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Planning for Brexit

The negotiations over what shape Brexit will finally take continue to show a marked divergence between political aspiration and legal certainty. Can businesses afford to put their contingency plans on hold following the EU and UK’s political agreement on a transition period?

One constant in the Brexit process has been uncertainty about what it will mean in practice. Businesses seeking to contingency plan have naturally focused not just on what the “end state” of EU/UK relations will be, but also on the need for a transition period.

The text of the draft withdrawal agreement was largely agreed at the EU Council meeting on 22/23 March. It includes a standstill transition until the end of 2020. The EU and UK negotiators will now move to talks on the future relationship. On this, there is still little clarity. Although the Prime Minister’s recent Mansion House speech showed more realism about the need to accept trade-offs than previous speeches, it was still criticised as attempting to “cherry pick”, which the EU has consistently said is unacceptable.

Despite the progress on the withdrawal and transition terms, businesses should be assessing the possible impacts of different scenarios (see panel) and preparing as best they can for those scenarios, sooner rather than later. Three reasons for this are that: the transition period is not yet a certainty, it may not offer a complete version of the status quo, and it does not guarantee a smooth landing when it ends.

Despite the progress on the withdrawal and transition terms, businesses should be assessing the possible impacts of different scenarios (see panel) and preparing as best they can for those scenarios, sooner rather than later.

Considerations

Although there is political agreement on the transition period, there will not be legal certainty on its terms until close to the end of this year – the legal text is agreed but will not be binding until it has been approved by the EU and UK Parliaments. There is still a risk that agreement on the withdrawal terms could fall over (for example because of unresolved issues over Ireland, Gibraltar or fishing rights), resulting in the UK leaving the EU in March 2019 with no deal agreed – the “chaotic Brexit” scenario.

If this happened the UK would become a third country trading with the EU on WTO terms, with relatively little preparation having been completed by businesses and governments. For example, without a transition period the UK Government may not be able to pass new domestic legislation or put in place systems (eg for customs controls) in time, and there is no clarity on planes being able to fly to and from the EU.

The transition period is not the same as simply extending the status quo. Under the withdrawal agreement, the UK will no longer be a member state of the EU from 29 March 2019, but will be treated until the end of 2020 as if it were still part of the EU (but with the UK being excluded from EU decision-making procedures). This should work to ensure that there is no immediate change to the regulatory environment in the EU27/UK as from next March but there are question marks over whether the transition period will apply as far as third countries are concerned. The EU has a variety of free trade and economic partnership agreements and bilateral agreements on specific sectoral issues, covering around 100 countries in all. In some cases, third countries may argue that the transition does not apply to their agreements. This would mean that the UK would be bound by EU law to comply with the terms of those agreements but would not necessarily get the benefit of them.

Even if most impacts of Brexit are deferred until the end of the transition period, the UK has accepted that it cannot continue to have the same benefits as it currently gets as a member of the single market. Changes to the likely future relationship between the UK and the EU, and the UK and third countries, look set to have significant impacts on businesses and the way they operate. In particular, businesses should expect new tariff and non-tariff barriers for trade in goods and services between the EU and the UK from January 2021. In practice this may mean that goods are more expensive or slower to move around, with more red tape and compliance systems needed, while some services may no longer be provided within existing organisational structures.

These changes may have direct impacts on your business, which can be planned and mitigated for. More difficult, perhaps, will be working out indirect effects, such as how your customers, service providers and suppliers will be impacted by, and react to, the changes that Brexit brings. For example, a UK exporter might decide to move manufacturing operations to the EU27 to be able to meet the needs of customers there and avoid exposing them to risks to just-in-time delivery and rules of origin compliance, but such a move may expose UK customers to those same risks.

There are many other issues to consider. Regulators have pointed out that systemic risks may arise unless long-term grandfathering arrangements are agreed, so as to allow continued performance of contracts such as derivatives and insurance contracts. Businesses that share data across the EU are anxious to see agreement to allow continuity of current arrangements, which may require specific agreement on the adequacy of the UK’s data protection regime. The wider macro-economic impacts of changes in the market for recruitment of talent and foreign investment against a background of evolving and potentially diverging regulation will also need to be considered in assessing the likely impacts of Brexit.

To conclude, our recommendation to businesses is that they should not give up preparing for worst case scenarios, albeit they can take some comfort from the fact that they are now more likely to have two years and eight months rather than just one year to plan for the impacts of Brexit. For more information see our Brexit microsite.

When (and how) might the UK leave? Some potential scenarios:

1. “Crash out” in 2019 with no deal

Why? EU27 and UK do not agree a withdrawal agreement, or EU or UK Parliament fail to approve the agreement

When? 29 March 2019, when the period set by Article 50 of the Treaty expires, or 31 May 2019 following a short extension to agree emergency measures (e.g. on aviation and security). An extension requires unanimity of member states; new EU Parliament elections are held at the end of May 2019 and this may be regarded as a hard deadline.

2. Limited Free Trade Agreement (broadly like Canada)

Why? Withdrawal agreement agreed and approved by EU and UK Parliaments. It includes a standstill transition under which UK technically leaves EU in March 2019 but continues to be treated as a member state for almost all purposes

During 2019 and 2020, negotiations on a FTA continue. Limited agreement possible in time available

When? The transition period expires 1 January 2021 and the FTA applies. This results in new tariff and non-tariff trade barriers for goods and services, requiring much of the same contingency planning as for the crash out scenario.

3. Bespoke Free Trade Agreement

Why? As in scenario 2, withdrawal agreement includes a standstill transition from March 2019, but the transition period is extended beyond 2021 (this is not provided for in the draft withdrawal agreement and extension would require all member states to agree, which may be difficult to achieve). A longer period would give more time to negotiate on a deeper and wider FTA covering goods and services with an extended transition period to allow for ratification and implementation.

When? 2022, or later. Considerable organisational changes for business, governments etc may still be needed.

In summary, issues for boards to consider

One

It is too early to say businesses can put contingency plans on hold – the withdrawal agreement and transition period could still fall over.

Two

Businesses therefore need to continue Brexit risk planning to identify what arrangements might be affected by Brexit, directly or indirectly. If any are significant, what can be replicated/put in place to minimise the impact and what is the long-stop date for actioning them?

Three

Businesses will need to be ready to make difficult judgment calls as to whether to press the “go” button on these plans or to hold off in anticipation of a transition period being legally agreed.