The Brexit negotiations on the future trade relationship

On 23 March 2018, the European Council in its Art. 50 formation welcomed the agreement reached earlier last week by the negotiators on parts of the legal text of the Withdrawal Agreement covering citizens’ rights, the financial settlement, a number of other withdrawal issues and the transition. Prime Minister May wrote following that agreement to European Council President Donald Tusk giving her full support to the draft Agreement and highlighting, in particular, her support for efforts to solve the Ireland border issue. The European Council was therefore willing to set out its guidelines with a view to the opening of negotiations on the overall understanding of the framework for the future relationship, which will be elaborated in a political declaration accompanying and referred to in the Withdrawal Agreement.

In this post, I discuss some of the trade implications of the European Council’s guidelines, particularly for trade in goods. (I apologise in advance for yet another post on Brexit on this blog about the CAP, but given the importance of this future trade relationship not least for EU farmers I think the attention can be justified). These guidelines must still be turned into negotiating directives for the EU negotiator by the Commission and approved by the General Council before formal negotiations get under way, but based on previous experience there are unlikely to be any major changes or additions when that happens.

The EU’s objective – an ambitious free trade agreement

More in sorrow than in anger, the Council notes that it must take into account the repeatedly stated positions of the UK, which will limit the depth of any future partnership. Being outside the Customs Union and the Single Market will inevitably lead to frictions in trade. In the light of those UK ‘red lines’, the European Council “confirms its readiness to initiate work towards a balanced, ambitious and wide-ranging free trade agreement (FTA) insofar as there are sufficient guarantees for a level playing field.” In particular, this FTA would address “trade in goods, with the aim of covering all sectors and seeking to maintain zero tariffs and no quantitative restrictions with appropriate accompanying rules of origin.” (Paragraph 7).

The first point to note is that the guidelines unambiguously see agriculture being covered in the future FTA. Some commentators have observed that, to date, the EU has never concluded an FTA embracing fully free agricultural trade. Agricultural trade is either omitted from the FTA agreement and covered in a separate bilateral deal (e.g. in the European Economic Area agreement with Norway or the Customs Union with Turkey) or full trade liberalisation is withheld for sensitive agricultural products (as in the Canadian FTA which fully liberalised 99 per cent of tariff lines but exempted some specific agricultural products where liberalisation instead took the form of improved access under tariff rate quotas).

The guidelines make clear that the aim is zero tariffs in all sectors and no quantitative restrictions. While this would be unique in the history of the EU’s FTAs to date, it also reflects the specific circumstances of UK-EU27 bilateral trade. The EU27 has a huge surplus on its agri-food trade with the UK (the EU exports USD 47 billion to the UK while importing just USD 18 billion of agri-food products from the UK). Thus any restrictions on agricultural trade in a future FTA would be likely to hurt the EU much more than the UK.

Nonetheless, there is concern among farm unions in some EU countries about the possibility of trade displacement. For example, under a free trade agreement, only UK beef and lamb would be entitled to the zero-tariff access to the EU market. The UK might import cheaper beef from Brazil, or cheaper lamb from Australia and New Zealand, but rules of origin would prevent this beef and lamb from being re-exported to the EU market to benefit from its higher price.

However, trade displacement could occur if the UK were to liberalise its agricultural trade policy (either by lowering its post-Brexit agricultural MFN tariffs or by entering into FTAs with competitive agricultural exporters). The effect would be to drive down prices on the UK market and make the EU market relatively more attractive for UK producers. UK beef and lamb which is currently sold on the UK market to UK consumers might be displaced by increased imports from third countries while UK producers take advantage of the relatively higher EU prices to increase their exports to the EU market. EU farm unions will be anxious to ensure that such trade displacement does not happen.

Such trade displacement may be limited for seasonality reasons (for example, supplies of lamb from the Southern Hemisphere are mainly available when supplies of UK lamb are not). One way to address this issue would be to include TRQs in the future trade agreement which would limit UK exports to current levels. However, if this became an EU demand, the UK would respond by restricting EU exports in a similar manner. Given the likelihood that UK agricultural self-sufficiency will fall when the UK alters its trade, agricultural and migration policies after Brexit, restricting agricultural trade flows through TRQs would not be in the interests of EU agriculture as a whole. I suspect that, instead, there could be a safeguard clause in the future FTA designed to prevent any sudden surge in imports arising from trade displacement.

The second thing to notice about the guidelines is that conclusion of an FTA is made contingent on “sufficient guarantees for a level playing field”. Not only was this phrase added in this paragraph since the draft guidelines circulated by Council President Donald Tusk on 7 March last, but it is repeated on four separate occasions in the guidelines.

The meaning of a level playing field is spelled out in Paragraph 12.

Given the UK’s geographic proximity and economic interdependence with the EU27, the future relationship will only deliver in a mutually satisfactory way if it includes robust guarantees which ensure a level playing field. The aim should be to prevent unfair competitive advantage that the UK could enjoy through undercutting of levels of protection with respect to, inter alia, competition and state aid, tax, social, environment and regulatory measures and practices. This will require a combination of substantive rules aligned with EU and international standards, adequate mechanisms to ensure effective implementation domestically, enforcement and dispute settlement mechanisms in the agreement as well as Union autonomous remedies, that are all commensurate with the depth and breadth of the EU-UK economic connectedness.

If the proposed tariff provisions would go further than in any EU FTA to date, this would come at the price of significant restrictions on the UK’s ability to diverge from EU standards in a much wider range of areas than have been included in previous EU FTAs, as Jill Rutter of the UK Institute for Government has pointed out here. The justification for this is “the UK’s geographic proximity and economic interdependence with the EU27”. The areas include competition and state aid, tax, social, environment and regulatory measures and practices. Indeed, the final guidelines go further than the draft guidelines in that the phrase ‘inter alia’ has been inserted, indicating that this is an exemplary list but not necessarily a complete one of the areas that should be covered. The view of the Institute for Government is that the UK would be unlikely to sign up to something that extensive.

The third point to note is that the promise of an ambitious FTA is also contingent on “appropriate rules of origin”. As rules of origin are invariably a requirement in any FTA, it is hard to know what to read into this phrase, particularly as it was also added to the draft guidelines circulated on 7 March. For example, it is not clear if the EU envisages that only its rules of origin (which form the basis for the Pan-Euro-Mediterranean cumulation of origin, which the UK might well be interested in benefiting from) are the only “appropriate” rules of origin that can be used. The significance of this issue for food trade has been highlighted in this publication by the UK Food and Drink Federation, which is well worth reading on this topic.

Regulatory co-operation

The UK’s opening position to avoid regulatory barriers to trade in the future is mutual recognition of the other party’s standards as providing equivalent levels of protection (or put in other words, achieving the same outcomes) even if the legislation differs. In her Mansion House speech early this month, the UK Prime Minister recognised that the UK Parliament might even want to pass an identical law as in the EU, given the advantages to business of a single set of regulatory standards. She has accepted there would need to be an independent mechanism to oversee these arrangements, but has previously stressed that this could not be the courts of one party having jurisdiction over the other.

The guidelines reiterate the EU position that “A non-member of the Union, that does not live up to the same obligations as a member, cannot have the same rights and enjoy the same benefits as a member.” They go on to stress that “there can be no “cherry picking” through participation based on a sector-by-sector approach, that would undermine the integrity and proper functioning of the Single Market.” This seems to suggest an absolutist black-or-white or in-or-out approach to single market membership.

Indeed, various commentators have highlighted that the principle of mutual recognition that underlies the EU single market relies on elements of a ‘true constitutional order’ (Micossi, 2016).

These are, firstly, the supremacy over national legislation of EU rules in areas of Union competence, and their direct effect within national jurisdictions, so that those rules become immediately applicable in the relations between private agents within the single market, including in domestic court proceedings; and, secondly, the existence of supranational institutions ensuring the correct application of the Treaties and Union law, i.e. the European Commission in its role as the guardian of the Treaties and the Court of Justice of the European Union (CJEU).

The UK appears to foresee the principle of mutual recognition operating in a much more distant relationship, as it rejects the principle of direct effect of EU law and the supervision of the CJEU. Furthermore, even Member States do not have the flexibility to determine their own rules in the way that the UK seems to want, as all Member States must implement the harmonised EU rules agreed as minimum standards in any specific area.

On a more flexible note, however, the guidelines state that an agreement with the UK “will have to be based on a balance of rights and obligations, and ensure a level playing field”. This seems to leave open the possibility that, the more obligations the UK is willing to shoulder in a specific area, the greater the market access and the lower the trade barriers it will face. An obvious area where this principle could have relevance is in the area of SPS regulations for agri-food trade.

Disciplines on TBTs and SPS standards

The UK has called specifically for regulatory equivalence on agri-food standards in its Northern Ireland position paper as a contribution to avoiding a hard border on the island of Ireland. Despite making this proposal in the context of the Irish border, such recognition of equivalence would presumably apply to the UK as a whole.

One option for achieving our objectives could be regulatory equivalence on agri-food measures, where the UK and the EU agree to achieve the same outcome and high standards, with scope for flexibility in relation to the method for achieving this. An agreement on regulatory equivalence for agri-food, including regulatory cooperation and dispute resolution mechanisms, would allow the UK and the EU to manage the process of ensuring ongoing equivalence in regulatory outcomes following the UK’s withdrawal from the EU. Providing the UK and the EU could reach a sufficiently deep agreement, this approach could ensure that there would be no requirement for any SPS or related checks for agri-food products at the border between Northern Ireland and Ireland.

In the guidelines, the European Council simply refers to the inclusion of “disciplines” on TBTs and SPS standards in a future FTA. We can try to interpret what this might mean with the help of a presentation by the Article 50 Task Force on regulatory issues in February 2018. It examined previous agreements for possible models for a future SPS relationship, including the SPS chapters in other FTAs (Canada, Chile) as well as specific veterinary equivalence agreements, such as with New Zealand and the US.

The Task Force noted that both approaches provide for an enhanced trading relationship with preferential market access based on “trust”, for example by:
• setting up the conditions for recognition of certain production standards (limited scope);
• re-affirming guiding principles, including appropriate level of protection and approach towards scientific uncertainty;
• committing to transparency and exchange of information on SPS measures;
• establishing common principles, e.g. for regionalisation, transparency, co-operation.

However, it stressed that these principles do not amount to “mutual recognition” of product standards, labelling of food, food ingredients, etc., and they do not remove mandatory border controls and country specific approval processes. If this is what is meant by ‘disciplines’ in the European Council guidelines, it clearly would not eliminate the need for border controls and inspections on the import of UK products into the EU.

Of course, the procedures the UK would follow in this situation would be up to it to decide. It could decide to forego inspections of imports from the EU on the basis that it was satisfied unilaterally that it met its own standards, although to avoid criticism from other WTO Members it would need to establish an objective basis for this differentiation.

On the other hand, this limited interpretation of what TBT and SPS disciplines mean does not sit well with the over-riding call for “a level playing-field” which would require a combination of substantive rules aligned with EU and international standards. The EU may not be prepared to embrace mutual recognition, for the reasons discussed above, but it would surely be counter-productive to refuse an offer of regulatory alignment simply on the grounds that this was ‘cherry-picking’ if the UK were so minded.

Public procurement and protection of GIs

The guidelines specify that negotiations should cover “access to public procurement markets, investments and protection of intellectual property rights, including geographical indications, and other areas of interest to the Union.” Local food advocates will watch the public procurement negotiations closely as concerns are frequently raised that such clauses in trade agreements may prevent schools, hospitals and other institutions from sourcing food locally if they wish to do so.

The EU will hope to persuade the UK to remain signed up to its sui generis system of recognition of geographical indications (GIs). Under the EU (Withdrawal) Bill in the UK, the EU’s GI system will automatically transpose into UK domestic law after Brexit, but it would then be open to the UK to move away from this system at a later date. The tension here is that UK hopes for a free trade agreement with the US after Brexit may be contingent on acquiescing to US demands on GIs, which would be incompatible with continued legal protection in the UK for some of the EU’s prized GIs.

Transport services

There is an important addition to the draft guidelines of 7 March in the section on transport services, which notably is designated as an area of socio-economic cooperation rather than an issue of single market regulation. The relevant paragraph 11 reads:

regarding transport services, the aim should be to ensure continued connectivity between the UK and the EU after the UK withdrawal. This could be achieved, inter alia, through an air transport agreement, combined with aviation safety and security agreements, as well as agreements on other modes of transport, while ensuring a strong level playing field in highly competitive sectors.

What is important is that the guidelines are now extended to cover transport services other than aviation, and thus cover road transport services which are vital for the future movement of food products between the UK and the EU27. Without in any way claiming credit for this inclusion, I had previously flagged the omission of road transport services when the draft guidelines were published.

The key issue here, as I explained in my European Parliament paper on the institutional aspects of Brexit last year, is that once the UK is no longer covered by Union legislation at the end of the transition period, it loses access to the Community licence. Hauliers with a community licence established in any EU Member State are permitted to undertake any international road haulage in the EU – the international road haulage market in the EU is fully liberalised. However, road transport between EU and non-EU countries is still largely based on bilateral agreements between individual Member States and these countries.

Bilateral traffic-sharing agreements split the traffic between the two parties to the exclusion of all others and provide a quantitative framework by annually establishing quotas for the number of authorised journeys (although transport of perishable goods is not generally covered by these quota limits). Each EU Member State would have to negotiate individual access for its hauliers to the UK market and vice versa.

Under the guidelines, there is the prospect that the worst features of this bilateral system can be avoided, but the future agreement may not be as liberal as that which is place today. For example, whether cabotage will be allowed (for example, the ability of a UK haulier to pick up and offload part-loads in other countries on its journey from the UK to southern Europe) is something that remains for negotiation. Less favourable conditions than exist today would presumably raise the costs of road transport and ultimately the price of food to consumers.

The ‘evolution’ paragraph

Another addition to the draft guidelines circulated on 7 March is paragraph 6, which has been dubbed the ‘evolution’ paragraph. It reads: “The approach outlined below reflects the level of rights and obligations compatible with the positions stated by the UK. If these positions were to evolve, the Union will be prepared to reconsider its offer in accordance with the principles stated in the guidelines of 29 April and of 15 December 2017 as well as in the present guidelines.

In other words, if the UK were to relax its red lines, for example, either by agreeing to stay within a customs union with the EU or within the single market, then the European Council would be willing to reconsider the guidelines and, presumably, offer a more generous deal. Even if unlikely, it is interesting that the EU continues to hold open the door in case the UK were to change its mind.

Conclusions

These European Council guidelines can be seen as the EU’s opening position, and subject to modification as the negotiations progress. However, up to this point, the outcome of the negotiations on the Withdrawal Agreement have been very close to the EU’s opening position.

As many commentators have observed, the EU’s position has evolved through detailed preparation of legal texts while the UK position has been enunciated mainly in speeches and statements in the House of Commons. In the coming months, it will be up to the UK to put forward alternative legal texts if it wants to influence the understanding of the future framework of relations that will be attached to the Withdrawal Agreement when it is sent for ratification.

From a purely trade perspective, there are two remaining concerns. One is the reiteration in the guidelines that “nothing is agreed until everything is agreed.” While businesses were relieved that the draft Withdrawal Agreement contains a clear and agreed text on the transition period, many pitfalls still lie ahead both on outstanding separation issues as well as the understanding of the future relationship. The Irish border issue still remains unresolved. Despite the sentiments in Prime Minister May’s letter to Council President Tusk that she is “committed to agreeing in the Withdrawal Agreement operational legal text for at least the so-called ‘backstop option’ set out in the Joint Report, in parallel with these other scenarios”, this issue could still, along with Gibraltar, collapse the negotiations. There also remains the question whether the current UK government will be able to ensure ratification of the Agreement in the UK Parliament when it comes to a vote.

The other worrying issue is whether the future free trade agreement can be agreed, signed and ratified before the end of the transition period, ready to come into force on 1 January 2021. Paragraph 8 recognises that “This agreement [i.e. the FTA] will be finalised and concluded once the UK is no longer a Member State” which will occur on 29 March 2019.

The future FTA will be a mixed agreement negotiated under Article 218 TFEU and will require ratification by Member States as well as the EU. Few believe that ratification could be completed before the end of the transition period. Indeed, many seasoned observers question whether it will even be possible to reach a draft agreement during this period, given the complexity of the issues at stake.

Voices in the UK Parliament are now suggesting the desirability of including in the Withdrawal Agreement a specific clause that could allow an extension of the transition period beyond 31 December 2020. The most recent report of the House of Commons Committee for Exiting the European Union recommended, by majority vote, that:

If a 21-month transition/implementation period is insufficient time to conclude and ratify the treaties/agreements that will establish the Future Partnership or to implement the necessary technical and administrative measures along with any necessary infrastructure at the UK border, the only prudent action would be for the Government to seek a limited prolongation to avoid unnecessary disruption. It would, for example, be unacceptable for business to have to adapt their import and export processes twice. We therefore recommend that the Withdrawal Agreement include a provision to allow for the extension of the transition/implementation period, if necessary, and with the approval of Parliament. However, we note that there is a risk that a transition/implementation period that lasts much more than two years might exceed the vires of Article 50 and be subject to a legal challenge in the CJEU.

An agreement on an FTA in goods with zero tariffs and appropriate rules of origin should be relatively straightforward. This could be approved by the EU alone and could certainly be in place by the end of the transition period. But it would leave unresolved many of the other issues with the potential to add to trade costs and to delays in moving goods across frontiers (showing compliance with regulatory standards, road transport services, customs procedures, etc.).

While the draft Withdrawal Agreement may postpone a ‘cliff-edge’ Brexit from May next year to December in the following year, the guidelines do not provide much comfort that it can be completely avoided.

Update 26 March 2018: The post has been revised to make clear that the FTA negotiations can only be finalised and concluded once the UK is no longer a Member State.

This post was written by Alan Matthews

Graphic credit: The Italian Insider

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