Brexit Manoeuvres: Another Cliff-edge Avoided, But More Ahead

“This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” - Winston Churchill

It is now clear that the UK will not go over the cliff by leaving the EU on 31 October without a Withdrawal Agreement: UK membership has been extended to 31 January 2020 (although Brexit could come sooner, if the recently revised withdrawal deal is ratified before then). But further cliff-edges may lie ahead. Indeed, a ‘No Deal’ Brexit could still come at the end of January, if that deal does not pass; the general election on 12 December may (or may not) provide clarity. But even if the new deal is ratified and the UK enters into a transition period, a  ‘No Deal’ cliff-edge of a different type may loom very quickly, if that period expires before a new UK-EU trade deal is in place. And there is a separate question regarding the possibly limited scope of any new trade deal that may be agreed, implying a source of possible future disruption. This brief considers these persisting risks. 

In the past two weeks, there has been a rapid sequence of significant developments:

• The EU and the UK agreed to revise the text of the Withdrawal Agreement¹ negotiated by the previous UK government under Mrs. May, replacing the controversial ‘backstop’ to prevent a hard border between Northern Ireland and the Republic of Ireland with new arrangements²;  
• The UK House of Commons, having three times rejected Mrs. May’s deal, gave initial approval to the revised Withdrawal Agreement, subject though to further scrutiny;
• That process was suspended when the House of Commons rejected the government’s proposed timetable that targeted ratification of the deal by 31 October;
• Prime Minister Johnson reluctantly submitted a request for a postponement of the 31 October deadline, as imposed on him by Parliament; 
• The EU agreed to a further postponement of Brexit, from 31 October to 31 January 2020 (or earlier if Parliament ratifies the deal before then); and
• The House of Commons agreed to hold a General Election on 12 December, with possible UK ratification of the deal on hold until after the election. 

UK General Election

The outcome of the election will determine the UK’s next steps on Brexit. The main party positions are these:

• A Conservative government would be likely to rapidly ratify the deal, enabling Brexit to go ahead, possibly as soon as the end of December;
• In the event of another hung Parliament, with no party holding a majority, depending on the Parliamentary arithmetic the government may have to seek amendments to the deal. The main ideas in contention are for the UK to remain in a customs union with the EU (at the price of not gaining freedom to negotiate its own free trade deals with third countries); the UK committing to maintain broad alignment with EU regulations on labour, social, environmental, tax and competition issues as well as goods and services (so-called ‘level playing field’ regulations); and for any deal to be subject to a ‘confirmatory’ referendum, with the alternative on the ballot paper being to remain in the EU;
• A Labour majority government would seek to renegotiate the Withdrawal Agreement to provide for at least the first two of the above amendments and would then put the revised deal to a confirmatory referendum; 
• The Liberal Democrats have committed to revoke the UK’s request under Article 50 to leave the EU, thereby ending the Brexit process without further negotiations or a referendum; and
• The Brexit Party argue for an immediate No Deal Brexit.

In the event of another hung Parliament, there is a risk of continuing deadlock, with the important question whether the new House of Commons would still have a majority determined to prevent a No Deal Brexit. If that were not the case then a cliff-edge would loom on 31 January. But equally we might see further postponement beyond that date, for further negotiation and/or a possible referendum – subject of course to the willingness of the EU27 to concede further delay.

The Transition Period

The Withdrawal Agreement provides for a transition period from the date of Brexit until 31 December 2020. This may be extended for “up to one or two years” i.e. at the latest to 31 December 2022. 

During the transition period, EU law would in effect continue to apply in the UK so that there would be no change to the practical framework. The period is intended to allow time for the negotiation of agreement(s) establishing the future UK-EU economic, political and security relationship - and to put in place the complex new arrangements designed to avoid a hard border in Ireland. 

When Brexit was originally due to take place on 29 March 2019, the transition period would have allowed 21 months for such negotiations. Crucially, that period has been reduced by the delay, rather than a new 21 month period running from the actual date of Brexit. Thus the period foreseen after a 31 January Brexit will have only 11 months left to run. But even 21 months was regarded by many as too short to complete a complex set of agreements. For comparison, the relatively straightforward EU-Canada Comprehensive Economic and Trade Agreement took seven years – and the new UK-EU FTA would require ratification by all 27 EU countries. Indeed the Canada agreement was held up by opposition from a regional parliament in Belgium and is still not fully in force. 

The timing is even tighter in one important respect, in addition to the already challenging 11 month period: while the Withdrawal Agreement does allow for an extension of the transition period, a decision to extend must be taken before 1 July 2020. That date would be only five months after a 31 January Brexit. The Johnson government is opposed to seeking an extension, in part because this would require the UK to contribute towards the next EU budget cycle, thereby increasing the politically sensitive Brexit ‘divorce bill’. This creates a serious new form of No Deal risk, with the UK and EU defaulting to WTO trading terms on 31 December 2020 if no trade agreement has been agreed and ratified by then. Extension of the period to the end of 2022, while reducing this risk, would not rule it out given the challenges of negotiating and ratifying an agreement in what would still be a limited timescale.

The cliff edge that would therefore loom at the end of the transition period is for a default to WTO trading terms. The consequences of that outcome have been a matter of debate between pro and anti camps, but at the very least it implies application of duties where none have previously applied. 

The UK-EU Future Relationship

The revised Political Declaration, agreed alongside the Withdrawal Agreement, outlines in non-binding terms the intended shape of the future relationship.³  While much is unchanged from the draft agreed by Mrs. May (e.g. financial services would be based on equivalence; chapters on other services would be negotiated while preserving regulatory autonomy for both sides; freedom of movement would be ended but with visa-free travel for short visits), the revised version includes two significant changes:

• For trade in goods: the previous aims of a “single customs territory" and close UK alignment with EU rules are replaced by an “ambitious” trading relationship "on the basis of a free trade agreement", co-operation on VAT, customs processes and some EU agencies (e.g. medicines, chemicals and aviation) but with greater scope for divergence; and
• For ‘Level Playing Field’ regulations: in place of the former “dynamic alignment” of these regulations is an aim of “non-regression”, with both parties in principle upholding standards of state aid, competition, social and environmental standards, climate change and tax.

This points towards a trade deal with the EU close to the ‘Canada model’ of a traditional free trade agreement based on zero or low customs tariffs and limited access in other areas such as services. This would be in contrast to the main alternative models of Norway and Switzerland (close regulatory alignment, close trade in goods and services, while outside the EU customs union) or Turkey (close regulatory alignment and inside the EU customs union).

This goes to the core of the argument for Brexit: that, by cutting itself free of what is seen as unduly restrictive EU regulation, the UK can boost its global competitivity and benefit from new trade deals with the more dynamic world outside the EU, particularly the Commonwealth, the US and the Pacific. At the same time, the UK wants to keep as many as possible of the benefits of its current trading relationship with the EU, which constitutes some 50% of UK trade (although declining). 

While Mrs. May put more emphasis on retaining close trade links with the EU, Mr. Johnson appears to have switched these priorities. Ultimately, if the EU perceives that the UK aims to set itself up as a ‘low tax, low regulation’ competitor (a ‘Singapore-on-Thames’), the EU could restrict the scope of the free trade agreement, potentially to the extent of not agreeing zero tariffs and other basic elements of the EU-Canada agreement. While this is unlikely, it cannot be ruled out: if it happened, it would constitute another cliff-edge since it would cause significant upheaval in the terms of the UK-EU trading relationship.

Implications for business

With the latest cliff-edge of a No Deal Brexit on 31 October averted and the prospect of Brexit going ahead after the election either on the basis of the revised Withdrawal Agreement (if the Conservatives win a majority) or some softened form of it (if they do not), many may be tempted to conclude that the main dangers of a No Deal Brexit have passed. But other forms of serious uncertainty remain, extending potentially many years into the future. Businesses would be well-advised to maintain their contingency planning accordingly.

Footnotes

_{1) New Withdrawal Agreement, 17 October 2019
2) Subject to periodic confirmation by the N. Ireland Assembly, these arrangements would align N. Irish regulations with the EU’s and require customs checks and duty payments on goods from the rest of the UK going to N. Ireland; duty could be reclaimed for goods remaining in N. Ireland
3) New Political Declaration, 17 October 2019}

This brief was authored by Alec Burnside and Richard Tauwhare on behalf of Dechert’s Brexit Task Force.