Having formally left the European Union on 31 January 2020, the UK has been seeking to negotiate a free trade agreement (FTA) with the EU, to govern its trading relationship after the Brexit transition period (due to end on 31 December 2020). The following Q&A explains how such agreements typically work and sets out our thinking on the scope of a possible EU-UK FTA.
Brexit: a Q&A on the proposed EU/UK trade deal
- What is a free trade agreement?
- What do free trade agreements typically cover?
- Is it possible to have partial or sectoral free trade agreements?
- What might an EU-UK trade deal look like?
- How will an EU-UK free trade agreement deal with movement of people?
- What is the issue over level playing field provisions?
- How might a future trade agreement be enforced?
- After the end of the Brexit transition, can the UK continue to benefit from existing EU trade agreements?
- If a trade agreement can be reached with the EU, what is the process for ratification?
- Will businesses have enough time to adapt at the end of the transition period?
- Could the parties agree more time to allow businesses to adapt?
What is a free trade agreement?
Put simply, the term "free trade agreement" (or FTA) encompasses any arrangement between two or more countries on any aspect of trade.
There is a tendency to think of trade agreements as being largely concerned with reducing import tariffs i.e. the duties which are levied on different types of goods when they imported into one country from another. However, trade agreements deal with many other aspects of trade which are equally if not more important in practice, including:
- Non-tariff barriers: removal or reduction of "non-tariff barriers" or NTBs, such as quotas, subsidies and "technical barriers to trade" or TBTs (e.g. regulatory requirements which may differ from one country to another, so that products/services which are legal in country A cannot be sold in country B).
- Investment: the terms on which a national of one country can invest in another (these are known as "bilateral investment treaties" or BITs), including the rights and protections afforded to those individuals (e.g. protections against appropriation of property without compensation). For further discussion of BITs in the context Brexit, see this briefing.
- Trade facilitation: e.g. measures to reduce border red tape.
NTBS AND TRADE FACILITATION
The role of trade agreements both in reducing NTBs and promoting trade facilitation is often under-appreciated. For example, in relation to goods, NTBs have been estimated to add around 10% to the cost. Meanwhile, in relation to services, it is not uncommon for NTBs to prevent cross-border trade altogether or make it uneconomic. Similarly, the impact of border red tape on costs of imported goods is estimated to be equivalent to an additional tariff of between 2-15%.
Another point that is not widely appreciated is that, although the EU has no agreements with China and the US relating to tariffs or non-tariff barriers, it does have agreements relating to issues such as trade facilitation. Without these, trade in goods between the EU and China and/or the US would be significantly more difficult than at present. As well as negotiating its future trading relationship with the EU, the UK will need to reach agreement with these and other third countries on how matters dealt with under these EU-negotiated arrangements will be handled after Brexit (see question 7).
What do free trade agreements typically cover?
Ambitious FTAs may cover all the aspects of trade mentioned in answer to Question 1 above. They may also cover additional issues such as government procurement, intellectual property, digital trade (including data protection), competition and state aid, together with labour and environmental standards. Such agreements (including schedules) are extremely complex and contain a high level of technical detail relating to thousands of different types of products and services; they typically run to over 1000 pages (including schedules).
The main aim for parties negotiating an FTA is usually to achieve a significant improvement on the terms of trading available to them based on their WTO commitments, which effectively act as a "baseline" for discussions (see Brexit Q&A: WTO Rules). For example, in relation to tariffs, WTO members commit not to impose tariffs on other WTO members above a certain level; these are known as WTO "MFN" or "Most Favoured Nation" commitments. An FTA would seek to either remove those tariffs altogether or to reduce them by a significant margin in relation to goods traded between the parties to the FTA.
Sometimes, free trade agreements also contain MFN provisions, but these are not the same as WTO MFN commitments. For example, Article 7.8 of the EU-South Korea FTA states that if one party agrees to grant greater access for services to another country in a subsequent FTA, the same treatment will be extended to the EU or to South Korea, as the case may be. This means that if any EU-UK FTA goes further than the South Korean model in relation to services, that treatment may have to be extended to South Korea as well.
For obvious reasons, this may make the EU reluctant to give the UK a better deal than South Korea in relation to services. There is a potential "get out" clause which states that the MFN obligation does not apply where the subsequent FTA "stipulates a significantly higher level of obligation." However, that may raise issues for the UK in terms of sovereignty, as it might require a closer relationship with the EU than would be politically acceptable in light of the vote to leave. For a more detailed discussion of MFN clauses in EU trade agreements, see this paper from the UK Trade Policy Observatory.
Is it possible to have partial or sectoral free trade agreements?
Subject to some exceptions (e.g. relating to developing countries), free trade agreements between WTO members must cover "substantially all trade" between the parties in goods or services (as the case may be). This rule is designed to encourage countries to undertake ambitious free trade agreements, as opposed to narrow agreements relating only to particular sectors. Since both the EU and the UK are WTO members, it will be difficult for them to ignore this rule by concluding a series of narrow sectoral agreements. If they were to do so, other WTO members could bring proceedings before a WTO Dispute Resolution Panel claiming that they should be given the same preferential treatment as would apply between the EU and the UK under the sectoral agreement.
That said, there would be nothing to stop the EU and the UK concluding a free trade agreement which provides for a higher level of integration for certain sectors, with others receiving a lower level of preferential treatment – provided that the agreement as whole was comprehensive i.e. it covered substantially all trade in goods and/or services. It is also not uncommon for countries to enter into sectoral agreements relating to issues such as mutual recognition of conformity assessment, which are not covered by the WTO rule referred to above. Examples of EU-negotiated agreements of this type can be found here.
What might an EU-UK trade deal look like?
Despite the initial indications that the UK Government was seeking to conclude an ambitious and wide-ranging FTA with the EU, it appears that, in reality, the scope of any trade deal will be more limited than initially thought.
There are, without doubt, some areas in which both sides have been reasonably ambitious in their proposals (at least by reference to other FTAs). For example, in relation to tariffs, both the UK and the EU are seeking to establish a free trade area in which there should be no tariffs, fees, charges or quantitative restrictions on trade in goods between the EU and the UK. This would go further than the EU-Canada FTA and even the tariff aspects of the EU's arrangements with EEA/EFTA countries relating to goods (where trade is mostly tariff-free, but tariffs apply on some agricultural products, for example). However, there are also numerous areas where the proposed FTA is likely to lead to increased friction/barriers on future trade.
INCREASED BARRIERS TO TRADE
- Goods: any trade deal is unlikely to remove the need for additional border red tape for goods and the associated costs and potential delays for businesses. It could contain some provisions which would help to "lighten the load" for businesses in terms of compliance burdens, but these will merely mitigate some of the downsides; they are very unlikely to preserve current levels of "frictionless trade" in goods.
- Services: neither the UK nor the EU draft FTA texts seek to go much beyond preserving levels of access currently enjoyed by non-EU countries. For example, where the current level of access goes beyond the EU's WTO commitments, the FTA may seek to entrench this i.e. it will effectively prevent the EU adopting a more restrictive approach in future. However, given that the UK has been used to a significantly enhanced level of access based on EU membership, such an approach is likely to result in increased friction/barriers for UK service providers selling into the EU.
As a result, even if a deal can be reached between the UK and EU, the trading relationship will not be as favourable as it has been whilst the UK was still part of the EU Single Market and Customs Union. This also means that the difference between a deal and no deal is not likely to be as significant as was first anticipated when Brexit negotiations first began.
For more information on the likely impact of Brexit on services, see our briefing: Service providers: getting ready for Brexit.
How will an EU-UK free trade agreement deal with movement of people?
Parties to free trade agreements typically recognise that movement of people is necessary to facilitate trade, particularly for services businesses – but they are often reluctant to commit to dispensing with requirements imposed by their own domestic immigration regimes. Based on the draft texts published by the UK and the EU, the proposed EU-UK FTA is unlikely to be an exception to this general rule. This means that business travel between the UK and the EU will probably be subject to additional red tape from 1 January 2021, even if there is a deal.
For more detail on these issues, see this briefing.
What is the issue over level playing field provisions?
The EU is concerned that the UK could pursue a policy of deregulation in certain areas or could decide to subsidise UK businesses, thus enabling them to undercut competitors in the EU. It is therefore seeking so-called "level playing field" commitments from the UK designed to prevent the UK engaging in such tactics. For its part, the UK insists that it does not wish to engage in a "race to the bottom" as regards regulation, but is also insistent that it should be free to regulate as it sees fit after the end of the transition period and should not be required to make changes to keep pace with EU regulation.
As explained in this briefing, we consider that there are potential compromises on level playing field issues such as state aid which could enable a deal to be reached. However, if both parties stick to their relatively extreme starting positions, it is possible that the negotiations could founder on this issue.
How might a future trade agreement be enforced?
Each trade agreement will normally contain its own specific enforcement mechanism, the extent of which will vary depending on the complexity and scope of the trade agreement. Enforcement can normally only be conducted at state-to-state level. This contrasts with the current position, where a business faced with barriers to trade which it believes are contrary to EU law can:
- Bring proceedings in national courts based on alleged infringement of EU law by the relevant Member State; and/or
- Complain to the European Commission, which effectively polices compliance with EU Treaty obligations (with an FTA, there is very unlikely to be any institution charged with policing the agreement to which businesses can complain).
A business faced with trade barriers which it believes are contrary to the provisions of any EU-UK FTA will have most likely have one option only, namely to seek to persuade its government to raise that issue through the dispute resolution mechanism of the agreement (beyond that, it cannot take action on its own behalf).
What do the EU and UK draft FTA texts say?
Both the UK and EU draft texts of the proposed FTA provide for dispute resolution to be referred to a panel of arbitrators, should "consultations" fail to resolve the matter. Additionally, the UK draft provides for a mediation procedure (but provides no detail), whilst the EU draft provides for the possibility of "accelerated consultations" for certain matters (again, these are not specified, nor is the relevant procedure). The key substantive difference is that the EU proposed text provides for the arbitration panel to refer issues to the CJEU where a point relating to the interpretation of EU law is involved. This is similar to the dispute resolution mechanism in the EU-Ukraine FTA (click here for more details).
THE ISSUE OF CJEU INVOLVEMENT
Clearly the EU's proposals for involvement of the CJEU cross one of the UK's red lines. However, there are ways in which this could be overcome:
- If the FTA did not require the UK to align itself with EU law in any respect, then the EU could probably drop its demand for CJEU involvement; or
- If the extent of UK alignment with EU law is very limited, then politically the UK may be able to live with a continued role for the CJEU on the basis that a referral would be relatively unlikely (and if it did occur, it would only relate to a limited aspect of the UK economy).
After the end of the Brexit transition, can the UK continue to benefit from existing EU trade agreements?
WHAT HAPPENS DURING THE TRANSITION?
During the Brexit transition period, the Withdrawal Agreement requires the UK to honour its obligations under international agreements (including trade agreements) negotiated by the EU. The non-EU parties to those agreements were not generally obliged to reciprocate, although in practice a significant number either chose to do so or formally agreed to roll over existing arrangements into the transition (see this briefing).
After the end of the transition, the UK stands to lose the benefit of EU trade agreements unless it has negotiated additional roll over arrangements or entirely new FTAs to apply from 1 January 2021.
At the time of updating this Q&A (October 2020), the UK had negotiated a significant number of continuity trade agreements with territories including South Korea, Switzerland, Chile, South Africa and Norway. The UK has also reached a trade agreement with Japan which is understood to be similar to the recent EU-Japan deal. However that still leaves a number of territories where talks are ongoing, including Canada, Mexico, Turkey and Singapore. Even where agreements have been reached, it should also not be assumed that they will necessarily replicate the benefits of existing EU trade agreements in full (for example, in relation to Japan, it is not thought that the UK has succeeded in matching the EU's agreement in all respects, although there are a small number of areas where it claims to have improved upon it). Click here for more detail.
How big is the impact?
The impact of losing the benefit of these trade agreements needs to be kept in perspective. According to the UK Government, the relevant agreements benefit only about 10% of the UK's total trade (note that this figure does not include Japan, but the EU-Japan trade agreement has only recently come into force). That said, for individual businesses that have significant customers in territories where benefits will not be preserved, the lack of a "big picture" impact will not be much comfort.
ADVERSE IMPACTS ON INDIVIDUAL BUSINESSES
Many of the EU's agreements cover less developed countries, which tend to have quite high tariffs for certain products. In such cases, UK exporters may lose the benefit of lower, preferential tariffs, making them substantially less competitive, especially vis-à-vis any EU-based suppliers.
It is also worth noting that even where a "roll over" has been agreed, this does not necessarily mean that everything will stay exactly the same. Take the example of a UK business which supplies components to an EU customer. That EU business then exports the finished product to South Korea. In order to benefit from lower tariffs under the EU-South Korea trade agreement, the EU business must demonstrate that a certain percentage of its product originates from the EU. Once the UK is no longer in the EU, UK components cannot count towards that percentage – which may prompt the EU business to switch to an alternative component supplier based in the EU.
If a trade agreement can be reached with the EU, what is the process for ratification?
One of the benefits of the proposed EU-UK FTA being relatively unambitious is that it should not need to be ratified by all EU Member State Parliaments, which can be an extremely lengthy process. Ratification by the EU Council of Ministers and the European Parliament should be sufficient.
Concerns that ratification by all Member State Parliaments might be necessary arose partly because of legal challenges and partly because the European Commission gave into political pressure for such a process in relation to the Canada-EU FTA. However, in a 2017 ruling on the EU-Singapore FTA, the Court of Justice of the European Union (CJEU) ruled that only those provisions concerning indirect foreign investment and investor-state dispute resolution procedures raised issues of so-called "mixed competence" (and therefore required ratification by each individual Member State as well as the EU). The draft FTA texts put forward by the UK and the EU do not appear to include such provisions. This means that the FTA should come within the EU's exclusive competence, which avoids the need for ratification by Member State Parliaments.
What if the agreement goes beyond a "thin FTA"?
That said, if the eventual deal with the UK were to include areas such as aviation, where there is mixed competence, or social security, where only the Member States have competence, then a longer ratification process might be in prospect (but see further below under "What if there isn't time to ratify before 31 December 2020?"). Similarly, if the FTA forms part of a wider Treaty covering issues such as security and fisheries, it would cease to be within the EU's exclusive competence, necessitating a longer process.
How long will ratification take?
Assuming that ratification only requires a decision by the EU Council of Ministers and the European Parliament, this should be possible before the end of the transition period on 31 December 2020 provided that the negotiations are concluded in sufficient time. Logistically, the key issue will be ensuring that meetings of both bodies can take place within the time remaining before 31 December (which may become more difficult if the negotiations do not conclude until quite close to that date). In the UK, the Constitutional Reform and Governance Act 2010 allows the Government to ratify a treaty 21 days after it has been laid before Parliament, provided that MPs do not vote against it (which seems relatively unlikely given the current Government's substantial majority).
What if there isn't time to ratify before 31 December 2020?
If the agreement cannot be ratified in time for the end of the transition period on 31 December 2020, the EU and the UK could decide to apply the agreement on a provisional basis. There is precedent for this e.g. the EU-Canada FTA was applied provisionally until it had been ratified by Member State Parliaments. Alternatively, the EU and the UK could potentially agree provisional arrangements that seek to maintain aspects of the status quo, perhaps along the lines suggested at Question 10 below – although these would probably have to be strictly time limited in order to minimise the risk of challenge by other WTO members.
Will businesses have enough time to adapt at the end of the transition period?
The Brexit transition period is set to end at 11.00pm GMT on 31 December 2020. Setting aside the political challenge of having to negotiate, and ratify, the relationship between the UK and the EU in such a short time frame, the task for UK businesses of being operationally ready for Brexit is immense, particularly given the additional pressures that the coronavirus pandemic has created.
A last-minute deal may leave businesses with very little time in which to put the necessary procedures in place and many commentators have expressed concern over the UK's readiness for the introduction of new border red tape from 1 January 2021 (much of which will be introduced whether or not there is a deal).
Could the parties agree more time to allow businesses to adapt?
The UK Government did not request an extension to the transition period by the deadline specified in the Withdrawal Agreement of 30 June 2020. Should the UK Government decide that it needs more time to either: (i) finalise the terms of an FTA; (ii) allow sufficient time to implement the terms of the FTA; or (iii) allow sufficient time for businesses and border authorities to adapt to a "no deal" scenario, the options would include the following:
OPTIONS FOR EXTENDING TIME
- Amend the completion date of the transition period in the Withdrawal Agreement (although this is regarded as legally problematic by the EU and may well be politically unacceptable to the UK);
- Negotiate a new standalone transition period (see comments above); or
- Include an implementation period as part of an FTA.
As regards this last option (an implementation period as part of an FTA), one approach would be to include provisions in the new EU-UK trade agreement which preserve some aspects of the status quo, pending full implementation of what has been agreed. Such provisions could make use of existing models, for example:
- The Irish Protocol from the October 2018 version of the draft Withdrawal Agreement, which effectively keeps the UK within the Single Market for goods and the Customs Union; or
- The "reverse Ukraine" model: the EU-Ukraine agreement allows Ukraine access to the single market in particular areas once it has aligned its laws with relevant EU legislation. A similar mechanism could be used "in reverse" to provide for "phased" exit by the UK from different aspects of the transition at different times. For more about the Ukraine model, click here.
However, published descriptions of the formal negotiating "strands" relating to the proposed EU-UK FTA do not refer to discussions of any implementation period. As a result, businesses should plan on the basis that the benefits of the transition period will cease on 31 December 2020.
Realistically, the best that can be hoped for may be a series of unilateral measures taken by each side with a view to giving business more time to adapt, as proposed by both the EU and the UK in the run-up to the end of the negotiating deadline for the Withdrawal Agreement under Article 50. However, these measures were limited in scope and businesses should not assume that significant transitional easements will be forthcoming.