Brexit: UK’s Options

Many terms, phrases, opinions (and, frankly, nonsense) are doing the rounds regarding the Brexit debate. Norwegian model, Turkish Model, EFTA, EEA, Customs Union, Free Trade Agreement, WTO terms?

The Financier presents this succinct guide. It frames the terms of the debate and explores the options available.

There are five broad options available to the UK:

  1. remain in the Single Market (EEA);
  2. leave the EEA but remain in the Customs Union (CU);
  3. sign a bespoke free trade agreement (FRA) and
  4. the default no deal pushing bilateral trade onto WTO terms.

The eventual Brexit is likely to be a blend of two of these options.

The EEA

This is the ‘Norway option’. Leaving the EU, but remaining in the EEA is the closest to the status quo, full EU membership. There would be no tariffs or quotas on trade in all categories of goods and services with the EU. The UK would sign up to (retain) the “four fundamental freedoms”: freedom of goods, people, services and capital. The EEA can be thought of as an EU-lite. The EEA agreement does not cover:

The Common Agricultural Policy;
The EU Customs Union and trade agreements with third countries;
The Common Fisheries Policy;
The Common Foreign and Security Policy.

A quantitative assessment of Norway shows that between 2000 and 2013, the EU adopted 52,183 pieces of legislation with only 4,724 incorporated into the EEA. The Commission would continue to exert control over the UK and we would be subject to the jurisdiction of the Court of Justice (ECJ).  Due to freedom of movement (people), Britain would be unable to restrict EU/EEA immigration unless a bespoke arrangement were agreed. Britain’s attempt to circumscribe freedom of movement was previously emphatically rejected by the EU under David Cameron’s premiership, but in the aftermath of the shock Brexit and with right wing, anti-EU sentiment at an all-time high across the Eurozone, the ultimate arbiters of EU policy (Merkel and Macron) might now be willing to show some flexibility. But given a treaty change will require unanimous approval of the remaining 27 member states, any significant restriction of freedom of movement is unlikely to be approved.

The UK would still contribute around 90% of its current contribution to the EU budget and we would also be mandated to abide by all EU regulations that fall within the EEA’s scope.

Remaining in the EEA is the goal of the “remainers” and “soft-Brexiteers” and is the least disruptive option.

Given that limiting immigration and ending payments to the EU budget were central themes in the Brexit campaign, an EEA-style Brexit is unlikely to satisfy Brexiteers. To put matters in context, in 2015, after adjusting for the rebate, the UK paid £14.6 billion, and received back £3.9 billion leaving a net contribution of £10.7 billion. Nailing a precise figure is highly contentious. The ongoing contribution is estimated to remain around £10 billion according to an authoritative House of Commons briefing paper.

An annual payment of £10.7 billion for frictionless access to the largest single market in the world seems a good deal for the UK.

Watch out for potential judicial reviews into whether the UK is automatically withdrawn from the EEA via the EU’s Article 50, or whether the government must formally issue an EEA Article 127. The last attempt at judicial review was struck out on a technicality.


Customs Union (CU)

A CU entails no customs duties are levied on goods travelling within the are of the CU and that member states of the CU agree to impose a common external tariff on all goods entering the CU, irrespective of which border the goods arrive at. The EU states are members of the CU as well as a select few others. Andorra, San Marino and Turkey have bespoke CU agreement with the EU that do not cover all goods.

Remaining in the CU would represent a middle-of-the-road Brexit. The UK would sign a bilateral deal with the EU to remain in the CU that abolishes tariffs and quotas on trade in agreed categories of goods. In the CU, the UK would be obliged to apply the common external tariff to any “third country” with which it struck a bilateral free-trade deal.

In a reversal of his previous decision, Chancellor Hammond, in the now minority Conservative government, has stated that he will seek to remain in the CU, thereby allowing goods to travel freely. Teresa May’s hard Brexit lies in tatters as her vice-like grip over policy vanishes, allowing space for ministers to wrestle back control of their departments. We are likely to see a less ideologically Brexit in favour of a more pragmatic approach driven by the hard realities of trade and economics. Politics will now take a backseat to economics, for the first time.

The CU alone, however, does not solve the critical provision of services question.

The Financier believes that Brexit within the meaning of remaining within the CU and a bespoke deal regarding the provision of financial services will be the most likely outcome.

This middle-of-road Brexit would most closely represent the aspirations of the majority of “Brexiteers”.

The ‘Turkey’ model

The Turkey model does not represent a plausible model for the UK. Turkey is in a CU with the EU for industrial goods but not agricultural goods and not for services. Given the pre-eminence of the UK’s financial services sector, this is not a suitable template.

 

Free Trade Agreement (FTA)

A FTA would be a bilateral agreement with the EU addressing all areas of common interest. The focus would be on the tariff-free or reduced tariff access of goods and the provision of cross-border services. This is the hard-Brexit option which Theresa May referred to “as frictionless access to the free market as possible.”

Britain would be free to pursue FTAs with other countries. The EU would likely oblige the UK to remain ‘equivalent’ to the EU’s regulatory regime by adopting large parts of EU regulations and directives, but Britain would not be required to sign up to the four fundamental freedoms, thereby enabling it to restrict immigration from the EU.

Before the UK could sign an FTA with the EU (or with any other entity), it will probably need to have its WTO arrangements set out – potential FTA partners need to know what terms the UK is offering the rest of the world before they can know what ‘preferential’ terms to seek for themselves.

The ‘Switzerland’ model

The Switzerland model is best described as a series of bilateral agreements with the EU that cover manufactured goods and processed food but, critically, not free movement of services. Swiss companies commonly set up EU subsidiaries in order to trade with the EU, thereby bringing services into the full regulatory regime of the EU, as well as having their capital tied up in the EU.

Swiss and EU nationals are allowed to travel to each other’s country for 90 days a year and must apply for business visas should they wish to take up employment.

The ‘Canada’ model

Canada concluded CETA (the Comprehensive Economic and Trade Agreement) with the EU this year after a mammoth 7-year slog which was almost scuppered by Belgium at the 11th hour – proving how hard striking a trade deal with the EU is.

Once the agreement comes into force, Canada will enjoy preferential access to the single market. Most trade tariffs have been removed. Importantly, if the UK were to follow the same lines as the Ceta deal, it would not give the UK financial services sector the current EU access it has and UK-based banks would need to secure ‘passporting’ rights for their services in the EU.


World Trade Organization (WTO) terms

The WTO is a group of 164 countries. WTO members have signed up to legally binding WTO rules as encapsulated in the “Final Act” brought into force by the 1994 covering declaration in Marrakesh. The tariff’s the EU imposes on other countries is documented here.

WTO members have agreed to a limit on the barriers to trade that it will impose on other members.

We do not believe this default WTO option will ever occur. The “no-deal is better than a bad deal” rhetoric is bluster and pre-talks posturing. The reality of a no-deal would be a severe shock to UK GDP, a probable deep recession with similar pain felt on the EU side.

The UK and EU would face considerable barriers to trade including tariffs, quotas and restrictions. Currently, a simple average of all the different tariff rates imposed on goods from the EU’s MFN (Most Favoured Nation) is 5.31% but this masks the individual disparity on goods. German car manufacturers are unlikely to welcome paying 10% tariffs to export into the UK.

 

Financial Services

According to one estimate, the financial services sector and related industries generates 12% of UK GDP, employing 7% of its workforce. Currently, under EU law, UK financial services companies can ‘passport’ their services into the EU without restriction as authorisation in one member state acts as authorisation to operate anywhere in the EU.

In 2016, 5,476 UK firms rely on passports to do business into the EEA and 8,008 EEA firms rely on passports to do business in the UK. These firms are lobbying their respective governments hard to ensure a sensible deal is reached in order not to effect business. This figure, ultimately, should ensure a bespoke deal which allows cross-border services is reached.

Finally, if no deal is reached, under Article 34 of MiFID II as well as the associated delegated regulation of 29.06.2016, UK firms would need to rely on the EU Commission adopting a MiFIR Article 47 “equivalence” decision in order to provide financial services into the EU. This would necessarily entail adopting most, if not all, EU regulations and directives in order to retain the equivalent status.

Divorce Bill

Keep an eye out for the contentious divorce bill the EU is demanding from the UK. Estimates vary wildly but a £50 billion bill is not unrealistic.

Our Prediction

Now that the UK is heading for a more consensual Brexit as opposed to an ideologically-driven hard Brexit, the likelihood of a deal is much increased. We make four predictions.

1- Unfettered freedom of movement is over. In its place will be the Swiss-EU model of 90 days visa-free travel, with work permits necessary for employment.

2- In the scenario of a continued minority Conservative government, the final outcome will be the UK remaining in the CU to a large part. There may be small tariffs for certain categories of goods. The City will gain a bespoke FTA agreement to cover services.

3- If the minority Conservative government collapses and a centre-left coalition government is formed, we are likely to see Britain’s FTA resembling membership of the EEA with the notable exception of freedom of movement.

4- Brexit negotiations are unlikely to be concluded within the two years time-frame. We are likely to see a transitional arrangement which could be Britain retaining membership of the EEA.

This is our call and we will revisit it once the Brexit final outcome is clear.

 

 

Picture Credits

Main: Mick Baker (CC via 2.0)

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