What the Brexit Plan means for Trade

With a view to trade relations between the EU and the UK, May ruled out any association based on the models of Norway, Switzerland or Turkey, and any other form of cooperation that would leave the UK “half-in, half-out”. This is because remaining in the Customs Union or in the Single Market would subject the UK to decisions made by EU institutions, in particular the case law of the Court of Justice of the European Union (CJEU). Moreover, the UK could not limit the free movement of persons, nor conclude its own free trade agreements with third countries. Therefore, it is only with regard to particular areas such as the financial and automotive sectors that May expressed a preparedness to “take in elements of the current Single Market”.

The Prime Minister seeks an agreement with the EU that would allow customs-free or at least customs-preferential trade between the EU and the UK. At the same time, the UK strives to restore its autonomy to conclude other free trade agreements and to limit immigration. May made clear that she does not hold a preconceived position on the specific form of any agreement with the EU. She also stated that the UK had already commenced discussions about free trade agreements with third countries including Australia, New Zealand, and India.

May assured the public that the final deal will be put to a vote in both houses of British Parliament. However, it remained unclear whether this vote should solely allow Parliament to accept or reject the deal, or also to have a say on the form and precise content of the agreement with the EU. In the meantime, the Supreme Court has ruled that authorisation by the British Parliament is needed for government to notify the EU of its intention to withdraw its membership.

Is the “Mexico Model” a Possibility?

May’s desired form of trade relations between the UK and the EU could be described as “Mexico Model” because it aims at close trade relations with an economic region (the EU) on the basis of a free-trade agreement. Mexico is a member of the North American Free Trade Agreement (NAFTA) and simultaneously maintains a multitude of bilateral free trade agreements. Similarly, under May’s Brexit plan, the UK aims to have close trade relations with the EU economic region on the basis of a free trade agreement while concluding a variety of bilateral free trade agreements with other countries including the US.

It is yet to be seen whether the EU will accept such an approach. The EU’s Chief Negotiator Barnier has excluded parallel negotiations on both the withdrawal from the EU pursuant to Article 50 Treaty of the European Union (TEU) and the conclusion of a free trade agreement. According to Barnier, Article 50 of the TEU creates an obligation to agree on the future framework for bilateral cooperation only. In the same vein, EU Trade Commissioner Malmström has stated that the EU may only conduct negotiations on free trade agreements with third countries – a status that the UK will not acquire until it has fully left the EU.

Irrespective of when negotiations of a free trade agreement with the UK commence, it is unclear whether the EU27 would agree to a deal that would allow the UK to retain partial access to the Single Market. Reluctance towards such a deal has already come from within the EU27 in the form of a tweet from the Czech State Secretary for European Affairs, Tomas Prouza: “UK’s plan seems a bit ambitious – trade as free as possible, full control on immigration…where is the give for all the take?”

Moreover, as the negotiations between the EU and Canada on the Comprehensive Economic and Trade Agreement (CETA) have demonstrated, negotiations can be long and protracted – even when both parties are keen on a successful completion. It is not far-fetched to assume that negotiations between the UK and the EU could take between five and ten years.

Any EU-UK free trade agreement would include the regulation of trade by means of preferential tariff rates and harmonisation of non-tariff barriers to trade – the latter of which makes the agreement more comprehensive and complex than a mere customs agreement. However, preferential tariff rates and the remission of customs duties would only apply to goods considered to be “originating products” from the EU or the UK. Accordingly, only products and raw materials which have experienced sufficiently high rates of value-added growth in the territories of the Contracting Parties can benefit from preferential conditions. Therefore, the exact terms of origin rules would be an essential point on the negotiation agenda of a free trade deal.

Even though, due to the increasing internationality of assembly and distribution lines of companies a product’s proof of origin can be a very complex issue. Furthermore, it has to be taken into account that any origin rules negotiated between the EU and the UK would only be applicable in the context of that specific trade agreement. There would still be a need for the UK to negotiate similar agreements with other countries.

Finally, May’s suggestions raise the question of whether the UK is actually competent to negotiate free trade agreements with third countries. This is because Article 207 of the Treaty on the Functioning of the European Union, which applies to the UK as long as it is a member of the EU, assigns the exclusive competence for trade policy to the EU.

Hard Brexit: Application of the WTO Rules

May also assured the public that the acquis communautaire would remain in force in the UK for the time being. According to May, EU regulations that will cease to apply to the UK once it leaves the EU will be converted into British law before the UK’s repeal of the European Communities Act. Consequently, says May, upon the UK leaving the EU, the UK and the EU27 will initially be subject to the same laws.

Until a EU-UK FTA is concluded, the UK’s customs regime will fall back on the rules of the World Trade Organisation (WTO). Thus, the UK will be treated as a non-preferential third country vis-à-vis the EU and the General Agreement on Tariffs and Trade (GATT) regulating the trade of goods will apply.

The UK is already a regular member of the WTO, but was previously represented by the EU in all policy matters related to the WTO. Therefore, the UK would be faced with the prospect of drawing-up its own WTO policy. This applies to preferential agreements and trade agreements between the UK and third countries. Moreover, there would be a need for the UK to negotiate its own annexes related to WTO treaties, such as the General Agreement on Trade in Services (GATS). Irrespective of the amount of tariff burdens resulting from bilateral negotiations, UK and EU companies will face substantial additional costs due to customs formalities.

What’s next?

While there might not be an immediate need for action, there are manifold questions that companies should be asking themselves now:

• Supply and distribution chains: How can additional costs caused by e.g. double customs clearing, be avoided or at least be kept at a minimum? Profitable solutions here might be the replacement of suppliers, the relocation of distribution hubs or the creation of subsidiaries.

• Market analysis: Will direct or potential competitors gain an advantage on the relevant market by means of a modified UK customs regime? What are the implications of such market developments and how can risks be mitigated?

• In relation to origin rules different aspects such as e.g. list rules and accumulation, need to be considered in order to foresee how products might profit from preferential customs tariffs.

Should you have any questions on the implications of Brexit for your business, please do not hesitate to get in touch with Roland Stein or Pascal Friton.