A hard Brexit, its impact and how to prepare for it

By September 14, 2020News

The withdrawal of the United Kingdom (UK) from the European Union (EU) took effect at 11 pm on 31 January 2020 bringing to an end, it was hoped, a three and a half-year period of political uncertainty.  With an electoral mandate to “Get Brexit Done”, the Boris Johnson led government set a limited transition period to the end of 2020 in which to negotiate a Free Trade Agreement (FTA) between the UK and the EU.  This time period would be challenging in any event but the UK/EU FTA discussions are almost unique in that, from the UK perspective at least, they have to address regulatory divergence rather than convergence, something that has not been done before.  With a view to concentrating minds, the threat of a No Deal Brexit has been kept on the table, particularly by the UK, almost since the outset.

As things stand, in the summer of 2020, a number of substantial gaps need to be closed if a FTA is to be negotiated between the UK and the EU by October of this year.

The world changed earlier this year with the global Covid 19 pandemic.  Not only has this been a global human tragedy but governments around the world have had to deal with and address matters and issues not faced on this scale in living memory.  Decisions relating to lockdowns, travel bans, closures of businesses and schools, furlough schemes and other forms of business and individual reliefs had to be made in real time often with inadequate information.  Dealing with a crisis of this magnitude puts a huge strain on both government ministers and civil servants who were already severely stretched in planning for Brexit.

In difficult turbulent times, there will always be some winners in the world of business but, for the most part, businesses have been severely impacted by the virus and business plans and budgets have had to be ripped up and immediate priority and focus given to ensuring the safety of employees and other stakeholders as well as the survival of the business.  For many businesses, it became, and continues to be, a case of crisis management and how to get through the next day, week or month.  Mid to long term planning for many businesses has had to be put on hold since many of them, particularly SMEs, simply do not have the personnel resources to fight this week’s fire and to prepare for longer term problems such as the possible impact of Brexit and the potential consequences of the increasingly bitter trade war between the USA and China.

Whether a UK/EU FTA is agreed or a hard Brexit becomes a reality, businesses will have to find time to assess any potential risk and to ready themselves the best they can for Brexit challenges since failure to do so may undo all the hard work they have put in to date to survive the Covid 19 crisis.

This article will focus primarily on the potential implications of a hard Brexit since it is difficult to predict what will be covered off in any final FTA between the UK and the EU.  Certain of the issues discussed below, such as non tariff barriers and rules of origin will apply whether a FTA is entered into or not but, without knowing the terms of the FTA, it is difficult to predict to what extent the consequences of such issues will be mitigated by any such FTA.

To understand the importance of a hard Brexit, we will briefly look at the extent of the UK’s trading relationship with the EU before considering some of the trading implications of a hard Brexit and then suggest some of the steps that businesses should be considering in preparing themselves for a hard Brexit and trading on World Trading Organisation (WTO) terms.

UK TRADING RELATIONSHIPS

The EU, taken as a whole, is the UK’s largest trading partner with UK 2019 exports to the EU representing 43% of total UK exports and EU imports into the UK representing 51% of all UK imports. The share of UK exports to the EU has fallen overtime from 54% in 2002 and EU imports have similarly fallen from 58% in 2002.[1]

The UK had an overall trade deficit of £72 billion with the EU in 2019.  A surplus of £23 billion on trade in services was outweighed by a deficit of -£95 billion on trade in goods.[2]

Even though the UK had a substantial trade deficit with the EU, it does not necessarily follow that the EU needs the UK more than the UK needs the EU as suggested by David Davis. In 2015, 47% of UK exports went to the EU whilst just 7% of exports from the rest of the EU came to the UK.[3] UK’s exports of goods and services to the EU were worth 13.4% of the value of the British economy in 2017 and it had been around 12-15% over the previous decade.  Depending on how figures were calculated, exports from the rest of the EU to the UK were worth about 3-4% of the size of the remaining EU’s economy.[4]  The two largest markets in the EU for the UK are Germany and France and their exports to the UK represented 2.6% and 1.4% of their GDPs respectively.

The EU has also negotiated over 40 FTAs covering 72 countries and others are in the process of being negotiated.  UK trade with these territories amounted to some 11% of UK trade in 2018[5] and therefore roughly 60% of UK trade is with the EU or EU FTA territories. If not for Brexit, this figure would have increased over time as some of the more recent FTAs become fully operational. On the positive side, the UK has managed to roll over some 20 FTAs with territories representing 8% of total UK trade.

Although it has just been announced that a FTA between the UK and Japan has been agreed subject to ratification, progress on talks with the USA has slowed with the UK’s reluctance to give easy access to the UK market to the US agrifoods industry.  Both the distraction of a presidential election later this year and the UK government’s recent announcement that it intends to revisit the Withdrawal Agreement may also prove to be problematic to any early agreement of a FTA with the USA.   Other countries may well hold fire until a clearer picture emerges from the trade talks with the EU and the US.  There have also been concerns about the UK’s ability to handle concurrent trade negotiations.  Trade negotiations have been EU led for several decades now and, as such, there is a shortage of experienced UK trade negotiators.  FTA negotiations are usually lengthy and tortuous and often people heavy.  Canada had a team of more than two hundred working on the EU FTA which took seven years to complete.  There have been recent rumblings from the New Zealand camp that progress has been slower than expected on their FTA discussions with the UK due to the inexperience of the UK negotiating team which may have been one of the reasons that prompted the recent appointment of former Australian prime minister Tony Abbott as a UK trade envoy.

On a country basis, in 2019 the USA was the UK’s largest export market with trade valued at $72.6 billion (up by 11.1% over the previous year) representing 15.5% of exports, followed by Germany (9.9%), France (6.7%), the Netherlands (6.5%), China (6.4%) and Ireland (5.9%).[6]

Ireland is interesting and illustrates the importance of geographical proximity since trade with Ireland was more than twice that of the much larger Italian and Spanish markets.

It is worth noting, as often pointed out by Brexiteers, that there are currently no FTAs between the EU and the USA and the EU and China. This however is not telling the whole story.  The EU has several trade facilitation agreements with other countries, including USA and China, that are designed to facilitate and ease cross border trade between the relevant contracting territories.  Such agreements include mutual recognition of product testing and streamlining of customs formalities which provide for simplified fast track customs procedures.  These arrangements can and do result in significant savings in cost and time and will be lost in the event of a hard Brexit.

However, despite this, it is fair to say that a failure to agree a FTA with the EU is not a zero sum game. Trade with the EU will continue but, as we describe below, there will likely be increased costs in trading with the EU resulting from a range of non tariff barriers and the imposition of tariffs on certain goods and products.  Some sectors will be much harder hit than others and it may be that some will struggle to survive.

TARIFFS

If the UK and EU fail to agree a FTA, trade between those territories will have to be conducted on WTO terms.

The WTO’s trading regime is based on certain key principles, the most important of which, for the purposes of this paper, is the “Most Favoured Nation (MFN)” non-discrimination principle.  Subject to certain exceptions, including the entry into of FTAs or a Customs Union, WTO members cannot discriminate between WTO members and must apply the same tariffs on like goods irrespective of the country in which those goods originated.  For example, if the tariff on Widget A produced in China is 10%, a tariff of 10% will have to be levied on a similar product produced in the USA.

If the UK is unable to agree a FTA with the EU by the end of the year, it will be treated as a third country under EU law and goods exported by the UK into the EU will be subject to tariffs on a MFN basis.  The UK will not be able to benefit from a more favourable tariff deal for any product it exports to the EU than any other nation trading with the EU on WTO terms such as the US or China.  Similarly, the MFN provisions will operate in respect of EU exports to the UK.  Widget A’s produced in Ireland are currently tariff free but, under the MFN provisions, the Irish widgets will have to be subject to the same 10% tariff imposed on those similar widgets produced in China and the USA.  If the UK wishes to reduce the tariffs on the Irish widgets to 2%, then the tariffs on the China and US widgets will also have to be reduced to 2%.

In setting tariff rates, governments need to weigh up the often competing interests of the consumer and the local manufacturer. The consumer will want both choice and low prices.  The government will also have to make choices to protect consumers from themselves.  An individual consumer may be willing to take a chance on chlorinated chicken or hormone-treated beef if the price differential is great enough.  The government however must consider public health considerations before deciding whether the consumer should or should not have the right to make that choice.  The local manufacturer will want at least a level playing field.  It does not want to have to compete with a manufacturer from a country that has no child or slave labour laws, limited health and safety or environmental and/or animal welfare protection laws or much lower sanitary/phytosanitary rules.  It also does not want to have to compete against companies that receive a substantial amount of government subsidy.

EU tariffs are generally low (on average around 5%), especially for intermediate goods and raw materials.  There is however, considerable variation across different sectors, eg the EU maximum tariff on cars outside the EU is 10%.  However, the EU agricultural markets remain particularly protected by relatively high tariffs eg EU average MFN tariffs on dairy products are 54%, on sugar are 31% and on cereals are 22%.  Roughly 80% of the UK’s agricultural exports are to the EU.[7] The relatively high EU agri-tariff rates will make it difficult for the UK farmers to continue to compete with their EU competitors within the EU market and the relatively high costs of production in the UK due to high sanitary and phytosanitary standards may make it difficult to compete in those global markets outside of the EU where these standards are not so rigorous and therefore the costs of production are often lower, sometimes significantly.  Failure to reach agreement with the EU on tariffs will have a significant impact on the UK agricultural sector

The Department of International Trade, in its response to the consultation on the UK Global Tariff, stated that under the new UK Global Tariff, they expect 60% of trade will come into the UK tariff free on WTO terms or through preferential access from agreed FTAs from January 2021.  Successful EU FTA discussions are likely to increase this percentage up to 87%.

However, tariffs on nearly 5,000 product lines will be retained including on agricultural products, ceramics, chemicals, bioethanol and motor vehicles.  The average UK tariff on agricultural goods will be 16.1% (compared to the EU average of 18.3%), on fish will be 11% (EU – 11.7%), on Processed Agricultural Products will be 10.6% (EU – 15.9%) and on Industrial Goods will be 2.5% (EU -3.7%).[8]

Clearly, the UK will have control on the tariffs it sets on its imports but, outside a FTA, it will have no control over the levels of tariffs on its exports. The UK’s territorial fishing waters have become a big political issue and one of the many issues that remain outstanding between the UK and the EU even though, as a sector, it’s size, at less than a £1 billion, is not particularly significant economically.  The UK does not have a large appetite for the fish that it catches within its own waters (eg mackerel and herring with mackerel being the most exported UK fish in tonnage terms) with eighty percent of what is caught being exported.  With average EU fish tariffs of 11.7% and tariffs of up to 20% on frozen mackerel,[9] the UK needs to be careful that it does not win control of its waters at the expense of losing its export markets.

There is also a strategic risk to the UK in setting its tariffs too low across the board or even introducing a zero tariff policy, which has been mooted, since not only could this be damaging to many sectors within the UK but there will also be less incentive for other countries to enter into FTA discussions since they would already have benefited from low or zero tariffs, which is a primary objective in having a FTA in the first place.

The cost burden of tariffs for importers can broadly be calculated as the tariff rate times the volume of imports.  This is a cost that needs to be met by the importer, initially at least, and this could have cash flow/working capital implications since it is a cash cost that, in respect of EU imports at least, did not have to be met previously.  The ability to pass this cost onto the customer/consumer is part dependent on the price elasticity of demand of the product and part on negotiating power.  However, with intermediate products, even if it is agreed contractually or commercially that the cost be passed onto to the next link in the supply chain, this will not be of great benefit if future business with that counterparty is put in at risk by a hit on that counterparty’s margins.

It is likely that some companies will benefit from these tariffs however, particularly those not in a complex supply chain and who primarily sell into the domestic UK market since, in that market, they will have a competitive advantage over their EU competitors which advantage may increase if there is a further fall in sterling as against the euro.

The position of exporters is similar but slightly different.  Technically the cost of the tariff needs to be met by the EU importer.  However if the cost of the tariff pushes up the price of the product to a level that is no longer competitive with other EU sourced similar products, then the UK exporter may choose to absorb some of the cost by accepting lower margins on that product.  Businesses will also have to consider currency risk here.  Sterling is already trading at very low levels historically as against the euro but a further drop in the sterling exchange rate could mitigate, in whole or in part, some of these tariff costs.  Conversely, a drop in the exchange rate could have the effect of increasing the costs of imports.

Some industries eg the motor, agricultural and aviation industries, have developed complex international supply chains.  Components or parts pass through several intermediate production steps before being passed on, often across borders, to the next step in the production cycle and then on to the final assembly plant.  The frictionless trade flowing from the EU single market and customs union has allowed these industries to flourish providing for high degrees of specialisation and economies of scale and ‘just in time’ goods delivery.  If there is no EU FTA post Brexit, the cumulative effects of these tariffs on complex supply chains may make these supply chains vulnerable with the result that the EU manufacturers may seek to source their UK supply chain components from elsewhere within the EU.

Post Brexit, UK businesses involved in these supply chains will either need to pass on the costs of these tariffs to their customers, with the risk of making themselves uncompetitive against their EU competitors, or absorb the cost themselves by reducing their margins and thereby impacting on their profitability.  Alternatively, they could seek to simplify or change their supply chain.

However, changing supply chains is often easier said than done.  It can take time to find suppliers of equal quality and reliability.  Trading relationships are often built up over a period of time and rely on trust and a track record of good service and reliability.  Taking on new suppliers can be a business risk eg can the new supplier ramp up production to meet times of high demand?  Are the quality standards the same?  Will there be business reputation and legal risks involved if there are accusations of eg child labour or modern slavery or environmental breaches?  Will there be possible Bribery Act sanctions?  Will there be increased transportation costs?  Will there be sanitary/phytosanitary reputational/regulatory concerns?

That said, due to Covid 19, many businesses will have had to review and revisit their supply chains and may well have been forced to adopt a more agile approach to their supply chain design already.  More traditionally, firms have emphasised long terms relationships with periodic reviews but there has been an increasing use of artificial intelligence, data analytics and modern day network science methods with a view to designing supply chains that are more agile in responding to change, uncertainty and volatility in the markets.

Tariffs are not levied on services and services amount to roughly 80%[10] of the UK economy and amounted for 43%[11] of the UK’s exports to the EU in 2019. However, though not directly impacted by tariffs, other non tariff barriers may have a significant impact upon those providing cross border services.  The loss of passporting and mutual recognition will have a particular impact upon services.  These will be discussed more fully below.

NON-TARIFF BARRIERS

Tariffs on goods traded with the EU are only one of the costs of a hard Brexit. Cross border trade in goods and services is also heavily impacted by non tariff barriers (NTBs). The obvious NTBs are customs controls and declarations and increased paperwork but other NTBs also include cost of compliance with EU product and safety regulations, labelling requirements, acceptance of EU common health and safety and other standards and processes, restrictions on the rights of business establishments, limits on immigration and the freedom of movement of people and the loss of mutual recognition and various passporting rights of goods and services.

It should be noted that, since the UK will be leaving the single market and the customs union, many, if not most, NTBs will have an impact on businesses whether a UK/EU FTA is entered into or not.  It may be that the terms of a FTA may remove some of these potential NTBs or reduce the impact of others, but it is difficult to see how a FTA between the UK and the EU will be able to cover much more than a deal on tariffs given the short time given to negotiate the FTA.  All businesses that trade with the EU will need to start identifying likely NTBs and start to plan for them accordingly.

In 2017 HMRC estimated that the additional administrative costs per year of trade between the UK and the EU following the introduction of customs declarations between the UK and the EU would be in the region of £17 billion to £20 billion of which only some £5 billion would be attributed to tariffs.[12]  It was also estimated that between 145,000 and 250,00 UK traders would have to make customs declarations for the first time. These estimates have not been universally accepted and the cost of NTBs will vary from sector to sector but it is clear that NTBs will have a significant impact on the cost and efficiency of UK/EU trade and this impact is likely to increase over time as companies will have to cope with the cost of divergence in technical standards and other regulations.

Steps are being taken to look into customs simplifications and at introducing new and upgraded customs systems to manage the vastly increased customs workload.  There will also be the need to increase the number of customs officials although there will inevitably be a time lag in terms of training these officials to the appropriate standards. However, even the government has acknowledged that these systems will not be fully in place and that the ports and other points of entry will not be Brexit ready by the end of the year.

Accordingly, the UK government announced in August 2020 that it will phase in checks on goods entering Great Britain from the EU.[13]

From January 2021, traders importing standard goods will need to prepare for basic customs requirements, including appropriate record keeping, and will have up to 6 months to complete customs declarations   Whilst tariffs will need to be paid on goods attracting tariffs, payment can be deferred until the customs declarations have been made.  There will be checks on controlled goods such as alcohol and tobacco and businesses will also need to consider how they will account for VAT on imported goods.  There will also be physical checks on all high risk live animals and plants at the point of destination or at other approved premises.

From April 2021, all products of animal origin (POAO) eg meat, pet food, honey, milk or egg products, and all regulated plants and plant products will also require pre-notification and relevant health documentation.

From July 2021, traders moving all goods will have to make declarations at the point of importation and pay relevant tariffs. Full safety and security declarations will be required whilst for sanitary and phytosanitary commodities, there will be an increase in physical checks and the taking of samples.  Checks on animals, plants and their products will take place at GB border control posts.

Again, these customs and border checks will be a particular challenge to the agri-food sector since delays at the ports and other points of entry will have an impact upon perishable goods such as fruit, vegetables and meat.

Note these arrangements will not apply to the flow of trade between Northern Ireland and Ireland or between Northern Ireland and Great Britain which is covered by the Withdrawal Agreement.

Despite this phased approach, many companies, particularly SME’s, will need to consider outsourcing some or all of the additional work needed to ensure compliance with these additional tariff and NTB issues, which is great news for the freight forwarders, customs brokers and other specialist professional advisers in this area but even these will need to ramp up recruitment and training to meet the increased demand.  However, the scale of the recruitment and the extent of training may well be difficult to determine at a time when it is still hoped that a deal will be negotiated with the EU.

As mentioned, the services sector will not be affected directly by tariffs but will be impacted by NTBs.  The financial services sector in particular is an essential part of the UK economy with exports of £61 billion in 2018.  This sector will be one of the most impacted industries due to the likely loss of passporting rights in a sector that is characterised by both a high level of regulation and a high level of connectivity between the UK and the EU banking systems.  The financial services sector generally has been one of the most proactive in its Brexit preparations. Most of the larger financial services institutions will, by now, have taken some steps to mitigate some of these risks by eg establishing a local presence or local regulatory authority.  However it is imperative for some of the smaller players in this sector and for those engaged in other service sectors to monitor continually regulatory developments, attempt to assess likely NTBs that could have an impact upon their businesses and to plan for likely future scenarios.

TARIFF-RATE QUOTAS, FTAs AND RULES OF ORIGIN

The imposition of tariffs is one device to help regulate imports.  The use of tariff rate quotas (TRQs) is another.  TRQs allows a lower rate tariff on imports of a given product up to a specific quantity and requires a higher rate on imports exceeding that quantity.  For example, a country may allow the importation of 100,000 Widget A’s at a tariff rate of 5% and any Widget A imported over that amount will be subject to a tariff rate of 25%.  These TRQs are frequently seen in FTAs but are also relevant under the WTO rules and the UK’s proposal concerning the reallocation of the EU’s TRQs between the EU (minus UK) and the UK is currently being objected to by a number of WTO members.  Although WTO TRQs rules are primarily focused on the agricultural sector, they are not exclusively so.

The issue of quotas has become topical lately with the European steel industry recently urging the EU to slash import quotas with a view to protecting the EU’s steel industry against shipments redirected to Europe after the Trump administration’s imposition of 25% steel tariffs effectively closed the US market to many exporters.  The EU commission has responded to this lobbying by providing, inter alia, that country specific quotas should be administered quarterly rather than annually in order to avoid stockpiling although there is a concern within the European steel industry that this has not gone nearly far enough.

When entering a FTA, the parties to that FTA agree to provide preferential trading terms to goods and services traded between those two countries/trading blocs.  Rules of origin have evolved to attribute a country of origin to a product to determine its nationality.  For example, if the UK were to enter into a FTA with both the EU and the USA, the EU would want to ensure that the US does not circumvent EU tariffs on US goods by shipping goods to the UK tariff free for forwarding onto the EU.  Rules of origin provisions are also relevant for TRQ purposes.

Pre-Brexit, the relevant nationality for UK goods was the EU. Post Brexit, the nationality will be the UK.  For many sectors this will not be an issue but, for some, this will be highly problematic. Certain goods eg cars and planes are made up of many parts and components.  For example, for a specific car model manufactured in the UK, the engine may be built in the UK but the engine blocks come from France and the transmission system from Germany and various other parts from eg from Spain, Italy, France, Germany and the UK.  The same also is true in the aviation sectors.  The UK aviation sector is largely made up of the manufacture and exporting of components eg wings, landing systems, engines and avionic systems.

Pre Brexit, if the relevant car or airplane was predominately built within the EU with a largely EU supply chain, then certifying the EU nationality was relatively straightforward.  Post Brexit, absent an agreement with the EU, it will become more complicated for both the EU and the UK.  Take the case of a car where 55% of its value comes from its UK production with 30% of its value coming from elsewhere in the EU. If the EU has a FTA which provides preferential treatment to cars with 65% EU content, pre Brexit, this would not be an issue but post Brexit it would be for both the UK and EU entities involved.

There are ways of addressing these issues at governmental level by way of agreeing full or bilateral and diagonal cumulation provisions but these would effectively require agreement of a FTA with EU.  Absent such arrangements being agreed, it may be necessary for supply chains to be revisited.

Ascertaining the origin of UK goods will be an additional new cost for many UK companies. Anecdotally, many businesses have indicated that they would prefer to take the tariff rate hit than incur the cost, time and administrative inconvenience of proving the origin of their particular goods.  Clearly, this decision would have to be made on a goods by goods basis depending on the tariff rate for the relevant good and the complexity of the relevant supply chain but this determination will need to be built into the strategic planning of those businesses that could be affected by these provisions.

LABOUR SUPPLY

In the event of a hard Brexit several sectors may be exposed to work force and/or skills related shortages.  Many sectors are heavily reliant on EU workers eg agriculture, hospitality, food and drinks, consumer goods, motor and healthcare/domiciliary care sectors.  In some of these sectors the largest contribution is in routine and semi routine functions but this is not consistent across all sectors.  Both the financial services sector and the healthcare sector has a significant number of EU workers in professional and management positions.

A report by BDO had suggested that there has been a 10% drop in the number of skilled workers from overseas applying to work for private companies since the Brexit vote, increasing concerns about a skills shortage.  Increasing numbers of skilled EU workers have indicated that they do not envisage staying in the UK long term due to the change in climate brought about by Brexit.

It is thought that around one third of London’s tech workers are non-British and around one in five is from the EU.  France is becoming an increasingly attractive alternative to those working in the tech sector particularly since France is now second to the UK in terms of potential venture capital investment and President Macron is keen to make Paris the leading tech hub in Europe.  He has even launched a special tech visa to attract talent to Paris.

The ‘brain drain’ is not only limited to foreign workers. One report https://wzb.eu/en/news/brexit-uncertainty-boosts-migration[14] has found that the number of British people leaving for continental Europe is at a ten year high and that these UK workers are among the most educated and skilled of those from any nation, with one of the highest net average income rates.

The Government earlier this year announced that its immigration policy would prioritise skilled higher paid workers with migrants having to meet a number of criteria to qualify for a work visa including a job offer with a minimum salary threshold of £25,600.  However, many sectors struggle to recruit local labour.  In 2017, Pret a Manger announced that only 1 in 50 of its applications were British.   The agriculture industry has been very reliant on EU workers, particularly at harvest time.  It will be interesting to see if, and to what extent, staffing shortfalls will be made good from the local population.

Retention of existing talent and recruitment of new talent will become more important than ever post Brexit and as we, hopefully, emerge from the Covid 19 lockdown.

NORTHERN IRELAND

The issue of the border between Northern Ireland (NI) and Ireland was perhaps the most difficult to address in the post referendum/pre Withdrawal Agreement period and was ultimately why the Theresa May deal failed. The key features of the NI compromise, as set out in the Withdrawal Agreement, include regulatory alignment on agricultural products and industrial goods (but note, not services) and that Northern Ireland would benefit from both membership of the EU’s customs union and the UK’s customs territory with the effect that a customs and regulatory border will be created in the Irish Sea between the island of Ireland and Great Britain (GB).

It is still somewhat unclear what this will mean in practice and, indeed, almost from the outset, there have been differences in interpretation of and approach to these provisions between the UK and the EU, with the UK seeking as light a customs burden as possible and with the EU being concerned that this arrangement does not leave an open back door to the EU single market and there has even been some suggestion that the UK government is seeking to introduce legislation to make changes to some of the provisions of the Withdrawal Agreement.

Under the Withdrawal Agreement Protocol (the Protocol), as currently drafted, NI’s imports from the EU, including Ireland, would face no tariffs.  Absent a FTA between the EU and the UK, imports of goods from GB to NI would be subject to EU tariffs if the goods in question were deemed ‘at risk’ of entering the EU. What ‘at risk’ means is still to be clarified. The EU default position is that all goods are ‘at risk’ although the Protocol does try to caveat this by listing different criteria to be taken into account by the Withdrawal Agreement’s Joint Committees when determining which goods are to be treated as ‘at risk’ and subject to EU tariffs or not. These criteria include incentives for smuggling, the final destination of goods, the nature and value of the goods and the nature of the movement.  It may be that certain categories of importers could be exempted, subject to audit eg wholesale food markets and distributors selling to NI retail outlets and restaurants. Clearly the UK will be seeking to have as few products as possible being treated as ‘at risk’, but the EU will likely wish to take a more cautious approach.

It is proposed that where tariffs have been levied on goods that are subsequently proved to have been sold to final buyers in Northern Ireland, a rebate for the tariffs shall be available.  This however raises questions of how easy or difficult will the rebate process be and what evidential burden will be required to apply for such rebates.  This will be particularly challenging for intermediate goods that may go through several stages of processing before finally leaving NI for the EU.

A zero tariff UK/EU FTA will however, eliminate many, although not all, of these tariff difficulties.  If no FTA is reached, Michael Gove has indicated that the UK government may be willing to consider indemnifying and reimbursing companies for any tariffs incurred by them.  In both these scenarios however, there will be cash flow implications for the relevant traders since tariffs will be payable upfront and it will take time to process the claims for rebates and receive payments for them.

If no FTA is agreed and tariffs are levied on a significant numbers of goods exported from GB to NI, it may well be that GB will, over time, lose market share in NI since NI companies may start to reorientate their supply chain away from GB to the EU.

There have also been differences between the EU and the UK in terms of the level and extent of customs declarations, border customs infrastructure and processes and other NTBs.  It has been agreed that there should be no checks or controls on goods crossing the Ireland/Northern Ireland border. However since the UK will be leaving the EU customs union but Northern Ireland will effectively be treated as part of it, some customs declarations will need to be made for shipments of goods from GB to NI together with some checks, particularly on agricultural products and products of animal origin.

The extent and scope of the paperwork and bureaucracy and infrastructure required to send goods back and forth between GB and NI is still being worked on but it is clear that the desired aim of the current government, as expressed during the general election campaign, of having ‘no forms, no checks, no barriers of any kind’ and that goods moving from GB to NI will remain unfettered, will not be achievable.  There will be additional cost, expense and bureaucracy involved going forward but it is hoped that these can, to the extent possible, be kept to a minimum.

The UK government is looking into the use of technology and electronic processes as a means of solving a number of these issues but it seems that no-one is confident that these solutions will be anywhere near ready by the end of the transition period or, indeed, for the foreseeable future.

Also, going forward, NI will have to function as if it remains within the EU customs unions, which means that issues of rules of origin will be applicable even if a FTA is agreed with the EU.  It may well be that the cost and administrative burden of proving rules of origin will be such that many businesses will decide either to pay any tariffs payable or reassess their trading arrangements with Northern Ireland.

NEW TRADE DEALS

One of the main arguments put forward for Brexit is that the UK will be able to negotiate its own trade deals prioritising the interests of the UK economy without getting stuck in the quagmire of Brussels bureaucracy. As a case in point, the FTA between the EU and Canada was nearly vetoed by the Belgian region of Wallonia.  FTAs typically take years to negotiate and, depending on what is covered in the relevant FTA, once negotiated have to be approved by each EU member state (and in some EU countries must be approved at a federal or local level) which can make a tortuous process significantly more tortuous. In terms of setting its external tariffs, the UK will have the benefit of greater flexibility in favouring the UK consumer in sectors where the UK has no real production presence, eg oranges where the EU has to consider the interests of Spanish orange growers when setting the common external tariff rate for oranges.

As mentioned, the UK has been able to agree new FTAs with some 20 territories or trading blocs, including South Korea and Switzerland and are in discussions with a number of other territories although it is not thought likely that these discussions will be finalised by the end of the transitional phase. Some of the territories that have agreed FTAs have been happy to work on the basis of largely copying and pasting the existing FTAs with the EU and modifying eg reducing TRQ numbers to reflect the smaller UK market. Whether this approach will be accepted by some of the UK’s larger trading or potential trading partners remains to be seen but the approach taken by a number of ‘friendly’ WTO nations such as the USA, Australia and New Zealand to the UK approach to its proposed WTO schedules would suggest that this is not something that can necessarily be taken for granted.

On a country basis, the US was the UK’s largest trading partner in 2019 and this was achieved without the benefit of a FTA.  So clearly there will be opportunities to expand this trading relationship even further if a suitable FTA can be negotiated with the US although the UK’s own assessment is that the long terms boost of any such deal to the UK economy will likely remain below 0.1% with the main gains from a deal being in digital trade and cross-border data flows.  However, some of the leaks in and around the trade talks with the US suggest that the powerful US agri and pharmaceutical sectors are seeking deals on lower food standards to allow for exports of eg chlorinated chicken and potential modifications to the NHS’ ‘reimbursement regime’ to ensure higher prices are paid by the NHS for US pharma products.  Both these areas are highly politically charged and the “No Deal is better than a Bad Deal” mantra is likely to be heard again as these US trade talks evolve.  Since trading relations with the US are already strong, it will be important to ensure that more is not lost than gained by the entry into of a FTA with the US.

In this context and as an illustration of the fact that the world does not stand still, in August of this year, it was announced that the EU and the US have announced a package of tariff rate reductions outside of a FTA on a range of products and certain foods such as frozen lobster products.  These reductions have been achieved without the EU having to compromise on eg food safety and animal welfare standards.

Again, as mentioned above, it is quite possible that many territories will adopt a ‘wait and see’ approach in terms of how trade negotiations with the EU and the USA progress before entering into FTA discussions with the UK in earnest.  If so, this will not help with the speed at which the UK would ideally like to proceed at.  Another impediment is the loss of negotiating leverage resulting from eg the much smaller and less experienced UK negotiating teams, the fact that the UK market is roughly one sixth the size of the EU market and that, in recent years, the EU has negotiated a number of MFN clauses in its FTAs with other jurisdictions such as Japan, Canada, Korea and Mexico.  Although the extent and scope of the MFN provisions in these FTAs vary, the broad principle is the relevant territory cannot offer better terms to the UK in any trade agreement in respect of the goods, services and investment opportunities covered by the MFN provisions without offering those same terms to the EU, effectively for free.  Since the size of the EU market is approximately six times that of the UK, the very existence of these MFN provisions will limit the UK’s ability to seek better terms than those agreed by the relevant territory with the EU.

Although it is fairly generally accepted that trade between the UK and the EU will be adversely affected by Brexit, particularly if no FTA is agreed, there has been a general consensus within the Brexit camp that Brexit will be the catalyst for targeting new markets and developing new trading relationships elsewhere and this will help offset or indeed exceed the loss of trade with the EU. The reality however is that these opportunities already existed. Germany has been running a trade surplus with China and, in 2019, the US was the UK’s largest trading partner on a country basis.

However, a number of the larger potential markets are subject to tough tariff regimes. The average level of MFN tariffs for Korea, India, Brazil, Turkey, China and Mexico are over 10%[15]  These are all substantial markets but, in 2018, India only amounted to 1.2% of UK exports and Turkey 1%.[16]  Building trading relationships with new partners behind steep tariff walls is difficult and there is no immediately obvious reason why UK exporters should fare significantly better against these tariffs post Brexit.. This may improve if FTAs are negotiated with these territories but these agreements may well take some years to negotiate and become operable and even the FTA with Japan is only predicted to add 0.07 per cent to the UK’s GDP.

It is also worthwhile noting that trade with other commonwealth countries is relatively small eg each of Australia and Canada accounted for 1.7% of the UK’s 2018 exports compared to the neighbouring Ireland which represented 5.5% of exports in 2018.[17]  Geographic proximity is a significant factor in international trade.

Pending agreement of FTAs with other territories, it is probably fair to say, in general terms, that UK businesses will be competing at a competitive disadvantage to its EU competitors on high tariff goods and on non tariff barriers generally in those territories that the EU have FTAs with. Where the EU has no FTA with a territory, UK businesses will not have the same competitive disadvantages as their EU competitors but they will be at a competitive disadvantage to the local market and to competitors from jurisdictions that do have FTAs or other trade agreements with that territory eg despite the recent trade war, there are trading agreements in place between the USA and China which cover commitments to increase trade in certain sectors and to reduce tariffs on certain goods.

Post Brexit, pending the negotiation of new FTAs and other trading arrangements, the UK will also likely lose the benefit of the many trade facilitation agreements that the EU has negotiated with the many territories that it does not have full blown FTAs with eg those with the USA and China.

GROUP STRUCTURES

Any business with a group structure that includes subsidiaries, branches or central administration in the EU will need to take steps to protect the group from changes that will take place with effect from 2021.

From 2021, UK companies will be treated as ‘third country’ companies for EU purposes which means that any UK company having its central administration or place of business in a EU country may not be recognised.  The legal impact of this will vary from EU territory to EU territory but it could mean that, in the worst case scenario in certain EU territories, the shareholders of any such UK company could lose the benefit of limited liability and thereby become personally liable for the liabilities of that company’s business activities abroad.  Accordingly, if this situation applies, it is important to seek local law advice to ensure that the limited liability status of any such UK company will not be lost as a result of the UK company being treated as a ‘third country’ company.

If this is an issue, remedial steps should be explored including, eg setting up a local company in the relevant jurisdiction. Any solution will require various factors to be considered, not least tax, accounting and ascertaining whether any new local approvals/consents to doing business will be required.

It will also be advisable for any UK group with EU subsidiaries or branches to carry out a local law hygiene check generally eg will that subsidiary/branch require directors/officers resident in that jurisdiction?  What additional filing requirements will be required?  Since some of the existing exemptions relating to the preparation of individual accounts will no longer be available, what changes will be required to comply with local accounting and reporting requirements?

The EU is currently looking into introducing new rules to provide protection to EU companies by introducing steps aimed at limiting the ‘distorting effect’ of subsidies received outside of the EU.  In outline terms these new measures would require foreign subsidies to trigger filing requirements and/or EU commission investigations if these subsidies were used by the recipient to compete in the EU against non-subsidised undertakings, to acquire an EU undertaking or participate in a EU procurement process.  It is proposed that the EU be granted a range of remedial powers including fines, a prohibition on the conflicting investment, divestment of certain assets and exclusion from certain public tenders and procurement programmes.  This regime would complement and not replace existing EU/WTO rules.

The UK’s initial response is that the UK has not historically granted the type of subsidies that the EU has identified as being distortive and therefore UK companies are unlikely to be impacted post Brexit.  However, it will be important for UK companies to make themselves aware of these new provisions as and when they are introduced.

BREXIT PREPARATIONS

We are currently living through a perfect storm of Covid 19, uncertainty around Brexit negotiations and the fall out of the trade war between the US and China.  Dealing with any one of these issues would be challenging enough at the best of times but having to plan for and to adapt to the challenges posed by each of them at the same time will be a severe stretch for many businesses globally.

In terms of Brexit planning, from recent public statements, it would appear prudent for businesses to prepare themselves for a potential no deal hard Brexit.  If a no deal Brexit turns out to be the actual outcome, there will be a period of Brexit confusion, uncertainty and possibly chaos.  Those businesses that are best prepared for this potential outcome will be those that will be best placed to navigate their way through this confusion, uncertainty and chaos.  Set out below are some of the steps and actions that businesses should be considering as we are entering into the final phase of the transition period with the EU.

Brexit working group

If not done already, businesses should establish a Brexit working group with a brief to stay up to date with Brexit developments and to set up a Brexit action and implementation plan.  Responsibility within this working group should be allocated depending on skill sets eg procurement, finance, HR, sales, data management.

The Brexit working group should be tasked to review the relevant business generally to assess how it will be impacted by Brexit, the potential risks and opportunities and whether opportunities beyond the EU should be explored or investigated as a consequence of Brexit.  This working group should work very closely with any working group established to deal with the Covid 19 crisis. Thinking and planning will need to be joined up and co-ordinated across those working groups.  Possible specific issues for the working group to consider would include:

  • what tariffs (if any) will the business’ exports and imports be subject to?
  • how will the business by effected by NTBs eg will new permits/licences/certifications/approvals be required?  If so, identify the relevant NTBs and attempt to quantify the cost of them, both in terms of monetary cost and the consequential cost of any potential delays.  Consider solutions for any potential increased cost and delays. Note, NTBs will be applicable irrespective of whether a FTA is agreed with the EU or not.  It is only the extent and scope that may change with a FTA.
  • to what extent should customs declarations and regulatory compliance and other NTB issues be outsourced? If so, to whom and at what cost?
  • supply chain issues to be explored and fault lines identified and possible solutions found – see below
  • consider whether there could be any potential working capital/funding issues arising from the need to pay new tariffs and other NTB costs. If this risk is potentially material, revisit banking arrangements.
  • consider the potential consequences of any potential foreign exchange risk, particularly if sterling falls further in the event of a no deal Brexit. A fall in sterling could lessen the competitive disadvantage of tariff burdens on exports but could have a corresponding negative impact on imports.
  • consider whether policies relating to stock levels should be revisited generally but particularly if ‘just in time’ delivery is at risk.
  • consider whether subsidiaries/branches should be established in the EU to benefit from passporting. In this context, consider the potential cost, the employee resource required, whether to relocate existing employees or recruit locally, the impact of any local taxes and regulatory requirements, necessary language skills and property requirements.
  • consider the need to carry out any cross EU group restructuring from a legal, trading and tax perspective.
  • carry out an audit of any EU subsidiaries and branches so as to understand what new steps (if any) will need to be taken to ensure that each will be compliant post 2020 and that limited liability will not be lost for any UK companies that are managed or resident in an EU territory.
  • check for any accounting and reporting changes that will need to be made across the group and check on any post 2020 changes to any local filing or corporate reporting requirements.
  • If any significant business is conducted with Northern Ireland, consider a strategy for dealing with the new hybrid arrangement and consider rules of origin and supply chain issues. Also consider working capital implications if tariffs are to be charged and establish systems and processes to ensure claims for tariff rebates are submitted in a proper and timely manner.
  • consider the availability of any government grants and check whether any EU funded grants will be lost.

Contract reviews

A review should be carried out of all material contracts involving cross border trade in goods or services to ascertain whether any commercial or drafting changes need to be made to deal with the impact of Brexit.  In particular:

  • key contracts should be reviewed to assess whether any Brexit implications are addressed or provide the sufficient level of protection. If not, consider revisiting those contracts with the relevant counterparties.  Relevant Brexit related provisions could include who incurs the cost of tariffs and NBT’s, the impact of exchange rate risk and possible indemnities for late delivery.
  • will any long term contracts cease to be profitable post Brexit? If so, will any Brexit issues give rise to termination rights for eg the imposition of tariffs. Are there any break clauses?  Is there any realistic prospect of renegotiating the commercial terms?
  • will the business or its counterparty be able to rely on force majeure arguments? If this is not clear, consider revisiting the relevant agreements to ensure there is clarity on the issue.
  • is it clear who will incur the cost of tariffs and NTBs? If the cost is to be borne by the counterparty, will the counterparty be able to withstand that cost and still survive? If not, are there other viable alternative counterparties that can be sourced who are better placed to survive?
  • if contracts refer to the EU, consider making clarifying amendments to ensure that parties are clear on territorial definitions. If the contracts refer to EU law, ensure that the UK legislation that succeeds EU legislation post Brexit is covered.
  • consider any enforcement of judgement implications if UK not subject to the Brussels convention.

Employees

Even if a deal can be struck with the EU, it is likely that, post Brexit, the freedom of movement of people within the EU will be adversely impacted.  In this context, businesses should:

  • consider whether the loss of key personnel is likely/possible as a consequence of Brexit? If so, the business should identify those that are important to the business and assist them with their residency and immigration status.
  • consider future staffing needs. Is future talent likely to be met in full from within the UK?  If not, become fully cognisant of visa entry requirements and set up a process and establish relationships with professionals who can make non UK recruitment as seamless as possible.
  • if the business is dependent on low skilled workers, need to consider alternative solutions eg technology, automation, flexible part time working offered to eg students or the retired or semi retired.
  • consider whether the business is prepared for its UK employees to travel to the EU from 2021 in terms of travel documents, medical insurance, mobile phone plans, which may require new roaming agreements etc.

Data

The use and control of data is an issue for all businesses but there are some businesses where the use of data is core to the business model. However, all businesses should:

  • check where data resides and where it is processed
  • determine whether UK will be treated as a third party country without adequate data protection rules. If so, develop a new data strategy.

 

Supply chains

For those businesses that are part of a cross border EU supply chain, they should:

  • identify each jurisdiction with which they trade or source parts from.
  • identify the country of origin for all products in the supply chain. Post Brexit, will any products not be classified as British in origin?  If so, are there possible solutions eg sourcing more of the products from within the UK.  Will this be possible?  Would this be cost effective? Will the payment of tariffs be a more cost and time effective solution? Note, this exercise will need to be carried out irrespective of whether a FTA is agreed with the EU or not although it may be that the burden of certain of the rules of origin will be mitigated if the FTA addresses such matters.
  • will there be a risk of the UK business losing its place in the EU supply chain if the relevant product loses its EU nationality due to the level of UK content?
  • identify any tariffs payable on the business’ imported and exported goods.
  • quantify the costs of any tariffs and determine who is to bear the costs of the tariffs. Is price sufficiently elastic for the cost to be borne by the consumer/counterparty? Is the business sustainable if the cost is to be borne by the business?  If the cost is to be borne by the counterparty, will that counterparty be able to absorb the increased cost?  Are there other solutions eg finding other lower tariff jurisdictions, simplifying the supply chain so that there is less back and forth movements across borders or sourcing more of the business needs from the UK?
  • identify all relevant NTBs and attempt to quantify both the actual monetary costs and the impact of any delays at ports and other points of entry.
  • put in place the necessary internal resources or establish outsourced relationships to ensure compliance with NTBs. If the resource is to be found internally, consider any additional recruitment and training requirements to ensure that the business is in a position to deal with the new environment from day one or as soon as possible thereafter.
  • factor in potential customs delays and the impact that they may have on delivery commitments. Can the business carry the cost of increased stock levels?
  • once the above analysis has been done, build on any work done to deal with Covid 19 supply chain issues to revisit the business’ supply chain design to reflect more volatile and changing markets. Consider using data analytics and modern network science methods as part of this process.

Financial

  • assess the financial impact of both a hard Brexit and potential UK-EU FTA scenarios, based on the issues identified by the Brexit working group, on products, sales, customers, suppliers, and the profitability of current and future operations.
  • prepare business plans, contingency plans, financial budgets, financing plans and financial reporting (including the disclosure of new business risks).

A hard Brexit will not impact every business in the same way.  Many UK businesses will hardly be directly impacted at all although it is possible that, over time, the macro economic implications of a hard Brexit could have an indirect impact.  However, those businesses that trade significantly with the EU will be impacted and those businesses that operate off small margins, in particular, may will struggle to survive unless they can change the way they operate or unless they can find new markets for their products or services.  It is imperative that these businesses not only understand the implications and consequences of a hard Brexit but also develop a strategy and a plan to deal with the changes that will be brought about by a hard Brexit.

[1] House of Commons Briefing paper Number 7851 date 20 June 2020 ‘Statistics on UK-EU trade’

[2] House of Commons Briefing paper Number 7851 date 20 June 2020 ‘Statistics on UK-EU trade’

[3] Office for National Statistics report dated 28.3.2017. ‘Trading places: UK goods trade with EU partners’

[4] Fulfact.org report dated 28 August 2018 ‘Everything you might want to know about the UK’s trade with the EU’

[5] Department of International Trade ‘Public Consultation: MFN Tariff Policy – The UK Global Tariff

[6] Worlds Top Exports paper dated 19 July 2020 ‘United Kingdom’s Top Trading Partners’

[7] House of Lords paper on Brexit and agriculture, Chapter 3: Future Trade in agri-food products.

[8] Department of International Trade ‘Public Consultation: MFN Tariff Policy – The UK Global Tariff”

[9] Parliamentary report on Fisheries and Trade

[10] Fulfact.org report dated 28 August 2018 ‘Everything you might want to know about the UK’s trade with the EU’

[11] House of Commons library paper dated 15 July ‘Statistics on UK-EU trade’

[12] House of Lords report, ‘Brexit, the customs challenge’ para 65

[13] Gov.uk Article ‘Government accelerates border planning for the end of the Transition Period – https://www.gov.uk/government/news/government-accelerates-border-planning-for-the-end-of-the-transition-period

[14] Oxford in Berlin Research

[15] The Federal Trust for education & research – paper dated May 2017 “Hard Brexit, International Trade and the WTO scenario”

[16] House of Commons briefing paper Number 7593, dated 1 November 2019 – “Geographical pattern of UK trade”

[17] House of Commons briefing paper Number 7593, dated 1 November 2019 – “Geographical pattern of UK trade”

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