For a PDF copy of this article, please click the title link below. In addition, the full text of the article is also available on this page.
On March 29, 2017, the UK officially triggered the formal process to leave the European Union. This started a two-year countdown in which to negotiate both the terms of the UK’s withdrawal, and a broad agreement on the future relationship between the UK and the EU.
Through Brexit, the EU and the UK have embarked on one of the most politically sensitive and legally complex international negotiations of modern times. After a difficult and lengthy negotiation, the EU and the UK finally concluded on November 25, 2018 an agreement concerning the terms of the UK’s separation from the EU (‘Withdrawal agreement’), and adopted a high-level political declaration setting out the framework for their future relationship (’Political declaration’).
The Withdrawal agreement covers 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. It provides for a 21-month transition period (it can be prolonged by up to two years) during which the status quo would be maintained, although the UK would no longer have a vote in EU matters, nor any representation in EU institutions, bodies or agencies. This transition period would enter into effect on March 30, 2019.
The Withdrawal agreement and particularly the question of the ‘Backstop’ solution to avoid a hard border on the island of Ireland in the event that the EU and the UK cannot conclude a trade deal before the end of the transition period has proved particularly contentious. The UK Parliament rejected the terms of the Withdrawal agreement on January 15, 2019 and there is considerable uncertainty as to whether the UK government will ever be able to obtain parliamentary approval for the deal.
In the event that there is no agreement (and, therefore, no transition period), the trading relationship between the UK and the EU would immediately revert to World Trade Organisation (“WTO”) terms (a “no-deal” Brexit, also often referred to as a “hard” Brexit). A “no-deal” 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 the UK/EU border, increase the cost of doing business, severely disrupt supply chains and influence the investment decisions of thousands of companies doing business in Europe.
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 “no-deal” Brexit. We then address the consequences of a “no-deal” 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 alternative trade arrangements to a “no-deal” Brexit, including some of the recent free trade agreements entered into by the EU.
1. WHAT IS A “NO-DEAL” 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 import 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 “no-deal” Brexit would see the UK leaving both the EU Customs Union and Single Market, and reverting to WTO rules when trading with other nations (both inside and outside the EU). In effect, a “no-deal” 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 “NO-DEAL” BREXIT ON TRADE BETWEEN THE UK AND THE EU?
The legal and economic implications of a “no-deal” 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 cornerstones of membership of the Single Market. To give just a few examples:
- With respect to the free movement of goods, 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, the Withdrawal agreement provides protections for EU citizens living in the UK, and UK citizens living in the EU27. Going forward, however, a “no-deal” 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 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 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. Given the risk of a no-deal Brexit, a number of financial services firms based in the UK have already implemented contingency plans and established operations in the EU27 and obtained the necessary licenses.
- Finally, a “no-deal” 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 may be able to 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 “NO-DEAL” BREXIT ON TRADE BETWEEN THE UK AND THIRD COUNTRIES?
A “no-deal” 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”) or economic partnerships with more than 60 countries (e.g., individual agreements with Canada, Japan, Korea, Mexico and Chile as well as multilateral agreements with multiple countries). The recent FTA with Canada provisionally came into force in September 2017 and another one with Japan will provisionally apply from next month. 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 (or during the transition period, if applicable). It is also questionable whether the UK alone would be able to strike a deal offering exporters the same level of advantages that the EU was able to achieve, given the relatively small size of the UK market (66 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 element 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 to which the EU agreed. 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. The UK has already begun consultations to identify the trade defence measures it would maintain after Brexit.
4. WHAT WOULD BE THE IMPLICATIONS OF A “NO-DEAL” 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 would 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 WTO MEMBER?
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 when trading with other WTO members, as there is only one so-called Schedule of Concessions for goods for the entire EU under the GATT. Similarly, the UK’s commitments applicable under the GATS (which governs trade in services) are consolidated in an EU GATS schedule.
Regardless of whether the upcoming Brexit qualifies as “hard” or “soft”, once the UK leaves the EU, it will need its own Schedules. Schedules 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 Schedules, 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 common Schedules that this member also used to apply. Should the UK want to have Schedules that differ from the current EU Schedules, this will lead to protracted negotiations with other WTO members.
In order to hasten the process, the UK has simply decided to offer the same Schedules of Concessions for goods and services as those currently in place at the EU level (with appropriate changes, as needed), using the 1980 Procedures for the Modification and Rectification of Schedules. This thereby ensures that other WTO members continue to have the same access to the UK market. Nonetheless, WTO members have already raised some objections to this manoeuvre, and may well seek additional concessions from the UK. These discussions will not, however, prevent the UK from trading on the basis of the WTO rules once it leaves the EU on March 29, 2019 (and assuming there is no transition period).
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 (or are in the process of reaching) 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 occur 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, as is currently envisaged in the Withdrawal agreement.
6. WHAT ARE THE ALTERNATIVES TO A “NO-DEAL” BREXIT
A “no-deal” Brexit, as described above, would have significant negative economic consequences that both the UK and the EU27 will try to avoid. Instead, the UK is seeking EU approval for a bespoke trade agreement with the EU that would allow it to determine its own trade and immigration policies. On this basis, the UK government has ruled out the Norway (EEA) and Turkey (Customs Union) models 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.
Instead, the UK and the EU have set out in the Political declaration their wish to enter into an ambitious, wide-ranging and balanced trade and economic partnership and the EU has recently expressed its desire to have an agreement with the UK of ‘unprecedented depth and breadth’. This includes zero tariffs on goods and close regulatory and customs cooperation. The idea is that more detailed trade negotiations would then take place during the planned 21-month transition period, but the EU has made clear that any trade agreement will not be as far-reaching as membership of the EU Single Market.
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 September, 21, 2017), 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, which provides for substantial market access, especially for goods, and might to a certain extent appeal to British policy objectives in that it does not provide for the jurisdiction of the Court of Justice of the EU to resolve disputes. Instead, dispute settlement is based on the WTO model. The agreement also 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 one, the specific circumstances that led to the existence of each agreement differ 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 FTAs takes time - CETA was more than 7 years in the making. Whatever the scope of the future UK-EU27 relationship, it will be extremely difficult for the parties to negotiate its terms within the transition period. Whilst concluding the Withdrawal agreement, and the Political declaration on the future relationship has been challenging, it may be that the most difficult portion of the negotiations is yet to come.
ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm of approximately 700 lawyers practicing throughout a network of 13 offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the technology, energy, and life sciences sectors. Since 1840, we have provided creative and effective legal solutions for our clients while demonstrating an unrelenting commitment to excellence. For more information, please visit bakerbotts.com.