What to expect from Brexit in 2018

Published on CapX 

When the EU conceded before Christmas that enough progress had been made on the so-called “divorce issues”, the Brexit negotiations could finally move on to talks about the future EU-UK relationship and how we transition from the status quo to that new relationship. What should we expect from a new phase in the Brexit talks?

From 29 January: negotiations on a time-limited transition period after Brexit

According to the European Commission, the real start of the “negotiations on transition” will take place on January 29th, when the General Affairs Council “meet in an EU27 format” (see picture). Until then, “preparatory talks at EU27” level are ongoing. The EU wants a transition period that lasts until the end of 2020, so for just under two years. We know that the EU is ready to provide market access to the UK but only if Britain sticks to all its rules – new and old – without being able to vote on them, and if it accepts the supervision of the European Commission and the ECJ, without any representation in either. Here, I explain how the transition stage is likely to look like.

According to the latest version of the guidelines that EU member states have sent to Brexit negotiator Michel Barnier, he must make sure Britain will be even more of a “rule-taker” than Norway. The UK will only be invited to attend regulatory committees “exceptionally on a case-by-case basis”. Being at such meetings is one of the main ways to influence the decision-making process without any voting power.

The EU also wants EU citizens arriving in the UK after March 2019 and until the end of the transition period to be eligible for special status to remain in the UK.

On trade during that transition stage, the EU wants the UK to have to seek “authorisation” in order to roll-over EU trade deals with third countries after March 2019.

It looks like the Brexiteers in the British government are so far ready to accept this. They may fear that Brexit would somehow be reversed and that therefore the priority must be to legally exit the EU and become a third country, even if that means accepting an undesirable transition status. Backbench Leavers are another matter altogether.

How long will transition negotiations take? The UK government is hoping a deal on the nature of the transition can be done in time for the EU summit in March. The EU’s timeline anticipates agreement at the October summit.

Interestingly, The Times reports that “EU negotiators have judged that Britain will make more concessions to obtain a transition deal and expect the government to ask for a longer period to allow business to adjust. Sources suggest that the request will remain secret until late this year to avoid a rebellion by Eurosceptic cabinet ministers and backbench MPs”. The newspaper adds that the guidelines for Barnier are not seen as “precluding” an extension at the last moment of trade talks, with one negotiator explicitly stating that “the transition will be longer…We expect Britain to ask for that.” The article even mentions “until 2022”, which would make sense as this would theoretically come just before a UK general election, which is clearly the real deadline for the UK to ditch “rule-taker” status.

By 18 October: a deal on “withdrawal” 

For all the excitement at the end of last year, a final deal on the “divorce issues” – which include the “financial settlement”, the rights of citizens and the Northern Irish border issue – is yet to be reached. Britain and the EU will continue to negotiate these questions, aiming to reach an agreement by the October summit. MEPs have already warned that there are still “phase one” issues to be resolved. And the Commission is still trying to push the ECJ as the institution that would police the application of this agreement.

From October: ratifying the withdrawal agreement which includes the deal on transition  

Assuming a deal on transition and withdrawal is finalised by October, it’s up to the 27 EU governments as well as the European Parliament to approve it. The British Parliament has also been promised a “meaningful” vote.

A “qualified majority” of 27 EU governments is needed, meaning at least 72 percent of the continuing member states representing at least 65 per cent of their population will need to agree. Failing their support, Britain will automatically leave without a deal two years after the UK government triggered Article 50.

Will there be unanimity among the 27 remaining EU member states? Probably. A deal on Brexit is so important that there needs to be a firm consensus on it. Of course, the fact that not every country has a veto means its power to force through its demands is fairly weak.

What about the European Parliament? Could MEPs scupper a hard-fought Brexit deal? Again, that seems unlikely. MEPs only have a binary Yes/No vote. They probably won’t dare go against their political masters. And the rather protectionist body won’t have to vote on an actual trade deal but instead on an agreement promising market access to the UK in return for the British giving up their voting rights. But there is the important caveat that you should never say never when it comes to the European Parliament.

Will national parliaments be involved? Most likely not, unless there are changes to some of the trade deals the EU has concluded with third countries, such as Mexico or South Korea. Initially, the UK government was planning to replicate before March 2019 up to 40 of the 750+ international treaties the EU has concluded, but now the UK government is apparently looking to ask to remain party to all of these arrangements during the transition. That will require the consent of EU member states and the external partners. Otherwise the EU would effectively be adding a country to the agreement at will. Opinion is divided to how legally and politically complex this will prove to be. It does however seem clear that the most important economies the EU has a trade deal with are likely to be flexible: South Korea isn’t waiting for a “trade fight” with the UK, Mexico has its hands full with Trump and Canada has its historic ties with Britain.

Draft EU documents that need approval foresee that the UK “will remain bound by” trade deals the EU has signed with third countries, meaning that the UK will not necessarily have access to third countries’ markets, while it will have to respect EU tariffs when receiving goods from the third country. In other words, the UK will be dependent on goodwill if those third countries. However, because some EU member states, such as the Netherlands, Ireland, Belgium, Sweden and Poland, are reportedly worried about this affecting production chains, which often have a substantial percentage of UK products in them, it can be expected that Britain will receive some EU backup if the likes of Canada, Mexico or South Korea were to complicate matters. In any case, Britain would get the right negotiate new trade deals with the rest of the world during the transition stage, although France is still holding out here.

At the EU Summit of March 22, EU countries are expected to sign off Barnier’s guidelines on the negotiations on the UK’s future trade relationship with the EU. Actually, the goal is not to have a trade agreement ready by March 2019 but a political declaration whereby both sides mainly pledge their intent to agree a trade deal during the transition stage. Because of that, we won’t have any formal negotiations this year but a mere “scoping” of what a future relationship might look like, so that the formal trade negotiation can take place during the transition stage.

Before the March 22 however, both the EU and the UK need to figure out their stance on what kind of post-Brexit relationship they prefer.

Before March 22: preparation for “scoping” of the UK’s future relationship with the EU

Theresa May plans to outline her government’s position on the future UK-EU relationship during the February Parliamentary recess. She apparently wants to agree the process of upcoming talks with the EU, what the future economic and security partnership should look like, and also how a so-called “level playing field” with the EU might look. The latter is a euphemism for the extent to which the UK – or the EU – is allowed to diverge in terms of regulations.

The Times notes that there are different stances within the cabinet on how much divergence the UK should aim for. Brexiteers Boris Johnson, Michael Gove and Liam Fox support more divergence, Philip Hammond and Amber Rudd much less, and the Prime Minister somewhere in the middle.

And how do EU27 governments see their future relationship with the UK? To say there isn’t much clarity here would be an understatement. And given that an economy equal in size to the 20 smallest economies in the EU27 is leaving the bloc, the lack of a sense of urgency is shocking.

Instead, the EU seems to be content to just wish the whole issue away. Just look at the interventions from Jean-Claude Juncker and Donald Tusk this week, in which they insisted that he UK could still change its mind about leaving. The debate on the EU’s new long-term budget may have focused minds and made some realise that Brexit actually has consequences, not least on the EU’s finances.

This is where the cracks in the EU’s united front start to show. At a recent Brussels summit, one prime minister is said to have complained that “I hope no one is suggesting that my country’s interests should be sacrificed in the EU’s name”, with The Times reporting that some countries with a high exposure to trade with Britain, such as the Netherlands, have been “angered” by suggestions that European pain will be necessary to punish Britain for leaving.

Furthermore, the Spanish and Dutch finance ministers have agreed to push for a Brexit deal that keeps Britain as close to the EU as possible. They too are concerned about the economic consequences of tariffs on UK-EU trade.

The differences of opinion don’t stop there. Another point of disagreement is the UK’s financial services sector’s access to the EU. Luxembourg’s Prime Minister has rebuffed Barnier’s claim that allowing easy access for the UK’s financial services would amount to “cherry picking”. As he put it, “while I stick to the principle that there can be no cherry-picking, I still think that we should refrain from orthodox or binary thinking”. Germany’s Financial Supervisor BaFin said last week that its first priority wasn’t grabbing business from London but to avoid disruption, stating “we try to be as flexible and as pragmatic as legally possible” with regards to Brexit, and warning that a hard Brexit with no transition period could threaten financial stability. Last but not least, Ireland’s Central Bank Governor Philip Lane has come out against ECB President Mario Draghi’s suggestion that Brexit costs will be containable and concentrated in Britain. Lane warned: “If there is a genuine shock and we have a Brexit without a transition period, then that is a financial stability risk.”

Ahead of the March summit, EU negotiators are identifying sectors of the economy where there is no EU unity. They include fisheries, aviation and financial services. Some EU officials apparently fear that in the event of a no-deal Brexit, EU27 governments could respond by unilaterally protecting their own economies in ways that would undermine the single market. In other words: the EU has a very big stake in securing a Brexit deal which avoids disruption.

From March 22, 2018: “Scoping” of the future relationship

The whole point of the transition period is to allow more time to negotiate the trade relationship between the EU and the UK. The ideal scenario would of course be that both sides simply pledge to allow free entry for products or services that are legal in the other jurisdiction, but this kind of “mutual recognition” is anathema to some of the more protectionist forces that hold sway over EU27 governments, at the expense of ordinary consumers.

It’s true that most trade deals take much longer to be negotiated than the three or four years that constitute the upper limit of the length of a transition period. But there is a big difference between a UK-EU trade deal and the agreements it is usually compared to. The two parties don’t have to convince each other to open up markets that have so far been closed. The agreement is about finding a way to maintain the status quo. In other words: when you have companies already exporting and importing without barriers getting in the way, the opposition to any trade restrictions will be far greater than when those trade flows do not exist yet. Moreover, there’s also the point made by Sam Woods, the head of the Bank of England’s Prudential Regulation body, who thinks that a trade deal with the EU, including financial services, could indeed be completed in 3 years, because “we’re fortunate in starting this discussion in the unique position in terms of having completely aligned rules and strongly aligned supervision.”

The Financial Times points out that “on even the most optimistic assumption, the process of scoping, negotiation, ratification and implementation of the new relationship will take a minimum of five years from 2018.” Maybe. But, as I’ve argued before, it’s possible to sign a trade agreement by 2021 or 2022, with terms entering into force provisionally. Parliamentary ratification could then happen in the years following. An alternative would be to let the UK exit its “rule-taker” status gradually, as and when agreement can be found on a sector-by-sector basis.

For some reason, the EU Commission may try to push talks about financial regulation as well as aviation backwards, despite the fact that the clock is ticking. The reason is a lack of unity, with one official saying: “That is where it becomes frankly complicated for our side… Once you go into individual sectors then interests differ.

At the end of December, The Times obtained information from “two of the EU’s most senior officials” on the EU’s strategy. To maintain EU27 unity, they plan to demand that after the transition, the UK signs up to a “level playing field mechanism” which would tie the UK to EU standards in return for access to the single market. The EU would like to include the possibility of penalties, such as tariffs, if, for example, a future British government subsidised its car industry or sought competitive advantage through new banking regulations.

A second part of the cunning EU plan to is reportedly to exploit “helpful rhetoric” from Brexiteer ministers to scare EU nations with strong trading links to Britain with the threat of a race to the bottom on corporate taxes and environmental standards. (Of course, those EU officials probably couldn’t imagine that EU citizens and companies might actually gain from lower corporate taxes or more sensible environmental regulations coming about due to regulatory competition between the UK and the EU.)

The whole point of all of this “scoping” is to agree some kind of a political declaration by March 2019. The first part is likely to include a commitment to negotiate a trade agreement by the end of the transition stage. This is not just to reassure Britain but also because it’s helps to comply with WTO rules which may not allow some of the transitional arrangements considered. The second part of the declaration will relate to the wider political relationship, including defence, security and foreign affairs.

Then, in 2019, the real work starts: detailing where trade between Britain and the EU will suffer disruption due to the unfortunate refusal to simply mutually recognise each other’s regulations. That – at least – is the plan.