The UK Government has indicated that it wishes to conclude an ambitious and wide-ranging free trade agreement (FTA) with the EU, to govern its trading relationship after Brexit. The following Q&A explains how such agreements typically work and sets out our thinking on what a possible EU-UK FTA might look like.
Brexit: UK's future trade relationship with the EU
- What is a free trade agreement?
- What do free trade agreements typically cover?
- Is it possible to have partial or sectoral free trade agreements?
- How long do trade agreements take to negotiate and ratify?
- How are trade agreements enforced?
- After Brexit, can the UK continue to benefit from existing EU trade agreements?
- If a trade agreement can be reached with the EU, will it have to be ratified by all EU Member States?
- If no trade agreement with the EU can be reached prior to Brexit, what is the UK's position?
- What might an EU-UK FTA look like?
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)
- Trade facilitation: e.g. measures to reduce border red tape.
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.
What do free trade agreements typically cover?
Ambitious FTAs of the type which the UK government is aiming to conclude with the EU typically cover all the aspects of trade mentioned in answer to Question 1 above. They may also cover additional issues such as government procurement and intellectual property. 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. 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.
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 narrow sectoral agreement. 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. In view of this, many commentators consider that the UK government's suggestion of special deals with the EU for certain sectors is, at the very least, problematic. 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.
How long do trade agreements take to negotiate and ratify?
There is no definitive answer as to how long it would take the UK to negotiate trade agreements with the EU or the rest of the world, but relatively few have been concluded within the two year time limit provided for in Article 50. Most take at least 3-4 years.
The wider the scope, the longer the agreement takes to negotiate. Given the importance of the UK-EU deal, it is likely to take a significant amount of time, hence the concern over the two year deadline imposed by Article 50 and the probable need for potentially quite extended transitional arrangements. The government has argued that agreement should be achievable within a reasonably short timeframe because there is already a high degree of regulatory convergence between the UK and the EU. However, no existing FTA between the EU and a third country provides for the level of market access which the UK appears to be seeking. Even if the EU were to agree to allow the UK to maintain current levels of access in many areas, translating that into an FTA will be a complex and time-consuming task. In reality, the EU is likely to be reluctant to preserve the UK's current level of access without appropriate mechanisms (including independent dispute resolution) to ensure that the UK continues to remain closely aligned with the EU in relevant areas of regulation. To the extent that the UK wishes to continue participating in aspects of the Single Market (such as the Single European Sky), the EU may also demand a significant financial contribution. Given this background, it seems to us that the negotiations are likely to be far from straightforward.
Ambitious trade agreements typically also require a substantial number of negotiators – for example, Canada had about 100 staff working on its agreement with the EU. As at November 2016, the UK's Department for International Trade (DfT) had recruited fewer than 200 staff. To conduct negotiations simultaneously with the WTO, the EU and third countries (as the government will need to do over the coming years in order to achieve its objectives), the DfT is likely to need considerably more resources.
How are trade agreements enforced?
Each 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 is not usually open to individual businesses (unless they can persuade their home state to take up a complaint on their behalf); it can normally only be conducted at state-to-state level. That said, some FTAs (such as the proposed TTIP between the EU and the US) contain provisions allowing enforcement by individual businesses, known as "investor-state DR mechanisms." Such provisions are also common in bilateral investment agreements or BITs (these are trade agreements setting out the terms on which an investor from country A can invest in country B and usually contain protections against e.g. appropriation of property by the host country).
Enforcement mechanisms also vary from one agreement to another. For example:
- The Switzerland-China free trade agreement requires the parties at first instance to resolve the dispute by consultation. Failing this, an inter-governmental arbitration procedure shall be convened.
- The Canada-Korea agreement allows the complaining party to select either the WTO or a panel to settle disputes.
- The EU-South Korea agreement provides for resolution by a 3 person arbitration panel (one arbitrator nominated by each party and one neutral arbitrator to act as chairperson)
- The EU-Ukraine Association Agreement provides for resolution of most disputes by arbitration but where the question is one of EU law (e.g. in areas where Ukraine has agreed to align its own law with that of the EU), then the Court of Justice of the European Union must rule on the point.
After Brexit, can the UK continue to benefit from existing EU trade agreements?
The EU has free trade agreements with over 40 other countries/trading blocs. Some commentators take the view that if the relevant trade agreement was a "mixed competence" agreement i.e. signed not just by the EU but by all the Member States (as is often the case), then the UK could continue to benefit from it after Brexit. However, others argue that the non-EU party would not be bound to carry on trading with the UK on those terms; in particular, the non-EU party may well take the view that it only agreed to those terms because it thought it was dealing with a multi-member trading bloc of over 500 million people, not a single country of only about 65 million.
It therefore seems doubtful that the UK can take the benefit of all the EU's trade deals after Brexit, although in practice some countries may be prepared to continue trading with the UK on the same or similar terms, at least for the majority of goods/services covered (and on condition that the UK reciprocates by keeping to its commitments under the relevant EU-negotiated FTA).
The impact of losing the benefit of these trade agreements also needs to be kept in perspective. A report of the Trade Policy Research Centre suggested that the EU's FTAs only benefited about 9% of UK goods exports and 11% of UK services exports. This is because most of the EU FTAs are with relatively small markets – so although the number of agreements is significant, they account for a relatively small proportion of the EU's overall trade with the rest of the world. That said, in monetary terms, the amounts at stake are by no means trivial; on 2015 figures, about £50 billion in exports would stand to be affected (although it is very unlikely that all of this trade would be lost). Having to renegotiate these agreements will also add to the already daunting task facing the UK's new Department for International Trade.
If a trade agreement can be reached with the EU, will it have to be ratified by all EU Member States?
In short, it seems likely that the answer to this question will be "Yes" – although it may be possible to bring any EU-UK FTA into force provisionally (see below). It is also important to distinguish between a future EU-UK trade agreement (which is likely to require ratification) and any withdrawal treaty concluded under Article 50 (where the position on ratification is less clear).
Ratification is problematic because it is time-consuming and effectively gives Member State legislatures a right of veto (as has occurred with the EU-Canada agreement, which is still not fully ratified). Although the European Union has exclusive competence in relation to international trade (which should mean that ratification by individual member states is not needed), the EU's trade agreements have become increasingly wide-ranging in scope, prompting arguments that such agreements trespass upon areas of competence which are shared with the Member States. This prompted some Member States to press for ratification of the EU-Canada FTA, which the European Commission reluctantly agreed to - whilst reserving its position on the exclusive competence point more generally. The matter is currently before the Court of Justice of the European Union in Case A-2/15, which relates to the EU-Singapore FTA. The Advocate General's Opinion in that case (which is not binding) concludes that wide-ranging FTAs of this type DO cover areas of shared competence - and therefore require ratification by Member States. However, her view was that the EU has exclusive competence in the following areas:
- Trade in goods
- Trade in services - but not transport services
- Trade and investment in renewable energy generation
- Foreign direct investment
- Commercial aspects of IP rights
- Competition and related matters
- Trade and sustainable development – but only in so far as the provisions in question primarily relate to commercial policy instruments
Although this is a reasonably wide-ranging list, it is unlikely to be wide enough to cover an ambitious free trade agreement of the type which the UK government appears to be seeking with the EU. One way of avoiding the need for ratification would be to narrow the scope of any initial EU-UK FTA to these areas (and to deal with any issues involving shared competence in a separate agreement) - but it is not clear whether EU Member States would be prepared to agree to the Commission proceeding on that basis. It could also result in a somewhat artificial partitioning of the issues under negotiation.
An alternative solution would be to accept that Member States will have to ratify any EU-UK FTA, but to agree that most provisions of the FTA can be brought into force provisionally - as has happened with the EU-Canada agreement (although this approach has been criticised on the grounds that Member States are effectively being forced to implement something which they may ultimately reject).
If no trade agreement with the EU can be reached prior to Brexit, what is the UK's position?
If the UK leaves the EU with no trade agreement in place and no transitional arrangements, it will have the status of a third party country in the eyes of the EU. This means UK businesses will in theory trade with the EU based on WTO rules, which is likely to have a significant disruptive effect (see Brexit: WTO rules). No EU-UK agreement would also potentially mean no arrangements with the EU on trade facilitation (see Question 1), which would put the UK in a worse position than third countries such as the US, China and Japan. Lack of transitional arrangements is likely to exacerbate the level of disruption (see Brexit: Transitional Arrangements).
What might an EU-UK FTA look like?
Although the government has stated that it is seeking a "bespoke" deal with the EU which is not based on any existing models, it is likely that precedents will play a role in the negotiations – particularly given the time constraints under Article 50. In addition, the EU may well be concerned that giving the UK a "special deal" may have implications for its relations with other non-EU member states, who may be encouraged to demand comparable treatment. Much will therefore depend on what the EU is prepared to offer. It is possible that the UK could adopt something of a "pick and mix" approach, seeking to combine different aspects of existing EU arrangements with third countries (which would allow the EU to maintain that the UK was not getting special treatment). Examples might include:
- The EU-Canada FTA: this has been widely held up as a possible model for any EU-UK FTA, although in terms of services access, it would fall some way short of replicating the UK's current level of access as an EU Member State. The government's White Paper on Brexit also gave some prominence to the dispute resolution provisions in the EU-Canada FTA, suggesting that they may be a favoured option for the UK.
- The EU-South Korea FTA: in relation to goods, this agreement includes a number of provisions designed to reduce red tape relating to goods exports which the UK may wish to replicate, particularly in relation to "rules of origin" paperwork (see Brexit: Customs Arrangements) and product testing/certification. In relation to services, some commentators have suggested that this agreement would be a better model for the UK than the EU-Canada FTA.
- The EU-Ukraine Association Agreement: this agreement gives significantly wider market access than the EU-South Korea or EU-Canada FTAs, but on condition that Ukraine aligns its own law with that of the EU in areas covered by the agreement. It does not, however, provide for free movement of people. This model may be politically difficult for the UK because of the need to align itself with EU law (although without committing to some degree of alignment, it is hard to see how the UK will secure the depth of access which it seeks). Although the agreement has its own dispute resolution mechanism, questions on interpretation of EU law have to be referred to the Court of Justice of the European Union. This too may be politically problematic, although it may be that the EFTA Court could be considered as compromise (see below).
- The EU-Swiss arrangements: the EU is known to be unhappy with its arrangements with Switzerland and like the EU-Ukraine agreement, they may be politically problematic as a model for the UK (because they effectively require the Swiss to align themselves with EU law in particular areas). Aware that involvement of the Court of Justice of the European Union would probably be politically unacceptable to the Swiss, it is understood that the EU has proposed that disputes should be resolved instead by the EFTA Court – but as yet, that proposal has not been accepted by the Swiss.
- The EU-Turkey customs union: a key problem which the UK will face in leaving the EU is the reintroduction of customs controls between the UK and EU member states, which has the potential to be extremely disruptive to goods trade. One option might be to enter into a partial customs union with the EU, as Turkey has done in relation to industrial goods and processed food (but not agricultural produce). However, this would require the UK to align its external tariffs with those of the EU and thus constrain its ability to pursue free trade deals with third countries (Turkey is able to conclude its own trade deals, but its customs union with the EU has sometimes proved something of a handicap in that regard). For more detail, see Brexit: Customs Arrangements.