Top Brexit developments in 2017 for ADG companies

by Hogan Lovells
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On 23 June 2016, the people of the United Kingdom (UK) voted in a referendum to leave the European Union (EU). The UK Government gave the EU formal notice of its intention to withdraw from the EU on 29 March 2017. This triggered Article 50 of the Treaty on the European Union and the formal start of the Brexit, setting a default date of March 2019 for the UK's withdrawal.  

As an EU member, the UK is part of (among other things) the European Single Market, which facilitates trade between Member States by providing for the elimination of non-tariff barriers and harmonizing regulatory and technical standards for goods and services across the EU. EU members are also members of the European Customs Union, which prohibits the imposition of tariffs, customs duties, and quotas on trade between Member States and sets EU-wide tariffs, duties, and quotas for trade with the rest of the world.  

According to Article 50, the EU Treaties (the constitutional documents of the EU) will cease to apply to the UK – and the UK's membership in the EU Single Market and Customs Union will end – either when a withdrawal agreement between the UK and the EU enters into force or, failing that, two years from the day the UK triggered Article 50, unless there is unanimous agreement to extend the process. Unless agreed otherwise, the UK will also cease to be party to the EU's free trade agreements with non-EU states post-Brexit, but will be free to negotiate new bilateral agreements of its own.

The potential impact of Brexit on the aerospace, defense, and government services (ADG) businesses is significant. Below we review some of the key issues facing the ADG industry as a result of the UK's decision to withdraw from the EU.

The exit process

During the negotiating period, the UK will still be an EU Member State. The UK will still be required to comply with EU law; will continue to participate in EU activities, institutions, and decision making (apart from any discussion concerning its withdrawal); and cannot enter its own free trade agreements with non-EU states.

The UK Government has stated that it will seek to simultaneously negotiate withdrawal and define the future relationship with the EU during the two- year period between its formal notice and the default date for withdrawal to be complete. This is currently being resisted by the EU, which claims that withdrawal and future arrangements should be negotiated sequentially.  
The withdrawal agreement requires approval of the EU Council by a 'super' qualified majority (approximately 72 percent of the EU27) after obtaining consent from the EU Parliament. A separate UK/EU future relationship agreement is likely (depending on its contents) to require unanimous agreement of EU Council and EU Parliament consent – it may also require ratification by individual EU Member States.

While negotiating the UK's withdrawal from the EU, the UK Government has announced that it intends to enact a "Great Repeal Bill," which will repeal the European Communities Act 1972 (the legislation that gives domestic legal effect to the UK's membership of the EU) and prepare UK law for Brexit. The Government's intention is that "wherever practical and appropriate, the same rules and laws will apply on the day after we leave the EU as they did before."  

As a result, it is likely that many of the rules that currently apply in the UK via EU law will continue to apply post-Brexit, albeit through new domestic laws. However, it will not be practical or possible to convert all EU law into UK law. For example, the right to seek a reference to the Court of Justice of the EU is unlikely to continue. Other EU law rights might not be transposed for political reasons. Important questions about this process also remain unanswered, such as how transposition will be achieved, both in terms of the form of words and whether it will be done by primary or secondary legislation. Some policy choices will have to be made pre-Brexit: this will not be a mechanical, non-political process.

For additional information, see our note on the Great Repeal Bill here.
 
Transitional arrangements

The UK and EU face the prospect of an abrupt and disruptive end to the application of EU law in the UK unless they can agree otherwise within the two-year negotiation period. Without suitable transitional arrangements, the regulatory regimes established under EU law could cease to apply in the UK. Certain aspects of these regimes are likely to be replicated at a domestic level via the Great Repeal Bill discussed above, but it will not be possible for the UK unilaterally to legislate for the cross-border elements of the prevailing EU law regimes (such as the pan-EU mutual recognition of licenses and certificates granted in accordance with EU regulatory regimes). UK-established businesses could also become subject to World Trade Organization (WTO) tariffs on trade with the EU, where previously there were none. This would have a particular impact on pan-European businesses and supply chains.

The UK Government has recognized that it is "in no one's interest for there to be a cliff-edge for business or a threat to stability" and has called for a "phased process of implementation" of any new arrangements as the UK and the EU move toward a new partnership, in order to deliver a smooth, orderly UK exit from the EU. The Prime Minister has suggested that different implementation periods could apply to different sectors, but has been adamant that this is recognition only that the new relationship needs to be implemented over time and expressly not a desire for some form of unlimited transitional status for the UK.  

It remains to be seen whether the EU will be amenable to such a proposal. A number of contentious issues will need to be resolved before such a phased implementation period can be agreed, such as:

  • the extent to which the UK would remain subject to the principle of free movement of people during the implementation period;
  • whether the Court of Justice of the European Union would retain jurisdiction over the UK during a transitional period; and
  • whether the UK would remain a member of the Customs Union, and therefore unable to implement its own free trade agreements with third countries, during the transitional period.

It is unlikely that the minds of the negotiators will be focused on the need for transitional arrangements at the outset. However, if the negotiations do not progress as fast as hoped, the focus is likely to shift to the need to avoid undue disruption to UK and EU businesses, including the ADG industry.

The Single Market and EU-wide supply chains

The expansive and flexible pan-European supply chains of the ADG industry are currently made possible by, among other things, frictionless trade and harmonized regulatory standards ensured by the Single Market. 

The Government has acknowledged that many goods industries, including ADG, have global supply chains where parts and components move across borders multiple times during the manufacturing process. The UK Government's recent White Paper cites the example of an airplane which is assembled in one country, with components assembled in another country, using parts designed and produced through cooperation between specialist teams across various European countries.   

The UK Government has indicated that it will not be seeking membership in the Single Market after Brexit, but will be seeking to agree to "the freest and most frictionless trade possible in goods and services between the UK and the EU." The UK's continued participation in aspects of the Customs Union post-Brexit is considered separately below.

The Customs Union and WTO rules

The Customs Union ensures that no tariffs or additional administrative customs processes are imposed on trade between EU Member States (known as the Common Commercial Policy). This has a significant effect on costs, efficiency, and competitiveness in transnational industries such as ADG. The Customs Union also requires Member States to adhere to the Common External Tariff, which sets uniform tariffs across the whole of the EU with respect to trade with third countries.

The UK Government has indicated that it will prioritize securing the ability to implement its own trade arrangements with non-EU states, something that is currently prohibited while the UK is a member of the Customs Union and subject to the Common External Tariff. However, unless agreed otherwise, this could also mean that the UK will no longer benefit from the Common Commercial Policy and could give rise to the imposition of tariffs on trade between the UK and EU.

The UK also currently benefits from a number of EU free-trade agreements with third countries. It is unclear whether the UK will continue to benefit from such agreements post-Brexit; the starting position is that such agreements will lapse.

The UK Government has stated that it will not seek to remain a member of the Customs Union, but instead wants to negotiate a new customs arrangement with the EU that will retain some of the benefits of the Customs Union, but not the disadvantages. However, the likelihood of negotiating such an agreement within two years remains unclear. 

If no such agreement is reached, the UK would revert to WTO rules.  In the context of ADG, at present (where no EU free trade agreement exists with a specific third country) the 1980 WTO Plurilateral Agreement on Trade in Civil Aircraft (Plurilateral Agreement) eliminates import duties between signatory states on all non-military aircraft, as well as products related to the production of aircraft, including engines and other component parts.  

The UK remains a member of the WTO post-Brexit, but will need to renegotiate its terms of membership, including its schedules of tariffs and services, which must be unanimously approved by all WTO states. Until it does so, the UK will also lose the benefit of the Plurilateral Agreement, which would significantly impact the ability of UK ADG businesses to trade competitively post-Brexit.

UK participation in EU bodies and projects

The UK currently participates in a number of EU agencies and projects by virtue of its EU membership, such as:

  • membership in the European Aviation Safety Agency (EASA), which is responsible for developing and regulating EU aviation safety standards; and
  • participation in EU funded projects, such as the Single European Sky Air Traffic Management Research project (SESAR), which funds research into new air traffic management technologies to be deployed across EU Member States, and the European Defence Agency (EDA), which provides funding for research into defense capabilities and technology.

Unless agreed otherwise, the UK will no longer benefit from membership of EASA or continued participation in projects such as SESAR and the EDA, which will automatically cease post-Brexit.  

The UK Government has stated that it will "discuss with the EU and Member States our future status and arrangements with regard to these agencies." If the UK were no longer a member of EASA, it would need to establish a domestic regime and designate a domestic supervisory body (most likely the UK Civil Aviation Authority) to fulfill EASA's functions. However, unless agreed otherwise, certification from the UK body under the new domestic regulatory regime would not be recognized in the rest of the EU, unlike certification granted under the existing EASA regulation. This could result in parallel regulatory regimes in the UK and the EU, under which businesses wishing to operate in both would need to obtain two sets of certification.

With respect to EU projects and funding, the UK Government has stated that it "will seek agreement to continue to collaborate with our European partners on major science, research, and technology initiatives." Whether the EU will be willing to negotiate this remains to be seen.

Withdrawal from the EDA would also be likely to reduce the UK's influence over strategic pan-European defense projects, such as the development of the Eurofighter Typhoon, and could impact UK-based businesses ability to participate in such projects. 

Free movement of people

The ADG industry relies on a highly-skilled, flexible, and geographically-mobile workforce that can easily move from one Member State to another over a project's lifespan. This is particularly important to the UK ADG sector due to shortages in the UK's engineering and physical sciences labor markets. Any restrictions (whether quantitative or bureaucratic) on the ability of ADG businesses in the UK to hire skilled workers from the EU (or vice versa) could disadvantage UK businesses and make the UK less attractive for investment.

The UK Government has made clear that controlling immigration from the EU is one of the central objectives for Brexit. It has stated that the principle of free movement of people, one of the four fundamental freedoms of the EU, must end in the UK as a result of Brexit. However, the UK Government has also recognized that "it is important that we [the UK Government] understand[s] the impacts [of migration controls] on different sectors of the economy and the labor market" and has stated that businesses will have the opportunity to provide input.  

In the event that the UK Government negotiates a new relationship with the EU whereby it is no longer subject to the principle of free movement of people, the UK will be free to reform its immigration system with respect to EU nationals.  

UK procurement regulations

Post Brexit, the UK will likely retain a regime that requires advertising and competitive tendering of large scale government contracts. However, it may be a less extensive and more flexible regime than the one currently imposed by EU procurement rules. 

The continuation of a regulated procurement regime in some form is implicit in the UK Government's January 2017 "Industrial Strategy" Green Paper. Indeed, that document recognizes that the State, as a major purchaser (especially in the health and defense sectors), can influence some of its wider strategic objectives. Of interest to the ADG sector, "strengthening the UK supply chain" is one of the objectives most clearly articulated in the Green Paper and measures suggested to achieve this include encouraging/mandating contractors on large (£10m plus) capital projects to "advertise at least some categories of sub-contracting opportunities through open channels." There is no suggestion that main contractors will be required to limit these adverts to UK audiences, but the size and nature of the opportunities likely to be advertised suggests that UK sub-contractors may be the main beneficiaries. 

Just as there has been no overt attempt to favor UK sub-contractors, the UK Government has so far indicated no clear intention to seek to restrict participation in post-Brexit government tendering to UK-based main contractors either. Although this option is theoretically available, in practice the UK will likely continue to adhere to the WTO's Government Procurement Agreement (GPA), which will require it to allow contractors from the other signatory states access to UK government contracts, with reciprocal access for UK contractors in the states concerned. However, the categories of governmental purchaser, and the types of contract, covered by the GPA are limited: many categories of service contract are excluded, for example. So if the UK opts to open its government contracts only on GPA terms, some opportunities currently available to non-UK ADG companies could be closed post-Brexit. In practice, however, the bilateral deals that the UK will seek to implement, both with the EU27 and also with its other major trading partners, are likely to provide reciprocal access for the parties' respective contractors to a much broader range of contracts than are covered by the GPA. The detail of these deals is potentially years away.

Conclusion

ADG clients should conduct a detailed review of the implications of Brexit for their businesses as the situation develops and engage with UK and EU authorities to ensure that their business priorities are heard. It is vital that their business interests do not become a source of compromise in the negotiations. That means engaging with policymakers to offer analysis and solutions that are commercially, legally, and politically credible.

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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