TABLE OF CONTENTS
1. What is a “hard” Brexit?..........................................................................................................................................................................4
2. What would be the implications of a “hard” Brexit on trade between the UK and the EU?.......................................4
3. What would be the implications of a “hard” Brexit on trade between the UK and third countries? ......................5
4. What would be the implications of a “hard” Brexit on Trade between the EU27 and third countries?.................6
5. What are the implications of Brexit on the UK’s status as WTO Member? .......................................................................7
6. What are the alternatives to a “hard” Brexit ..................................................................................................................................7
Active 36289951.7 5 October 2017
The Brexit train is now in full motion. The EU and the UK have embarked on one of the most politically sensitive and legally complex international negotiations of modern times: those relating to the UK’s withdrawal from the European Union.
The negotiations will focus on two main agreements. First, a divorce agreement on the terms of the UK’s separation from the EU, which needs to cover three politically-charged issues: the UK’s outstanding EU budget commitments and other financial liabilities towards the remaining 27 Member States of the Union (the “EU27”), the rights of EU citizens in post-Brexit UK (and vice versa), and the border between Northern Ireland and the Republic of Ireland. Second, an agreement on the future relationship between the EU27 and the UK. Importantly, the EU27 have made clear that negotiations on the second agreement can commence only when sufficient progress has been made as regards the divorce agreement.
The difficulty of these negotiations is further compounded by the fact that they take place under enormous time pressure as the agreements must be in place at the latest by 29 March 2019, i.e., the second anniversary of the UK’s formal notice of its intention to withdraw from the EU. On that date, the UK will automatically leave the EU, unless the UK and the EU27 agree on an extension, which seems highly unlikely at present. In practical terms, this requires that actual negotiations terminate by October 2018 in order to allow sufficient time for ratification. The consensus is that it will be impossible to reach agreement on all outstanding issues within such a tight timeframe. In light of this, the UK and the EU27 may agree on transitional or provisional measures in order to avoid the “cliff edge” that a “no deal” Brexit would entail on 29 March 2019. On 22 September
2017, Prime Minister May proposed during a speech in Florence to implement a two-year transition period, starting on 29 March 2019, during which the UK and the EU27 would continue to have access to each other’s markets on current terms.
In the past months, the terms “hard” and “soft” Brexit have been used abundantly in the press, often with little explanation of what these terms really mean. In a nutshell, a “soft” Brexit refers to a scenario where the UK would largely maintain access to the EU’s Single Market. By contrast, in a “hard” Brexit scenario, the UK would lose access to the EU Single Market and instead trade with the EU on WTO terms.
As things currently stand, the most likely scenario is that of a “hard” Brexit. From very early on, the UK Government made it clear that it would enter Brexit talks with three main objectives in mind: to regain control over immigration (including from other EU countries); to escape the jurisdiction of the Court of Justice of the EU; and to regain the UK’s ability to negotiate its own trade deals with third countries. While many proponents of Brexit, prior to and in the immediate aftermath of the Brexit referendum, thought that the UK could meet these objectives while at the same time maintaining access to the Single Market, it soon became clear that this type of “have your cake and eat it too” approach would not be acceptable to the EU27. Even though the UK general elections of 8 June 2017 deprived Prime Minister May of the “strong mandate” she was looking for, and have brought to the fore certain cabinet splits over what kind of Brexit the country actually wants, the current UK government policy has not changed. Unless the UK Government backtracks on some of its negotiation “red lines”, the prevailing view is that the UK is likely headed towards a “hard” Brexit, or a clean break between the EU27 and the UK.
A “hard” Brexit would have far-reaching legal and economic implications for businesses and individuals in the UK and the EU27. It could significantly impact the trade flow of goods across Europe, increase the cost of doing business, severely disrupt supply chains and influence the investment decisions of thousands of companies doing business in Europe. At the same time, even though a “clean break” with the EU seems likely,
it will obviously be in everyone’s common interest to maintain some form of economic partnership to avoid a “no-deal cliff edge”, and many uncertainties remain as to the extent and form that such a partnership could take.
In this paper, we discuss these important concepts and attempt to provide answers to some of the most relevant questions on the legal implications of the UK’s future, but uncertain, relationship with the EU. We first explain in more detail what is meant by a “hard” Brexit. We then address the consequences of a “hard” Brexit for trade between the EU27 and the UK, the UK and third countries, and the EU and third countries, as well as for the UK’s status in the WTO. We conclude by exploring some alternatives to a “hard” Brexit.
1. WHAT IS A “HARD” BREXIT?
As a member of the EU, the UK is currently part of the EU’s Customs Union and Single Market.
The EU Customs Union is an enhanced free-trade area in which goods, including those imported from third countries such as the U.S., move freely between Member States, without being subject to tariffs, quantitative restrictions or other non-tariff barriers and administrative and financial trade barriers like customs checks and charges. For trade with third countries, members of the EU Customs Union apply a common system of tariffs and imports quotas (the “CCT”) agreed upon at the EU level. Trade defence measures such as anti-dumping and countervailing duties are applied only at the EU level. Individual members are not allowed to negotiate their own trade deals with third countries, as those agreements are negotiated by the European Commission and concluded by the EU on behalf of all Member States.
The EU Single Market presents features in terms of economic integration that go beyond those of the EU Customs Union. It strives to remove so-called "non-tariff barriers" through the adoption of harmonised rules in a wide spectrum of activities across Member States, enforced by supranational EU institutions. In simple terms, once a certain good is put on the market in one EU Member State, it can then be imported and circulate freely in all other Member States. Most importantly, the Single Market not only covers the free movement of goods (as the Customs Union does) but also the free movement of services (including the right of establishment), capital and persons.
A “hard” Brexit would see the UK leaving both the EU Customs Union and Single Market, possibly reverting to WTO rules when trading with other nations (both inside and outside the EU). In effect, a “hard” Brexit would put the UK in a position similar to that of a third country (e.g., the U.S.) vis-a-vis the EU27.
2. WHAT WOULD BE THE IMPLICATIONS OF A “HARD” BREXIT ON TRADE BETWEEN THE UK AND THE EU?
The legal and economic implications of a “hard” Brexit on trade between the UK and the EU27 would be enormous, since businesses and individuals on both sides would lose the benefits of the four fundamental freedoms (free movement of goods, persons, services and capital) which are the cornerstone of membership of the Single Market. To give just a few examples, as regards each freedom:
• With respect to the free movement of goods, it would mean for instance that goods manufactured in the UK, when exported to the EU, would be subject to the same regime (in terms of tariffs and quantitative restrictions) as the regime that applies to countries which do not have a free-trade agreement with the EU. While for many industrial products these tariffs are very low, other products would be hit more significantly (e.g., by a 10% tariff for cars). The most severe impact would be for agricultural products, which are subject to very high duties and levies (e.g., a 109% combined tariff for beetroots).
• Additionally, customs controls would be re-introduced at the border between the UK and the EU27, in both directions, resulting in a substantial administrative burden for customs clearance and costly delays. For example, it is estimated that the volume of goods arriving at Dublin port from the UK that would need to wait for customs clearance, would correspond to a daily line of trucks 9 km in length.
Moreover, in order to gain access to the EU market, UK goods would have to comply with a whole set of EU rules and regulations, the formulation of which the UK would no longer be able to shape. Even though this situation might not be problematic in the short-term, since UK goods now comply with EU rules, significant divergence might emerge in the long-term, as the UK parliament starts enacting its own set of rules and standards.
Most importantly, both these impediments would arise not only with respect to goods produced in the UK
but also to goods imported into the UK (e.g., from the U.S.) and re-exported into the EU.
• With respect to the free movement of persons, both the UK and the EU27 have announced that they would enter Brexit negotiations with the firm intent of finding a solution that does not disrupt the lives of those already established in the UK or the EU27. Going forward, however, a “hard” Brexit could mean, among other things, that EU nationals not currently residing in the UK would lose the right to move and live there in order to work, preventing UK companies from hiring at will EU-originating personnel as they see fit (and vice versa as regards UK nationals wanting to move to the EU, and EU-based companies wanting to hire UK nationals).
• Similarly, as regards the freedom of establishment and the freedom to provide services, it would mean that UK companies would lose their guaranteed right to set up agencies, branches or subsidiaries in other EU Member States in order to pursue their economic activities in these countries and that self-employed UK nationals would lose their guaranteed right to establish themselves in other Member States in order to work there, e.g., as lawyers, (and vice versa for companies and nationals from the EU27). Most importantly, it would likely put an end to the seamless cross-border flow of services that UK firms can currently provide to clients across the Channel (and vice versa). UK financial services providers, in particular, could be hit hard, as their so-called “passporting rights” could be in jeopardy. These rights allow them to offer financial services to the rest of the EU, while only having to follow one set of regulations (those of the UK) and without the need to set up offices in those other locations.
• Finally, a “hard” Brexit could also significantly affect capital flows between the UK and EU27, as it could lead to increased restrictions on direct investments (e.g., participation in new or existing undertakings), investments in immoveable property, as well as operations in securities and loans. On the other hand, investors could rely on the protection stemming from bilateral investments treaties (BITs) in place between the UK and individual Member States of the EU27.
3. WHAT WOULD BE THE IMPLICATIONS OF A “HARD” BREXIT ON TRADE BETWEEN THE UK AND THIRD COUNTRIES?
A “hard” Brexit would also have a profound impact on the UK’s trade relations with third countries. By leaving the EU’s Customs Union and Single Market, the UK would no longer be bound by the EU’s Common Customs Tariff (“CCT”) system nor be part of the EU’s Common Commercial Policy. In fact, the UK would have exclusive competence to determine its own foreign trade policy. While this may at first appear to be an attractive proposition for the UK, a closer look reveals that it could also create significant risks for UK exporters.
For example, the EU has signed free-trade agreements (“FTAs”) with more than 50 countries (22 agreements with individual countries, e.g., Korea, Mexico and Chile and five multilateral agreements with multiple countries). A new FTA with Canada recently came provisionally into force and another one with Japan will soon follow. As an EU Member State, the UK is a co-signatory to these trade agreements, and UK exporters benefit from the market access created by these agreements.
Once the UK leaves the EU, it will no longer be a party to these trade agreements and UK exporters will no longer benefit from the lower tariffs for goods and the elimination of non-tariff trade barriers for goods and services that these agreements brought about. In order to prevent this, the UK will need to negotiate new agreements. This will take time, because the negotiation of a trade agreement typically spans several years and, under EU law, the UK can only formally start negotiating with third countries after it has left the EU. It is also questionable whether the UK alone would be able to strike a deal offering to exporters the same level of advantages that the EU was able to achieve, given the relatively small size of the UK market (56 million consumers) compared to the current 500 million-consumer EU-wide market. For example, when the U.S. starts negotiating a trade agreement with the UK, it will benefit from a much larger bargaining power than it has vis- à-vis the EU; and although President Trump stated that he is prepared to act quickly to secure a deal, it seems unlikely that the U.S. would not use this edge to its advantage. On the other hand, it may well be that a post- Brexit UK will opt for a more open trade policy than seems possible for the EU, which could lead the U.S. and other countries to give greater concessions.
As regards imports from third countries into the UK, these will be subject to the duties that the UK decides to impose. The same will apply to any imports from countries which are party to a trade agreement with the EU, as these imports will no longer benefit from the reduction of tariffs that the EU agreed to. Finally, anti- dumping and countervailing duties imposed by the EU against dumped or subsidized imports from third countries will no longer apply to imports into the UK. This could pose significant problems for certain UK industries, notably the steel industry. While the UK could adopt its own anti-dumping countervailing duty laws, it will likely take more than a year before it can impose equivalent protective duties, as it must first conduct a fresh investigation establishing that the products concerned and imported into the UK are dumped or subsidized and have caused injury to the domestic industry in the UK.
4. WHAT WOULD BE THE IMPLICATIONS OF A “HARD” BREXIT ON TRADE BETWEEN THE EU27 AND THIRD COUNTRIES?
In principle, Brexit would not affect trade between the EU27 and third countries. However, goods declared for free circulation in the EU27 will have to undergo additional customs clearance if subsequently shipped to the UK.
It is theoretically possible, but rather unlikely, that countries that have concluded FTAs with the EU may seek to renegotiate specific aspects of these FTAs on the grounds that the FTA no longer provides for preferential access to the UK market. Similarly, it is theoretically possible for third country exporters to request interim reviews of anti-dumping or countervailing duties imposed by the EU against imports from third countries, if they can show that the exclusion of imports into the UK, and injury to the domestic industry in the UK, from the analysis results in substantially different findings. In practice, such an outcome seems unlikely.
5. WHAT ARE THE IMPLICATIONS OF BREXIT ON THE UK’S STATUS AS
The UK is already a member of the WTO. However, as an EU Member State, it does not have its own voice at WTO level and operates through the EU, which is also a member in its own right. Most importantly, all EU Member States apply the same EU bound tariffs or market access concessions when trading with other WTO members, as there is only one so-called Schedule of Concessions for the entire EU. This is true both for the Schedule of Concessions applicable under the GATT (that deals with trade in goods) and for the Schedule of Concessions applicable under the GATS (which governs trade in services). The EU Member States have no individual Schedule of Concessions.
Regardless of whether the upcoming Brexit qualifies as “hard” or “soft”, once the UK leaves the EU, it will need its own Schedules of Concessions. This could prove trickier than it may seem. Schedules of Concessions are typically negotiated when a country joins the WTO (e.g., China in 2001), not when its status changes as a result of having left an existing country or trade bloc. Also, while there are precedents for the scenario where individual WTO members, each with their own Schedule of Concessions, decide to form a customs union with a common customs tariff, there is not yet any precedent for a situation where a WTO member leaves a customs union with a common Schedule of Concessions that this member also used to apply. Should the UK want to have a Schedule of Concession that differs from the current EU schedule, this will require the consent of the other WTO members and could lead to protracted negotiations. Moreover, even if the UK simply decided to offer the same Schedule of Concessions as the one currently in place with the EU, other WTO members could be tempted to seek additional concessions from the UK. This would put the UK’s status as a WTO member into limbo.
WTO rules will also affect the trade relationship between the EU27 and the UK post-Brexit. A fundamental principle of the WTO is the obligation to trade on most-favoured-nation (MFN) terms, meaning that each member must, in principle, apply the same rules (e.g., tariffs) without discrimination when trading with all other WTO members. An exception to this rule exists for members that have concluded between them an FTA or formed a customs union. Thus, unless the EU and the UK have reached such an agreement at the time the UK leaves the EU, WTO rules will oblige the EU to trade with the UK based on MFN principles and will prevent it from treating imports from the UK more favourably than imports from any other WTO member with whom the EU27 does not have an FTA in place. To complicate matters further, under WTO law, the EU27 and the UK would arguably only be entitled to conclude an FTA or to form a customs union after the UK adopts its own WTO Schedule of Concessions, which in principle, under EU law, it can only negotiate after it has left the EU. The only way to avoid this chicken-and-egg situation seems to be for the UK to remain within the EU Customs Union for a transitional period.
6. WHAT ARE THE ALTERNATIVES TO A “HARD” BREXIT
A “hard” Brexit, as described above, would have significant negative economic consequences that both the UK and the EU27 will try to avoid. The UK will want to maintain some form of economic integration with the EU, as close as possible to the current one, while at the same time protecting its negotiation “red line”. Other EU Member States will also want to protect their national interests, and in particular their access to the important British market, without striking a deal that could be perceived as too accommodating to the UK, for fear of fuelling pro-exit movements in their own country. These two positions seem almost impossible to reconcile.
Unless the UK reneges on its main policy objectives, it would be very difficult, it seems, for the UK to adopt a Norway (EEA) or Turkey (Customs Union) model of cooperation with the EU27. The former (membership of the EEA) would prevent the UK from taking control over immigration from the EU27 and oblige it to adhere to EU laws, rules and regulations (in the adoption of which it would have no say) and de facto accept the jurisdiction of the Court of Justice of the EU. The latter model (forming a customs union with the EU) would require the UK to align its external trade policy with that of the EU. Prime Minister May seems to have recognized this when she stated, in her Lancaster House speech, that the UK wanted neither a partial nor an associate membership to the EU or anything that left the UK “half-in, half-out”. This position was restated by Prime Minister May in her recent Florence address. The UK, she said, was not seeking to adopt one of the models already enjoyed by other countries.
The only alternative to a truly disruptive “no-deal” Brexit therefore seems to be some form of a comprehensive free-trade area between the EU27 and the UK. In both her Lancaster House and Florence speeches, Prime Minister May said she wanted to pursue a bold and ambitious FTA with the EU27, allowing for a free and frictionless cross-border trade in goods and services. The agreement, she mentioned, could take elements of current Single Market arrangements in certain areas. Just how realistic this option is, however, remains to be seen. The EU27 have invariably stressed that the UK will not be allowed to “pick and choose” the parts of the Single Market it wants to maintain with the EU, that access to the Single Market is conditional on respect for the free movement of persons, and that, as a matter of logic, the UK could not expect to get a better deal outside of the EU than the deal it currently has. The big question is thus whether there is room, between these two negotiating positions, to strike a free-trade deal, and whether that can be achieved by October 2018.
Numerous examples of FTAs between the EU and third countries exist. The recent Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada (which entered provisionally into force on 21
September), for instance, is the most far-reaching of the EU trade agreements to date and is intended to remove more than 99% of the tariffs currently imposed on trade in industrial goods between Canada and the EU. Another interesting example is the Association and Free Trade Agreement which the EU has concluded with the Ukraine (partly in effect since 1 January 2016 pending ratification by the Netherlands) which provides for substantial market access and would probably appeal to British policy objectives in that it does not require the application of EU law or compliance with the case law of the Court of Justice of the EU, and does not provide for the free movement of persons.
Despite their ambitious scope, however, none of these agreements can serve as a blueprint for a future EU27- UK FTA. For instance, none of the agreements provide for the liberalisation of trade in financial services which is so strategic to the British economy. Also, the specific circumstances that led to the existence of each agreement differs significantly from the Brexit scenario. In particular, these agreements were reached with a view to achieve greater integration of the parties’ economies. Brexit is about disentangling economies that have been completely open to the other party for more than 40 years. With that in mind, it is therefore clear that the future EU27-UK agreement will be sui generis in both form and scope. While the inclusion of most goods should not be particularly problematic, the inclusion of services and in particular financial services which represents such a big part of the UK’s economy and exports to the UK will certainly be the object of heated discussions.
Another issue adding to the many challenges of the Brexit process is timing. As the recent EU/Canada agreement illustrates, negotiating comprehensive free-trade agreements takes time - CETA was more than 7 years in the making. Whatever the scope of the future UK-EU27 agreement, it will thus be virtually impossible for the parties to negotiate its terms within the 18-month period left to agree on Brexit. As mentioned above,
Prime Minister May has now officially proposed the implementation of a two-year transition period, starting on 29 March 2019, during which the UK and the EU27 would continue to have access to each other’s markets on current terms. Whether, and under which conditions, this transition period is accepted by everyone remains an open question which is only likely to be resolved by late 2018 as part of the overall negotiation.