Brexit Postponed…and Softened?

by Dechert LLP
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Brexit has been postponed again, until at least 31 October 2019, but with the possibility that it may occur sooner, maybe even within a few weeks.

While a “no-deal" Brexit remains a default possibility, both the UK and EU seem as a practical matter determined to avoid it. Revocation of the Article 50 notice has entered discourse as an option favoured by a substantial minority, but is not under active consideration.

The UK government continues to seek a majority in the UK Parliament to support the Withdrawal Agreement; and if Parliament ratifies the agreement at any point before then, Brexit could happen before October. The focus currently is on discussions between the government and the Labour Party. In this update we review what has been agreed by the EU, as well as the main issues under discussion between the government and Labour: a Customs Union and the Single Market.

EU Decisions

On 11 April the EU decided:1

  • to grant the UK an extension of the deadline for its exit from the EU, originally set for 29 March and previously extended to 12 April. The extension will last only as long as necessary and no longer than 31 October 2019, although a further extension is not ruled out. If the Withdrawal Agreement is ratified by both parties before this date, the withdrawal will take place on the first day of the following month;
  • if the UK has not ratified the Withdrawal Agreement by 22 May 2019, it must hold elections to the European Parliament. If it fails to do so, the UK will leave the EU on 31 May 2019. The UK government still hopes to avoid the need to hold these elections, given its previous commitment that the UK would leave the EU in March; but the necessary steps have been taken to allow the elections to proceed;
  • there could be no opening of the Withdrawal Agreement. However, the EU is prepared to reconsider the non-binding Political Declaration on the future UK-EU relationship;
  • the UK will remain a Member State with full rights and obligations, and is expected to act in a constructive and responsible manner in accordance with the treaty duty of “sincere cooperation." This aims to address the perceived risk of the UK holding EU decisions hostage in order to secure improvements to the terms of its departure.

Timeline

  • 12 April: UK was due to leave the EU, following postponement of the original 29 March deadline.
  • 23 May: UK must hold elections to the European Parliament if the Withdrawal Agreement has not been ratified.
  • 31 May: UK leaves the EU if it has not held European Parliament elections.
  • 20-21 June: European Council "stocktake" of Brexit, but no decisions are required.
  • 2 July: European Parliament inaugural session.
  • 31 October: new deadline for UK to leave the EU. Coincides with the end of the term of the present European Commissioners: the new Commission will take office on 1 November.

Next Steps in the UK

Having failed three times to secure a majority in Parliament for the Withdrawal Agreement, the government announced on 2 April2 that it would begin talks with the opposition Labour Party to seek an agreement between them on the future relationship with the EU.

There is no deadline for these talks, but the government has said that if it cannot reach agreement with Labour, it will instead aim to agree with them on options for the future relationship that could be put to Parliament in a series of votes to determine which course to pursue; and the government has said it would abide by the decision of Parliament.

The focus of the current cross-party talks is assumed to be on key elements of the Labour Party’s policy, namely:

  • a permanent and comprehensive customs union with the EU;
  • close alignment with the Single Market underpinned by shared institutions and obligations, and dynamic alignment on rights and protections;
  • (less contentiously) participation in EU programmes, including in areas such as the environment, education, industrial regulation and in future security arrangements; and
  • potentially, a confirmatory public vote (i.e. a second referendum) on whatever deal is approved by Parliament.

The following sections summarise the main issues at stake in establishing a customs union with the EU and close alignment with the Single Market.

Customs Union

A UK government "red line," defined by the Prime Minister in January 2017,3 is for the UK to be free to strike trade agreements with countries outside the EU. This would preclude a customs union with the EU. However, the UK wants "a new customs agreement" to enable UK-EU trade to be as frictionless as possible: this is reflected in the Political Declaration on the future UK-EU relationship, agreed with the EU.4

It is far from clear whether the government or Parliament would accept a UK customs union with the EU as proposed by Labour, or some variant of it. But since this appears to be a key area of difference between them, it may be helpful to recall the main arguments.

What would it mean?

Members of a customs union apply no tariffs to trade between them and a common set of tariffs to imports from third countries. In the EU, the common external tariff is established by the European Commission, which also negotiates free trade agreements with third countries on behalf of the EU. Some sectors, such as agriculture, may be excluded (as in the case of Turkey, which has a customs union agreement with the EU).

Pros

  • A customs union is likely to be readily negotiable with the EU, which supports it.
  • Being in a customs union but outside the Single Market would achieve the UK’s objectives of controlling the movement of people from the EU, not being obliged to follow EU policies or law, not being subject to the Court of Justice of the EU (CJEU) and ending obligatory contributions to the EU budget.
  • It would significantly eliminate friction on UK-EU trade in goods by avoiding customs declarations, tariffs, quotas and onerous rules of origin requirements, thereby helping to maintain existing cross-border supply chains and facilitate new ones.

Cons

  • A customs union would in effect prevent the UK from negotiating its own free trade agreements with third countries. While it could in principle strike agreements on trade in services, securing greater access to services markets would be unlikely if the UK cannot offer concessions on access to its goods markets.
  • The UK would have a reduced voice in the negotiation of new EU free trade deals, while having to accept whatever terms are agreed. Labour has proposed that the UK should have a seat at the negotiating table for EU free trade deals, but securing EU agreement is by no means certain.
  • New EU free trade deals would grant third countries access to the UK’s market without the UK automatically benefiting from reciprocal rights to the third countries’ markets. The UK would need to negotiate such access separately. But since access to the UK market would already have been granted, it would have little to bargain with. This is a significant weakness of the EU-Turkey customs union and the UK would need to reach a stronger agreement on this with the EU.
  • A customs union alone would not enable a frictionless border. Without regulatory alignment for at least those goods subject to border checks (e.g. agricultural goods, food, chemicals, electrical goods), such checks would still be required. A customs union would not therefore remove the need for the contentious "Northern Ireland Backstop" in the Withdrawal Agreement (to prevent a hard border having to be established between Northern Ireland and the Republic of Ireland).
  • A customs union in itself would not address UK-EU trade in services, which comprises some 80% of UK GDP and 45% of UK exports. As noted above, without being able to offer access to the UK goods markets, the UK would struggle to gain greater access to third countries’ services markets, which has been presented as a major opportunity arising from Brexit.

Single Market

Neither the UK government nor Labour has proposed that the UK should remain in the EU Single Market, since this would oblige the UK to accept free movement of people from the EU; make payments into the EU budget; and to accept the jurisdiction of the CJEU. While both parties favour some form of alignment with the Single Market, the details on both sides remain unclear.

The Political Declaration sets the aim of "an ambitious, wide-ranging and balanced economic partnership" underpinned by provisions ensuring a level playing field for open and fair competition covering state aid, competition, social and employment standards, environmental standards, climate change and relevant tax matters, and for regulatory approaches for both trade and services that avoid “unnecessary barriers” and are “compatible to the extent possible." On goods, the UK will “consider aligning with Union rules in relevant areas." However, in sectors such as financial services the ambition does not go beyond equivalence frameworks that allow each party to declare the other’s regulatory and supervisory regime equivalent for relevant purposes.

Without clarity on what is proposed it is difficult to assess the pros and cons of “alignment to the Single Market” beyond recognising the key trade-off: while close alignment with EU rules would facilitate trade, it would limit UK autonomy to set its own regulations ("being a rule-taker rather than a rule-maker") and to strike its own trade deals (the U.S. has already indicated that it would expect changes in UK regulations to enable greater access for U.S. goods).

What this does lay bare is the reality that concluding the Withdrawal Agreement would be no more than the end of the beginning: negotiation of the future new relationship promises to be long and contentious, with the clock already running down on the time available for these negotiations during the intended transition period (until end 2020, extendable to end 2022). The Political Declaration contains things to please both sides, and aspirational sentiments – but deeply embedded in caveats and qualifiers.

Implications for Business

Uncertainty over the outcome of the Brexit process continues, while those who had hoped for a longer postponement, to provide a period of relative stability, will be disappointed. Short of a breakthrough in the cross-party talks or in Parliament – both of which pose substantial challenges – it remains unclear when a resolution will be reached. While remote, there remains the possibility of a "no-deal" Brexit by miscalculation or after a major change in political sentiment. Being so, companies are advised against unwinding their contingency planning.

Footnotes

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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