The position of the UK in the World

At the heart of what Brexit could actually mean for businesses with a trading link to the UK will be the terms of trade agreed between the UK and its major trading partners, including the EU-27. These terms will differ from sector to sector and will directly affect the barriers that businesses may face when looking to move goods and provide services around the world (and the price of those goods and services). Any goods could be subject to new rules on tariffs, import quotas, regulatory standards, competition law rules, IP and many other areas. Although Free Trade Agreements (FTAs) have traditionally sought to facilitate cross-border trade in goods, the second generation of agreements now increasingly also cover issues such as indirect barriers to trade, services and investment, public procurement and sustainable development principles, including labour rights and environmental protection.

February 2019

As a member of the EU, the UK benefits from around 40 FTAs that the EU has concluded with over 70 countries as part of its external trade policy (under the EU rules referred to as the `Common Commercial Policy'). Whilst the EU represents all of its Member States in trade negotiations with non- EU countries, some elements of trade deals have to be signed off by both the EU and all the individual Member States. This is because, under these "mixed agreements", competence on certain issues (such as agriculture, fisheries, social policy, health and consumer matters) is shared by the EU and its Member States. However, in practice, negotiating trade deals with third countries has been the preserve of the EU. The UK will need to find a way of either preserving the direct benefit of these agreements or replacing them. The UK is already finding that this is far from an easy task, although it signed a trade agreement with the Swiss government in February 2019. The agreement largely replicates the terms of the current EU-Swiss FTA and it ensures that many existing rights and obligations will continue to apply after the UK leaves the EU.

Similarly, the World Trade Organisation (WTO) framework is likely to play a key role in defining the UK's trading relationships, at least in the short to medium term.

Free Trade Agreements - the basics

International trade agreements are governed by principles of international law, namely, international conventions, international custom (laws implied from general practice or conduct), general principles (common laws and principles established by nations) and judicial decisions.

In broad terms, the specific nature of each trading arrangement will result in differing levels of integration between the parties. They may be FTAs (which may remove or reduce tariffs within the trading group), customs unions (establishing common tariffs for countries outside the union), common markets (alignment within a trading group on issues relating to goods or services) or economic unions (the trading group adopts common economic policies). Within these arrangements, there are a number of topics which are likely to be negotiated, including the movement of goods, services and people, rights relating to investments and market access, intellectual property, competition policy and the administrative framework for the functioning of the agreement (including the resolution of disputes).

One common feature of trade agreements is that they take a significant amount of time to agree (on average several years) and their conclusion is frequently delayed by political deadlock.

There is no general principle of international law that guarantees unfettered trade and countries are largely free to determine their own trade policy, including setting domestic tariffs and import rules. The WTO position only lays down basic rules to facilitate cross-border trade in goods and services and, therefore, many countries enter into FTAs with their trading partners to improve on the WTO position, including by the adoption of lower or zero tariffs and addressing nontariff barriers (NTBs) such as laws concerning customs inspections and rules of origin. Nonetheless in practice, a significant part of international trade is still conducted within the framework of the WTO rules. This would be the fallback position in the event that the UK was unable to conclude FTAs with its trading partners, including the EU.

World Trade Organisation - key principles and concepts

The WTO is an intergovernmental organisation with over 160 member countries. It was established in 1995 as a negotiating forum focused primarily on removing trade barriers. It evolved out of the General Agreement on Tariffs and Trade (GATT), which has been in existence since 1947. The WTO operates under a multi-layered framework of agreements negotiated by WTO members and implemented in 1995 under the "Uruguay Round" of negotiations.

Simplistically, the WTO is made up of:

- an umbrella agreement which establishes the WTO;

- the Annexes (the key ones being GATT for goods, the General Agreement on Trade in Services (GATS) and the agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS)); and

- schedules containing the members' commitments.

The WTO is based on certain key principles, the most important of which are two principles of non-discrimination: the "Most Favoured Nation" (MFN) concept, and the principle of National Treatment, both of which are described below.

Trade in goods under GATT is regulated by a schedule of concessions (Goods Schedule) for each WTO member, reflecting specific tariff concessions and other commitments given during negotiations. Each member's schedule of concessions classifies a large number of goods and is divided into separate parts covering MFN concessions (which are split further into tariffs for agricultural products, quotas for agricultural products and tariffs for other, non-agricultural products), preferential concessions, concessions on non-tariff measures and specific commitments on domestic support and export subsidies on agricultural products.

GATS Article I:2 covers the cross-border provision of services as specified through four modes of supply: (i) cross-border supply, (ii) supply for consumption abroad, (iii) service by a supplier in one member through a commercial presence in the territory of any other member, and (iv) service through the presence of natural persons of a member in the territory of another member. WTO members make their commitments to open-up their markets to the cross-border provision of services in their Services Schedules. These commitments set out the sectors being opened, the extent of market access applicable to those sectors (for example, whether any restrictions on foreign ownership will apply) and any applicable limitations on national treatment (see below), such as whether any rights granted to local companies will not be granted to foreign companies. Public services are explicitly excluded from the scope of the GATS.

In some cases, issues relating to the supply of goods under GATT and services under GATS may overlap (e.g. where a service is provided in conjunction with a particular good). Here, a measure could be considered under both GATT and GATS.

Most Favoured Nation

The MFN rule is one of the most important rules in international economic law and is a principle of non-discrimination, i.e. a country must treat other countries at least as well as it treats its "most favoured" country. Under the first Article of GATT, WTO members must extend any advantage (with respect to the measures mentioned in Article I:1 of GATT) which has been granted to one country to all like goods originating in all other WTO member countries.

As an example, if a country imposes a 10% tariff on car imports from one country, it cannot impose a different level of tariff on imports of the same goods from a different country (absent a FTA). The MFN principle arose as a way of ensuring that tariffs and other concessions applied equally to all trading partners in respect of the same goods.

The principle is also subject to exceptions for regional trade agreements (entered into between countries and blocs) and customs unions. There are also other limited exceptions to the MFN principle, such as the imposition of anti-dumping measures and safeguard measures as these trade instruments apply in a non-discriminatory manner. Such measures may ultimately be challenged through the WTO dispute settlement system (see below), although this only occurs in a fraction of cases.

National Treatment

The concept of National Treatment is slightly different. It seeks to prohibit discriminatory national measures against imported goods. Under one of the main provisions of GATT (Article III), the tax and regulatory treatment (taxes, internal charges, laws, regulations etc) of "like" foreign goods must be equal to the treatment applied to domestic goods (once goods enter the territory). The National Treatment rule does not apply to rules relating to government procurement and the payment of subsidies (these are now addressed in separate WTO agreements). The rule has been the subject of a number of disputes relating to complex issues of similarity between two products, and how to define a standard in this regard.

Origin of goods

Another key concept of FTAs is the methodology for defining the origin of goods falling within the scope of the agreement. Rules of origin are used, especially in FTAs, to ensure that only goods originating in a member country of the FTA (or in other countries under rules allowing for the cumulation of origin under the agreement) benefit from the preferential treatment offered by the agreement (such as reduced or zero tariffs). They are also used for other associated issues, such as whether quotas or anti-dumping measures will apply. Under often highly complex rules of origin, FTAs may require that a minimum level of content or processing occurs within a member country of the FTA in order for the preferential tariff rates to apply. The complexity arises partly because, in today's global value chains, it can be extremely difficult to determine the origin of a product with multiple components sourced or processed in a number of different countries.

The complexity also arises because the rules of origin themselves can be complex, with distinctions within an FTA depending on the product and as between FTAs. There can also be differences between non-preferential rules of origin that apply in the absence of an FTA and preferential rules of origin that apply under preferential trade.

WTO dispute resolution

The WTO's Dispute Settlement Understanding (DSU) contains a framework for resolving WTO disputes between WTO members. The DSU establishes a Dispute Settlement Body (DSB), composed of representatives of all WTO members, which oversees disputes that arise under the WTO system.

In the event of a dispute, the parties must first try to resolve the dispute amicably through a consultation process. If a settlement cannot be reached within 60 days of consultations, the complainant member state can request that a Panel is set up. A Panel is usually composed of three people, and will receive written and oral submissions from the parties and any other WTO members having a substantial interest in the matter. The Panel can also engage experts to advise it, although rarely does so. The proceedings are confidential (although members can release their submissions), and any private parties are excluded even if they are directly affected by the measures, which are the subject of the complaint. In principle, a dispute should be resolved in no more than 12 months, or 15 months if there is an appeal.

The Panel issues a report, first to the parties and subsequently to all WTO members. In principle, the Panel is aiding the DSB in resolving the dispute, but in practice the decision in the Panel's report is final (absent an appeal) because only a consensus of the DSB against the Panel's decision can block it.

The DSB's decision can be appealed before three members of the seven-member WTO Appellate Body on points of law. Under the DSU, appellate proceedings should last no longer than 60 days, although, in practice, they almost always take longer. Once the Appellate Body's report has been sent to the DSB and the parties to the dispute, the DSB must adopt it, unless all WTO members reject it.

At the time of writing, the Appellate Body is partially paralysed as the US government is refusing to appoint new Appellate Body members and there are only three remaining (the minimum to hear a case), and proceedings will be blocked if a member has to recuse themselves for impartiality reasons. Also, two Appellate Body members are due to step down at the end of 2019 when their term of service expires. The EU has proposed reforms to try and resolve the dispute.

The DSU also contains provisions designed to ensure that WTO members comply with DSB rulings and recommendations. These include the payment of compensation by the state in question, and the suspension of concessions to which the state in question is entitled (also known as `retaliation').

Clarifying the UK's position under the WTO

The UK was a member of GATT and was also a founding member of the WTO, as part of the EU in 1995. EU Member States coordinate their position in WTO negotiations. However, the European Commission carries out almost all WTO negotiations on behalf of its members. The UK is bound by the Goods Schedules and Services Schedules negotiated by the EU and has no specific schedules of its own.

Following Brexit, however, the UK would no longer have the benefit of these arrangements and has to agree its own country-specific commitments. The UK submitted to the WTO its draft goods schedule last summer and, in December 2018, its draft services schedules for certification. These largely replicate the UK's commitments under the EU schedules. A number of countries have, however, objected to the allocation of the UK's share of the EU-wide tariff rate quotas (quantities inside the quota are charged lower customs duties) provided for in the goods schedule. It could take some time for the UK to have its WTO schedules certified, but this will not prevent the UK from trading on the basis of its uncertified schedules once it leaves the EU.

What comes next?

Whilst much needs to be resolved in the coming months and years, it is clear that the UK's ability to regularise its arrangements under the WTO and establish replacement FTAs with its other major trading partners will be key. Businesses need to carefully model the impact that different trading terms will have on their upstream and downstream supply chains and the interplay redefined trading terms will have with wider sector regulation.