BREXIT TRANSITION PERIOD

The UK leaves the European Union (EU) at 23:00 GMT on 31 January, but that won't be the end of the Brexit story. That's because the UK will immediately enter an 11-month period, known as the transition, that will keep the UK bound to the EU's rules.

Top of the to-do list will be a UK-EU free trade deal. This will be essential if the UK wants to be able to continue to trade with the EU with no tariffs, quotas or other barriers after the transition.

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.
• 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. 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. 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. 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. 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.

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.

At the end of the transition phase, there will be three possible Brexit outcomes:

1. A UK-EU trade deal comes into force: If a UK-EU trade deal is ready by the end of the year, the UK could begin the new trading relationship as soon as the transition ends. If a trade deal is reached but questions remain in other areas - like the future of security co-operation - then the trade deal would go ahead. However, contingency plans would have to be used for other parts of the relationship.
2. The UK exits transition with no EU trade deal: Under this scenario, UK and EU negotiators fail to agree and implement a trade deal by 1 January 2021 and no transition extension is agreed. That would leave the UK trading on WTO (World Trade Organization) terms with the EU. This means that most UK goods would be subject to tariffs until a free trade deal was ready to be brought in. If other aspects of the future relationship aren't ready, they too would have to proceed on no-deal terms.
3. The transition period is extended while negotiations continue: If a trade deal is in sight but not finalised, Prime Minister Boris Johnson could decide to extend the transition period (as long as the EU also agreed to it). Under the terms of the withdrawal agreement, the transition period is allowed to be extended by 12 or 24 months. If a trade deal were to be struck sooner, the transition period could be ended earlier. The withdrawal agreement says the two sides need to agree to extend the transition by 1 July 2020 - just five months after the UK's departure. However, this scenario seems unlikely as the legislation going through Parliament would rule out an extension to the transition period, and Mr Johnson has also said he will not sanction one. Either way, while Mr Johnson has pledged to "get Brexit done" by 31 January 2020, many more months of negotiation lie ahead.