December 03, 2018

Brexit Briefing: Deal or No Deal?

Over the last few weeks and months, complex political and trade negotiations have taken place on Brexit, which inches ever closer. On November 25, 2018, the leaders of the EU27 (the 27 EU member states, excluding the U.K.), endorsed the draft agreement on the withdrawal of the United Kingdom of Great Britain and Northern Ireland (U.K.) from the European Union (EU) and the European Atomic Energy Community (Withdrawal Agreement) and approved the political declaration setting out the framework for the future relationship between the EU and the U.K. (Political Declaration).

The endorsement concludes the period of negotiations on the U.K.’s withdrawal from the European Union which started in June 2017. Following the announcement of a deal in principle, the U.K.’s political climate has been particularly febrile, and the U.K. government has actively turned its attention toward selling the virtues of the Withdrawal Agreement to the public.

How may the situation develop as we enter 2019? Businesses in the U.K. and U.S. businesses with subsidiaries and/or trading partners in the U.K. and the EU should be alert to the practical consequences which the potential outcomes may have on their operations.

Withdrawal Agreement and Political Declaration

Withdrawal Agreement

The Withdrawal Agreement is a complex legal instrument and many provisions relate to the technicalities surrounding withdrawal, including financial settlement (commonly referred to as the “divorce bill”). The key points to note for businesses are:

  • There will be a transition period starting on March 30, 2019, and ending on December 31, 2020 (Transition Period), with the option for the U.K. and the EU to agree to a one-off extension of between one and two years. This would avoid activation of the Irish backstop protocol on January 1, 2021 (Irish Backstop), in the event legal agreements relating to the U.K. and the EU’s future relationship have not been finalized (see below).
  • During the Transition Period:
    • EU law will continue to apply to the U.K. as if it were a member state, except that the U.K. will no longer take part in EU decision-making, political institutions or other agencies. Accordingly, the U.K. will continue to participate in the EU Customs Union and the Single Market (with freedom of movement continuing for both U.K. and EU citizens).
    • The U.K. will continue to be bound by the EU’s trade policy and cannot become bound by trade agreements with third countries. The U.K. will retain the benefit of trade agreements signed by the EU, and third countries will keep the same level of U.K. market access as established under the EU’s trade agreements.
  • There are separation provisions to ensure legal certainty in respect of goods or transactions which may be in transit or process at the end of the Transition Period. For example, goods placed on the market lawfully in the EU or the U.K. prior to the end of the Transition Period may continue to circulate freely until they reach their end users without the need for product modifications or relabelling (although there is an exception for the movement of live animals and animal products).
  • The U.K. will continue to protect more than 3,000 geographical indications (e.g., Cognac, Roquefort cheese, Sherry) to the same standards as EU law currently provides. EU-approved geographical indications of U.K. origin (e.g., Welsh lamb) will continue to be protected under EU law.
  • The U.K. and the EU must use their best endeavours to negotiate “expeditiously” the agreements governing their future relationship as referred to in the Political Declaration, with a view to such arrangements applying from the end of the Transition Period. If such arrangements have not concluded (and the Transition Period is not extended), the Irish Backstop will come into force. The Irish Backstop is not the preferred or expected outcome of either the U.K. or the EU but has been agreed to avoid a “hard” border between the Republic of Ireland and Northern Ireland. This border is the only land border shared between the U.K. and the rest of the EU and, for a range of historical, political and economic reasons, both the EU and the U.K. wish to ensure that this border remains completely open to trade, people and services. Under the Irish Backstop:
    • There will be a single EU-U.K. customs territory, which will purportedly avoid the need for tariffs, quotas or rules of origin checks between the EU and the U.K., although it is unclear quite how “frictionless” trade will be maintained given there would still be significant regulatory and commercial policy differences between the U.K. (particularly Great Britain) and the EU.
    • Northern Ireland (but not Great Britain (i.e., England, Scotland and Wales)) will be subject to a deeper set of rules (for example, the EU’s Customs Code and a limited set of rules related to the EU’s Single Market which are required to avoid a hard border — e.g., state aid rules, VAT and excise on goods rules, and others).
    • The U.K. has agreed to comply with a series of “level playing field” measures to ensure open and fair competition between the U.K. and the EU during the period of the Irish Backstop. These cover areas such as state aid, competition, taxation, labour and social protection, and the environment.
    • In terms of trade, the U.K. must maintain the EU’s common external tariff on third countries and align its international trade policy with the EU. This would significantly limit the U.K.’s ability to enter into international free trade agreements during the Irish Backstop period.
    • The Irish Backstop can only be ended by agreement of the Joint Committee (essentially the U.K. and the EU jointly).

Political Declaration

The Political Declaration is not legally binding but sets a framework for the legal agreement on the future trading relationship between the U.K. and the EU following the end of the Transition Period and/or the Irish Backstop. The arrangement envisaged by the Political Declaration is for a deep and comprehensive free trade agreement. Objectives include:

  • The European Commission starting the U.K.’s assessment as an “adequate” country for data protection purposes as soon as possible after withdrawal, with the U.K. offering a comparable facilitation of personal data transfers to the EU.
  • Having comprehensive arrangements to create a free trade area, combining deep regulatory and customs cooperation, underpinned by provisions ensuring a level playing field for open and fair competition.
  • Ensuring no tariffs, fees, charges or quantitative restrictions across all sectors, with ambitious customs arrangements that build and improve on the single customs territory outlined in the Withdrawal Agreement.
  • Allowing for the temporary entry and stay of natural persons for business purposes in defined areas and allowing for visa-free travel and short-term visits.
  • In financial services, endeavouring to assess equivalence with respect to each other’s regulatory regime as soon as possible after the U.K.’s withdrawal.

What if U.K. MPs Reject the Withdrawal Agreement?

Many members of parliament (MPs), from both pro-Remain and pro-Brexit camps, have expressed scepticism of the terms of the Withdrawal Agreement, with between 80 and 90 MPs in the Prime Minister’s own party suggesting they will vote against the deal. The Prime Minister hopes to persuade MPs to vote for her deal in the House of Commons motion expected on December 11, 2018. This is one of several necessary steps under the European Union (Withdrawal) Act 2018 if the U.K. is to ratify, and leave the EU on the terms of the Withdrawal Agreement.

If MPs fail to vote for the Withdrawal Agreement in the December vote, which on present indications is more likely than not, the government must make a statement setting out how it wishes to proceed in relation to the negotiations within 21 days of the vote. Potential outcomes include (a) renegotiation, (b) a no-deal Brexit, or (c) extension or withdrawal of Article 50 notification under which the U.K. initiated its departure from the EU.

Renegotiation

Some commentators have suggested that the government may seek minor changes to the deal to make it more palatable to MPs in the hope of winning a vote at second attempt. Some also advocate reopening negotiations to agree a different and “better” deal. In recent weeks, the proposal that the U.K. should seek to join the European Free Trade Association and become part of the European Economic Area has been mooted as a serious alternative to the proposed deal. This would involve the least disruption from a business perspective, but crosses many of the current government’s red lines.

The official positions of both the EU Commission and the U.K. government are that the Withdrawal Agreement is the only deal available and there is limited appetite and political will to reopen negotiations. Moreover, as things stand, the U.K. will automatically exit the EU by operation of law on March 29, 2019, regardless of whether there is a deal. In practice, without an extension of the U.K.’s Article 50 notification, it is unlikely there is sufficient time to engage in a substantive renegotiation.

No-Deal Brexit

This is the option favoured by many pro-Brexit purists, including a substantial minority within the governing Conservative party. Most economic forecasts suggest that a disorderly no-deal Brexit would be the most damaging outcome for the U.K. in the short to medium term. Furthermore, while the government has belatedly produced a collection of papers on how to prepare if the U.K. leaves the EU with no deal, there is broad consensus that the U.K. is not sufficiently prepared to mitigate the unavoidable disruption and uncertainty which would result. However, given the automatic nature of the U.K.’s exit on March 29, 2019 (without other action), a no-deal outcome is a real possibility.

No Brexit/Second Referendum

The final potential outcome involves the extension or withdrawal of the U.K.’s Article 50 notification to allow time to hold a second referendum (or even another general election). Once regarded as an unrealistic and minority view, the idea of a second referendum has gained traction, with growing demands from both civil society groups and from MPs. Nevertheless, it is far from clear what form the referendum question would take or whether it would provide for a different result. Theresa May has ruled out a second referendum while she is Prime Minister, and it does not represent U.K. government policy. In any event, a second referendum (or general election) would almost certainly require the U.K.’s Article 50 notification to be extended or withdrawn. Extension would require all EU27 countries to agree – an outcome itself fraught with uncertainty. As for withdrawing the notification altogether (which would essentially mean no Brexit), the Court of Justice of the European Union is currently hearing a case on whether the U.K. has the right to do this unilaterally, or whether the unanimity of EU member states is required. The U.K. government is opposing the challenge.

Looking Ahead

Even if the Withdrawal Agreement is approved by the U.K. parliament in December, it only addresses the relationship between the U.K. and the EU during the Transition Period. The real challenge will be for the U.K. to negotiate a long-term trade agreement with the EU, building on and fleshing out the Political Declaration, which is more of a “wish list” than a concrete and realizable proposal. Only once the long-term trade agreement is agreed and operational will the U.K. have moved beyond the exit process and will Brexit truly have reached a resolution.

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