The progress of the UK’s negotiations on EU withdrawal (June to September 2018) Contents

3Future EU-UK economic relationship

Introduction

46.On 12 July 2018, the Government published a White Paper, which set out its vision of the future EU-UK relationship, including the future economic relationship. The White Paper is the most detailed exposition so far of the Government’s vision of the future EU-UK relationship. On 3 September 2018, Michel Barnier told us there were many parts of the White Paper that were welcome and highlighted the chapters on security in particular. However, he also made it clear that the proposals on customs and a common rulebook for goods and agri-food are unacceptable to the European Union.72 Michel Barnier told us on 3 September 2018:

The proposals made in the White Paper on two points are not acceptable as they are; they are not acceptable to the European Union. That is the White Paper proposal on customs and the White Paper proposal on the common rule book for goods.73

Customs arrangements

47.The customs arrangements that will replace the UK’s membership of the Customs Union will sit at the heart of the future EU-UK economic relationship. In our May 2018 report, we concluded that it was “highly unsatisfactory that nearly two years after the referendum, Ministers have yet to agree, and set out in detail, what kind of trading and customs arrangements they wish to negotiate on with the European Union.”74 While the Government has now reached a settled position on what these arrangements should entail, the Government’s proposals have been rejected by the European Commission as unworkable.

48.The White Paper proposed the “phased” introduction of a ‘Facilitated Customs Arrangement’ (FCA). The FCA is intended to:

ensure that goods entering the EU via the UK have complied with EU customs processes and the correct EU duties have been paid. This would remove the need for customs processes between the UK and the EU, including customs declarations, routine requirements for rules of origin, and entry and exit summary declarations. Together with the wider free trade area, the FCA would preserve frictionless trade for the majority of UK goods trade, and reduce frictions for UK exporters and importers.75

49.The FCA would entail the UK operating two separate tariff regimes—one for goods that are destined for the UK market, and one for goods that are destined for the EU market. When a good reaches the UK border and the destination can be demonstrated by a trusted trader to be destined for the UK market, the UK tariff rate would apply, and the European Union tariff rate would apply to goods that are demonstrated to be destined for the European Union. If a good reaches the UK border and the destination cannot be demonstrated, the higher of the UK or European Union tariff rates would apply. Where the destination of a good is later identified to be that of a lower tariff jurisdiction, the UK Government would repay the difference. According to the White Paper it is estimated that up to 96% of UK goods trade would be likely to be able to pay the correct or no tariff upfront, with the remainder likely to use the repayment mechanism.76

50.The White Paper proposed a tariff revenue formula that would take account of goods destined for the UK entering via the European Union and goods destined for the European Union entering via the UK, to ensure that tariffs are remitted to the correct jurisdiction. However, it also said that “the UK is not proposing that the EU applies the UK’s tariffs and trade policy at its border for goods intended for the UK” and that the “UK and the EU will need to agree mechanisms, including institutional oversight, for ensuring that this process is resilient and verifiable.”77 From this, it appears that the tariff revenue formula, based on trading trends, would be a reciprocal arrangement in that it would take into account goods entering the European Union destined for the UK. The Government would remit duties on goods destined for the European Union market, minus estimated European Union duties collected on goods destined for the UK market.

51.The European Commission has said in the strongest terms that the FCA (and also the common rulebook) are not acceptable as they are. On 2 September 2018, it was reported that Michel Barnier said that the European Union “cannot relinquish control of our external borders and the revenue there to a third country—that’s not legal.”78

52.Furthermore, he criticised the FCA for being vulnerable to fraud and that it was not possible to track goods reliably to their end destination, to ensure that the correct tariff rate was paid. On 20 July 2018, Michel Barnier asked, “How can customs authorities verify the final destination of goods, and therefore assure that the correct customs tariff is applied? Is there not a major risk of fraud?”79 On 2 September 2018, he was reported to have said:

Moreover, the British proposal is not practical. It is impossible to tell exactly where a product ends up, on the UK market or in the internal market. For example, sugar is transported by the tonne in 25-kilo sacks, so you cannot trace every sack to its destination. That would only be possible with insane and unjustifiable bureaucracy. Therefore, the British proposal would be an invitation to fraud if implemented.80

53.The White Paper set out some actions that the Government would take to reduce the risk of fraud and its ability to track goods where necessary:

Where there is a material risk of circumvention of higher UK tariffs, the UK would make it illegal to pay the wrong tariff, and use risk and intelligence-based checks across the country, rather than at the border, to check that the right tariffs are being paid. This would protect against fraud, ensure that the UK has an effective trade remedies regime and strengthen the UK’s position in trade negotiations.81

The White Paper also said that it was possible that greater data sharing across borders, “including potentially the storing of the entire chain of transactions for each goods consignment, while enabling that data to be shared securely between traders and across relevant government departments” could reduce bureaucracy and help to combat fraud.82 The White Paper did not indicate how long these measures would take to implement.

54.The Government’s proposal for a Facilitated Customs Arrangement, and its associated common rulebook for goods, is integral to its vision for the future EU-UK economic relationship. However, the European Commission has made it clear that they regard the proposal as unworkable, saying that it would create legal problems, involve unacceptable cost and bureaucracy and call into question the integrity of the Single Market.

Common rulebook

Trade in goods and agri-food

55.The White Paper proposed the establishment of a free trade area for goods and agri-food. This free trade area would rest on a common rulebook, which would include “only those rules necessary to provide for frictionless trade at the border”. The UK would commit by treaty to ongoing harmonisation with the relevant European Union rules. The White Paper said:

This free trade area would protect the uniquely integrated supply chains and ‘just-in-time’ processes that have developed across the UK and the EU over the last 40 years, and the jobs and livelihoods dependent on them, ensuring businesses on both sides can continue operating through their current value and supply chains. It would avoid the need for customs and regulatory checks at the border, and mean that businesses would not need to complete costly customs declarations. And it would enable products to only undergo one set of approvals and authorisations in either market, before being sold in both.83

56.The White Paper stated that the common rulebook would be comprised of rules for manufactured goods, alongside UK participation in EU agencies that facilitate goods being placed on the EU market. It would also include rules for agriculture, food and fisheries products, encompassing those that must be checked at the border, alongside equivalence for certain other rules, such as on food policy. To ensure that rules were upheld in both markets, the Government and the European Union would cooperate on market surveillance. The White Paper also said that the UK would commit to a wide range of UK-EU ‘level playing field’ provisions. On 20 August 2018, the Government published slides that explained that the Government is proposing a common rulebook on state aid and a commitment that the UK would make “an upfront choice to commit by treaty to ongoing harmonisation with the EU’s state aid rules.” Furthermore, the Government proposed non-regression commitments for level playing field provisions on environment and social and employment standards.84

Services

57.One of the Government’s priorities in the negotiations is to re-establish the ability to exercise an independent trade policy, without creating friction for trade in goods with the European Union at the UK border. To this end, the Government’s White Paper said that it would pursue “regulatory flexibility” for the UK’s services industry, which could give the Government more latitude to strike trade deals on services in the future. On 24 August 2018, the Secretary of State told us:

You will know from what we have said in the White Paper that we are seeking to make sure that we have as much flexibility in regulatory terms as possible and as much freedom in terms of international negotiations [on free trade agreements] as possible. The reason that there is a distinction between services, and goods and agriculture relates to friction at the border, which obviously does not apply in relation to services.85

58.The Government has said that diverging from Single Market rules on services means that “the UK and the EU will not have current levels of access to one another’s markets.”86 The Government has not set out its evidence-base for why this would benefit the UK economy. On 24 July 2018, we asked the Secretary of State for Exiting the European Union what assessments had been undertaken by the Government on the economic impact of the decision not to have a common rulebook on services.87 The Secretary of State committed to write to us with an answer and on 23 August 2018, the Secretary of State provided us with a response. He said:

The Government is undertaking a comprehensive and wide-ranging programme of ongoing analysis in support of our EU exit negotiations and preparations. This analysis helps to define our future partnership with the EU, and informs our understanding of how EU exit will affect the UK’s domestic polices and frameworks. I know that you appreciate our specific responsibility not to reveal information that could reveal our negotiating position. As a result of this responsibility, I do not feel that it would be appropriate for Government to provide details of ongoing analytical work. When we bring forward the vote on the final deal, we will ensure that parliament is presented with the appropriate analysis to make an informed decision.88

59.However, we were told by some service providers that they were not keen to trade away alignment with Single Market rules, with the ease of access that this provides to the Single Market, to secure opportunities for easier access to other markets. Adam Minns, the Executive Director of the Commercial Broadcasters Association said:

When I saw the Secretary of State talk about flexibility, I assumed that he did not mean broadcasting, because I do not know anyone in the broadcasting sector who is asking for more flexibility and, even if we were, we could get more flexibility without sacrificing mutual recognition or leaving the Single Market because the UK gold-plates so many rules anyway. It certainly is not going to be mitigation for losing access to 45% of our market, which is what the EU is.89

Giles Derrington, Head of Policy for Exiting the European Union at techUK, said, “there is a lot of talk about the potential benefits of flexibility. We struggle to really identify where those might be on a global scale.”90 Catherine McGuiness, Chair of the Policy and Resources Committee for the City of London Corporation, said, “business being business, it pursues opportunities where it sees it and, therefore, people have been pursuing opportunities in Asia already, as China in particular opens out to the world and as there are other opportunities.” She continued, “What we need to be doing to make up for this significant loss—and it is significant because it is one of our biggest service export markets—is helping to see further opportunities in the other markets that business has not yet seen.”91

60.It is unclear to what extent trade in services can be separated easily from goods, as many exported goods include a service or maintenance contract. This is especially true of data and communications products such as smart phones, but it is also true of manufactured goods such as lifts or aeroplane engines, which require engineers to fit and maintain components on an ongoing basis. Catherine McGuinness told us that her members have said “that the real value and the profit that they make on a number of the goods that they sell is almost entirely the service contract”.92 She described the division of goods and services as “a false distinction”.93 Giles Derrington, Head of Policy for Exiting the European Union at techUK told us that this entwining of goods and services would continue to increase. He said:

You are likely to see that potentially more in the future. If you think of things like 3D printing, at what point is trading something a good and at what point are you providing a service, which is a blueprint or whatever else it might be. Those kinds of things are only going to increase. There are big challenges globally. There is a lot of discussion at WTO about how you deal with some of these things in the future. Within our current status in the EU that is not a problem but trying to separate it is very difficult.94

Witnesses told us that the result of this entwining or “servitisation”95 of goods means that if the European Union and the UK were to introduce barriers to trade in services, this would also negatively affect the UK’s ability to trade in goods.96 Furthermore, there are limitations to how far Free Trade Agreements, such as CETA, have been able to overcome trade barriers on services. Giles Derrington said:

There are potentially quite severe limitations within certain free trade agreements, if you look at them, about how you can provide services, particularly in terms of movement of people to provide that service. With something like CETA, effectively you can provide the first 12 months of a service through a person going back and forth. For those members who provide a UK hub for their engineers, et cetera, that means you cannot really house the engineers in the UK and have them serve five, 10 or 15-year contracts elsewhere in the EU. Do you locate them here? Probably not. You have to move them across as well.97

61.On 17 July 2018, Michel Barnier made a similar point to the House of Lords EU Select Committee:

20% to 40% added value comes from services. In any product put on the European market, between 20% and 40% of the added value of the product comes from services. Europeans are constructive but not naive, and they will not accept a rule whereby you have unfair regulatory competition from services via free movement of goods.

He said that for this reason, the four freedoms—products, services, capital and persons—are indivisible.98

62.On 3 September 2018, Michel Barnier told us that the common rulebook proposal was unacceptable to the European Union. He and his team described the Single Market as a coherent ecosystem and said that allowing the UK to diverge from European Union rules on services while retaining access to the Single Market for goods would therefore give UK businesses an unacceptable trade advantage. For this reason, he told us that the European Union viewed the UK’s proposals on the common rulebook and the FCA as a request to compromise on the European Union’s foundations and said that they were a direct threat to the integrity of the Single Market. He said:

We will not agree to unravelling or weakening the Single Market where goods and services are part and parcel of an integrated ecosystem, which we constructed together with you and your representatives over a 30-year period … How could we ask European Union companies to accept the regulatory divergence that you want for services and thus accept unfair competition for goods? We cannot accept that. We won’t, but it has nothing to do with free trade or a customs union of goods. Here we are talking about a Single Market, so we respect your red lines. You should respect our position. We will not agree to unravelling or weakening the Single Market.99

63.The European Commission has now indicated that the Chequers proposals for a Facilitated Customs Arrangement and a common rulebook are not viable and if this remains the position then the Government will need to adapt its approach to the future EU-UK economic relationship. The Commission is proposing a CETA-style Free Trade Agreement, but we note that this would not, on its own, ensure the type of friction-free trade that many companies with just-in-time supply chains need. Moreover, the Government has not yet set out how it would maintain an open border between the Republic of Ireland and Northern Ireland in this scenario without imposing customs and regulatory checks.

64.Achieving the Government’s stated objectives of maintaining friction free trade in goods and keeping an open border on the island of Ireland will require a much greater degree of customs and regulatory co-operation than that which is contained in CETA. We note that Michel Barnier has said that customs and regulatory cooperation would be possible in the context of a ‘CETA-like’ arrangement, but work to show whether this could in fact achieve frictionless trade would need to begin immediately rather than continuing with the Chequers proposals. The alternative ways for the UK to retain friction free trade with the European Union and to solve issues relating to the Northern Ireland/Republic of Ireland border would be either in an EU-UK Customs Union, combined with continued alignment on relevant EU rules, or through EEA membership together with a customs union. We note that neither of these options are Government policy.

65.The Government has said that there will be significant opportunities for the UK’s service sector from the UK securing trade deals with non-EU countries. However, any increase in trade that is gained outside the European Union will need to compensate for any reduction in trade caused by the new barriers to Single Market access for UK businesses. We note that the effect of diverging from EU regulations and standards will have different effects on different sectors, and that it will be up to a future Parliament to decide on whether to deviate. Witnesses from some of the UK’s most successful service sectors, for example broadcasting, told us that they were sceptical that opportunities to trade elsewhere would make up for the significant loss that they believed the Government’s proposals would entail.

66.Reaching a Withdrawal Agreement must be linked to obtaining a satisfactory Political Declaration on the framework for future EU-UK relations. The Secretary of State has indicated that the financial settlement should depend on achieving this outcome. He said that there are different ways “to give effect to the principle of conditionality”, including by making “explicit reference in the withdrawal agreement to the political declaration.” We note that Michel Barnier has also said that “there might be a link between the Withdrawal Agreement and the Political Declaration” and call on the Government to include any such link, if agreed, in the Withdrawal Agreement and Implementation Bill.

Financial services and equivalence

67.There has been significant debate in the UK over which model the Government should pursue for the future EU-UK financial services relationship—one that is based on mutual recognition or one that is based on the European Union’s equivalency regime. Equivalence is a lesser form of mutual recognition, where there is recognition that the standards of a third country are the same as those of the European Union, but that recognition can be withdrawn unilaterally by the European Union at any time. On 2 March 2018, the Prime Minister outlined a vision for reciprocal market access between the EU and the UK that appeared to be based on some form of mutual recognition. She said:

As in other areas of the future economic partnership, our goal should be to establish the ability to access each other’s markets, based on the UK and EU maintaining the same regulatory outcomes over time, with a mechanism for determining proportionate consequences where they are not maintained.100

On 7 March 2018, the Chancellor of the Exchequer gave a speech on the future EU-UK financial services relationship. He described a system that would be enshrined in an ambitious free trade agreement, based on regulatory equivalence (but not the European Union’s own equivalence regime, which was rejected as too limited) and mutual recognition. He said that under this system, the UK and European Union’s financial regulatory systems would “evolve separately” but that their trajectories would be guided by the European Union’s single rulebook as it exists today, and therefore both the European Union and the UK would continue to “deliver fully equivalent regulatory outcomes”. He stressed that the size of the UK financial services market, its contribution to UK GDP, its complexity and the risk that is borne by UK taxpayers meant that it would be inappropriate for the UK to be a rule-taker in this area.101

68.Rather than a model based on mutual recognition, the White Paper proposed a system of market access based on the EU’s equivalency regime, albeit one that would be improved and expanded.102 Witnesses told us that they were concerned by this policy change and that equivalence failed to meet the needs of their sectors. Huw Evans, Director General of the Association of British Insurers, said:

Ours is a world-leading sector; it is easily the most international insurance sector in the world and is the largest in Europe by some measure. For us a future regime that is built on the foundations of the European Commission’s equivalence model poses potentially significant risks that we end up as rule-takers, either completely or de facto.103

69.Catherine McGuinness said that the City of London Corporation “did not welcome the White Paper and the way that it treats financial services”.104 She was concerned that equivalence does not cover the whole of the financial services sector and that the European Union could withdraw it for political as well as legal reasons. She said:

Indeed, we have seen that recently with the Swiss stock exchange, which has been given a temporary permission for 12 months when really it ought to be given a longer one for certainty. We see that it can be very quickly withdrawn and we need clarity. We need stability, so that people have a longer time to off-ramp—I think that is what we are now calling it—if recognition is withdrawn. There could be a very significant impact on the business that people can do if they have to rely on that system.105

70.The European Union’s equivalency regime does not cover all sectors and it does not offer a uniform level of market access for those that it does cover. Huw Evans told us:

It is a piecemeal approach, done differently according to different directives, with different levels of market access—in some cases none at all—that come with it. It is an ongoing process. It is not something you can agree on day one and then you live happily ever after. It is an ongoing process of assessment. What you sign up to means that you have to be content that, ten years down the line, that is still going to be working in both your mutual interests. 106

71.Witnesses were sceptical that the Government would be able to negotiate an enhanced form of equivalence. Catherine McGuinness described it as an “uphill task to persuade the EU27.107 Huw Evans said that “it is a very ambitious ask” because the Government was asking for the European Union to let the UK have a say over how the third country equivalence regime would operate in future, “whereas… the equivalence mechanism in the third country regime is something that the EU considers proprietary. It is theirs.”108

72.On 26 April 2018, Michel Barnier set out in a speech his view of a future UK-EU financial services relationship. He stressed that the EU cannot accept mutual market access without the common safeguards that underpin it, and that these safeguards would be undermined if the European Union had to rely on the rules, supervision and enforcement mechanisms of third countries whose banks were operating within the Single Market. He said, “This is not something that any country in the world would accept.” Instead, the UK would be offered third country equivalence, which was in the process of being improved. He said, “Why would the equivalence system, which works well for the US industry, not work for the City?”109 On 3 September 2018, Michel Barnier told us he was confident the Withdrawal Agreement would cover the exchange of personal data between the UK and the EU up to the end of the transition/implementation period, but that exchange of data in the future would require new negotiation, drawing on tools such as those used in agreeing equivalence in financial markets with the US and Japan.110

73.The White Paper sets out a model for the future EU-UK financial services relationship that is based on an enhanced version of the EU’s third country equivalency regime. Michel Barnier has said that there are already improvements underway to the European Union’s equivalency regime. The UK Government’s use of the term enhanced equivalence may not be too distant from the European Union’s suggestion of improved equivalence. However the existing equivalence regime clearly has its limitations, as it does not cover all parts of the financial services sector, would require the UK to be a rule taker, and can be withdrawn unilaterally by the European Union at any time. While we note that enhanced equivalence is an ambitious goal, we agree with the Government that it is a pragmatic negotiating objective, given the contribution that the financial services sector makes to the UK economy and its importance to the economies of our trading partners in the European Union.


72 See Frankfurter Allgemeine Zeitung, Interview mit Michel Barnier, 2 September 2018 and Guardian, Michel Barnier says he strongly opposes May’s Brexit trade proposals, 2 September 2018.

74 Exiting the European Union Committee, The progress of the UK’s negotiations on EU withdrawal (March to May 2018), Fifth Report of Session 2017–19, HC 1060, 24 May 2018, para 20

78 Frankfurter Allgemeine Zeitung, Interview mit Michel Barnier, 2 September 2018 and Guardian, Michel Barnier says he strongly opposes May’s Brexit trade proposals, 2 September 2018. On 3 September 2018, Michel Barnier told us, that there are four reasons why we cannot accept those proposals on these two points in the White Paper. First… “It is not possible for the Union to delegate to a third country protection of its customs union or the control of its external borders or the management of a collection of its customs revenue.” Second, “these proposals…would create…extra cost and bureaucracy.” Third, “they might create deflection in trade by the UK applying a more advantageous customs tariff and it could also lead to major distortion in competition to the detriment of EU business if UK businesses were able to not have to respect the same rules that we respect in terms of the factors of production, our social standards for labour and environmental standards regarding production methods.” Fourth, “our objective analysis of these two proposals leads us to believe that they would call into question the very integrity of our Single Market.” Q2537

80 Frankfurter Allgemeine Zeitung, Interview mit Michel Barnier, 2 September 2018 and Guardian, Michel Barnier says he strongly opposes May’s Brexit trade proposals, 2 September 2018

83 Department for Exiting the European Union, The future relationship between the United Kingdom and the European Union, 12 July 2018, page 7

84 Department for Exiting the European Union, Framework for the UK-EU Partnership: Open and Fair Competition, 20 August 2018, para 48

86 Department for Exiting the European Union, The future relationship between the United Kingdom and the European Union, 12 July 2018, para 48

88 [insert link to letter once Committee has agreed to publish]

95 Q2144 [Michael Dougan]

101 Chancellor of the Exchequer, HSBC speech: financial services, 7 March 2018

102 Department for Exiting the European Union, The future relationship between the United Kingdom and the European Union, 12 July 2018, para 65




Published: 18 September 2018