Transitional arrangements for exiting the European Union Contents

3. UK-EU trade in the absence of an agreement

Overview

32.Unless the Withdrawal Agreement specifies otherwise, or the parties unanimously agree to extend the two-year Article 50 window, the EU Treaties will cease to apply to the UK on 30 March 2019. Without an agreement providing an alternative basis for trade, the UK’s trade relationship with the EU will at that point then be determined by market access commitments made by the EU at the WTO. For brevity, this is referred to in the rest of this chapter as a ‘no-deal’ scenario.

33.In the last Parliament, the Committee concluded that relying on WTO commitments as a basis for trade would be “economically costly”,58 and the evidence it has received since then—both general and sector-specific—supports this view. Shanker Singham, Chairman of the Legatum Institute Special Trade Commission told the Committee that while “the WTO deals very well with tariff barriers”, it “does not deal well with the issue of regulatory barriers or non-tariff barriers”. In relation to services trade in particular, Mr Singham said:59

If you look at the services schedules of most countries, including the EU services schedule, they are fairly weak. The UK’s major industry is services. It is very important for us to get this right.

34.Sir Ivan Rogers echoed Mr Singham’s evidence about the importance of non-tariff barriers:60

The whole point about a single market, which we are leaving, as I say, is the tackling, erosion of and, ultimately, elimination of non-tariff barriers. People keep on obsessing about the tariff barriers but, by and large, tariff barriers, with the exception of agriculture and one or two sectors like automotive, have largely been eliminated.

35.Hosuk Lee-Makiyama, Director of the European Centre for International Political Economy, described the WTO as: “more of a life insurance policy or worst-case scenario […] you could say that the WTO commitments today function more as a least possible level of decency as to how two trading entities should behave with each other. If 50 per cent of the UK’s trade is with Europe, you cannot have those terms imposed upon it”.61

36.Were the UK to trade with the EU solely on the basis of WTO commitments, this would place it in an unusual position. Most advanced economies—even those without a preferential trade agreement covering tariffs—have arrangements with the EU that go some way to addressing the non-tariff barriers to trade that exist under WTO-only arrangements. For instance, the United States has agreements with the EU on (among other things) customs co-operation, and the mutual recognition of conformity assessment procedures for certain goods. An equivalence determination by the European Commission made in February 2016 also allows central counterparties (CCPs)62 based in the US to serve EU clients on the same basis as CCPs based in the EU. Sir Ivan Rogers said that, in such a scenario:63

We have no more rights than Venezuela or Yemen in the EU market. We have no more rights of access, because we have got no preferential agreement and we have got no legal agreement.

37.The economic forecasts of the Office for Budget Responsibility and the Bank of England assume a smooth adjustment to a new trade relationship with the EU. The OBR described the “policies and regimes [that] supersede those presently associated with EU membership” as one of the risks to its forecast.64 Dr Mark Carney, Governor of the Bank of England, has said that there are “considerable risks” to the Bank’s outlook “which include the response of households, businesses and financial markets to developments related to the process of EU withdrawal”.65

38.The Committee received evidence that, for certain sectors, a ‘no-deal’ scenario will have an immediate impact on their ability to do business across borders, generally as a result of changes to the legal framework for trade. These sector-specific impacts, which are not exhaustive but instead reflect the evidence received by the Committee, are considered in the following section of the report. The Committee also heard that changes to data sharing arrangements, customs procedures and border formalities will have immediate consequences for the flow of cross-border trade more generally. These cross-cutting consequences are considered in the section entitled Cross-sectoral issues.

39.The consequences of a ‘no-deal’ scenario are examined against a counterfactual in which transitional arrangement is reached that preserves the ‘status quo’ on a temporary basis. Many of the changes, particularly with respect to customs procedures and border inspections, will eventually occur even under a comprehensive trade agreement, as a result of the Government’s decision to leave the Single Market and Customs Union. For many of those submitting evidence, the principal concern is the imminence of the changes in a ‘no-deal’ scenario, and the absence of time to prepare for them.

40.The medium-term risks, changes and opportunities that lie ahead will be considered in more detail in the Committee’s future work, as the terms of the long-term trade relationship between the UK and the EU become clearer.

Sector-specific issues

Banking and insurance

41.In a ‘no-deal’ scenario, banks and insurers based in the UK66 would lose the legal authorisation to serve clients in the rest of the EU,67 either on a cross-border basis or through foreign branches. In written evidence, Lloyd’s of London described the impact on insurers that currently use these passporting rights:68

without either a new agreement in force or transitional arrangements, Brexit will mean that the activities in the EEA of UK passporting insurers will become unlawful. If they have branches in EEA Member States they must close them down and they will no longer be legally represented in those jurisdictions. They may not arrange new insurance contracts and may not renew existing contracts.

42.UK Finance (then the BBA) wrote of the impact on the provision of banking services in similar terms:69

EU27 businesses would suddenly be unable to receive services from UK-based banks, and vice versa, and existing legal agreements could suddenly become unenforceable. Without clarity and transitional arrangements, banks and their customers will be unable to continue, extend or begin contracts for these types of services, particularly for the many banking products that have a reasonably long duration.

43.Market infrastructure providers, such as the London Stock Exchange Group, would find themselves in a similar situation. In particular, without an equivalence determination by the European Commission, it would become uneconomic for EU27 banks to use central counterparties located in the UK.70 JP Morgan wrote that such a situation would have “serious repercussions […] any banks using their services would have to move entire pools of exposure […] EU27 banks would find themselves in breach of regulations and would suffer punitive capital increases […] there is a risk of market disruption and sharply increased costs of clearing, both of which would affect the non-financial end-users of markets”.71

44.A ‘no-deal’ scenario could also cause discontinuity in cross-border insurance and derivatives contracts that straddle ‘Brexit day’, since companies will no longer legally be able to collect premiums or pay claims (in the case of insurance contracts), or undertake life-cycle events (in the case of derivatives). The Bank of England has estimated that “six million UK policyholders, 30 million European Economic Area (EEA) policyholders, and around £26 trillion of outstanding uncleared derivatives contracts could […] be affected”.72 It added that “it will be difficult, ahead of March 2019, for financial companies on their own to mitigate fully the risks of disruption” and that both “UK and EU legislation would be required” to preserve the continuity of these contracts.73 Andrew Bailey, Chief Executive of the Financial Conduct Authority, told the Committee that “if we woke up one morning and the passport was not there—those contracts could not be legally serviced. That is the guts of it”.74

45.As with other sectors, the potential disruption arising from a ‘no-deal’ scenario stands to affect both the UK and the EU. Dr Carney told the Committee that, given the dominance of the UK as a financial services provider to the rest of the EU, “these issues are bigger for Europe than they are for us, although they are material for us”.75 He has also commented on the extent of reliance of the EU27 on UK financial services:76

Banks located in the UK supply over half of debt and equity issuance by continental firms, and account for over three quarters of foreign exchange and derivatives activity in the EU. If these UK-based firms have to adjust their activities in a short time frame, there could be a greater risk of disruption to services provided to the European real economy, some of which could spill back to the UK economy through trade and financial linkages.

46.The Bank has also noted that UK-incorporated companies provide around half of wholesale banking services used by EEA customers. And the ECB estimates that UK central counterparties (CCPs) clear approximately 90 per cent of euro-denominated interest rate swaps used by euro-area banks.77

Automotive

47.In the automotive sector, compliance with EU standards is assessed by Notified Bodies in each Member State, which are responsible for certifying that vehicles, and their systems and components, meet relevant environmental, safety and security standards. In the UK, the Vehicle Certification Agency (VCA) is the body responsible for issuing the accreditation (known as “type approval”) that allows vehicles manufactured in the UK to be sold into the rest of the EU. Type approval typically takes between 6 and 18 months and costs £350,000 to £500,000.78 The UK exports over half of the cars it manufactures to the rest of the EU.79

48.In a ‘no-deal’ scenario, the VCA would no longer be able to issue type approvals that allowed UK-manufactured vehicles to be sold into the rest of the EU. The validity of existing type approvals would also be uncertain. Mike Hawes, Chief Executive of the Society of Motor Manufacturers and Traders (SMMT), told the Committee in the last Parliament that WTO rules would be “the worst of all worlds” for the automotive sector.80 In written evidence, the SMMT stated that a “no deal scenario” could be “hugely damaging to the UK automotive industry”.81 Ian Howells, Senior Vice President of Honda Motor Europe told the Committee that it “probably means that the product that we produce on 30 March, even though it is identical to that produced on the 29th, would not be allowed into the European marketplace”.82

49.In written evidence, Honda stated that:83

If EU and UK Type Approvals issued after Brexit are no longer mutually recognised, we would be unable to place products onto the market. Additionally, if approvals for parts and components are no longer recognised, we would face significant difficulties sourcing appropriately approved components from suppliers in the UK and EU. Both of these factors would have a very significant impact on our production activity.

Chemicals

50.Most chemicals regulation in the UK is derived from the EU, the principal pieces of legislation being REACH, the CLP Regulation and the Biocidal Products Regulation. In particular, under REACH, EU companies are required to provide information to the European Chemicals Agency on the hazards, risk and safe use of chemical substances that they manufacture or import. These registrations are stored in a publicly accessible database. Exporters from outside the EU seeking to sell into EU markets are not bound by the obligations of REACH. That responsibility lies with either the importer of the chemical, or with a single representative (known as an ‘only representative’, or OR) appointed by the exporter. ORs must be established within the EU. Without a REACH-compliant importer or OR, chemicals exported to the EU cannot be released for free circulation.

51.UK companies have made more than 5,000 registrations under REACH, 40 per cent of which were made by UK-based ORs for non-EU manufacturers seeking to export to EU markets.

52.The Cosmetic, Toiletry and Perfumery Association explained the effect of a ‘no-deal’ scenario for the chemicals sector:84

Once the UK leaves the EU, UK manufacturers and importers would not be recognised as being established within the European Community and would each have to appoint an ‘Only Representative’ (OR) in an EU Member State in order to continue to sell chemicals on their own or in finished cosmetic products into the EU. On the same note, companies based in the UK currently acting as ORs for non-EU-based companies exporting into the EU would no longer be able to act in that role. Issues that would need to be addressed include the status of existing REACH registrations and of future registrations.

53.BASF also highlighted the possibility that, in a ‘no-deal’ scenario, existing chemicals registrations made by UK firms would cease to be recognised. It wrote that, while “this extreme outcome we hope is implausible”, it would “effectively end trade in some chemicals between the UK and EU until such a time as the impasse was resolved”.85

54.In advice to companies, the European Chemicals Agency has stated that existing UK registrations will be regarded as “non-existent” after Brexit. It goes on:86

Consequently, your EU-EEA customers will need to register the respective substance themselves. Alternatively, in order to continue supplying your EU-27(or EEA)-based customers on the basis of your own registration, as a manufacturer you will need to either relocate to the EU-27/EEA or to appoint an Only Representative within the EU-27/EEA.

Air services

55.The consequences for air services of a ‘no-deal’ scenario are potentially severe because, as the Airport Operators Association (AOA) stated in written evidence, aviation does “not form part of the WTO system. Instead, countries negotiate bilateral or multilateral air services agreements to provide airlines with the legal rights to fly certain places”.87

56.Within the EU, the Single Aviation Market was developed in the 1990s and there are now no commercial restrictions for airlines flying within the EU. Externally, the EU has negotiated a number of air services agreements, of which the most important is the EU-US Open Skies Agreement that enables any EU or US airline to fly any transatlantic route. A further 113 countries have a bilateral air services agreement with the UK. The movement of passengers and cargo within the EU is also facilitated by the European Aviation Safety Agency, which develops and monitors aviation safety legislation, and is responsible for the type certification of aircraft, engines and parts. The AOA described the consequences of a failure to reach a new EU-UK air services agreement, and new agreements to replace the EU’s external agreements:88

if there is no new agreement on air services once the UK leaves the EU, the legal framework for flights covered by the current EU-level arrangements disappears. While the UK has had bilateral air services agreements with most (but not all) EU27 countries prior to the Single Aviation Market coming into existence, these date from a different era and are no longer fit for purpose as a fall-back option. There is also a question over whether they are still legally valid since the Single Aviation Market superseded them. The same applies with the UK’s historical bilateral agreements with non-EU countries where there is now an EU-level air services agreement, like the US.

57.Sir Ivan Rogers said that, with no agreement in place:89

UK air carriers that had been operating within the Single Market pre-Brexit would lose their EU air traffic rights. To keep operating flights within the EU and continue to qualify as EU air carriers, which is the precondition to operate intra-EU air services, those companies would need to relocate their principal place of business into the EU27, i.e. where they oversee those air services’ conduct, maintenance and repairs and maintain their principal financial functions.

58.In evidence to the Transport Committee, representatives from the air services industry considered that the consequences of a failure to reach an agreement on air services were so severe that it was, in practice, unlikely. John Holland-Kaye, Chief Executive of Heathrow Airport said:90

I share the Secretary of State’s confidence that arrangements will be put in place to make that [a transitional arrangement] happen. […] There will be pressure within the EU to make sure that a sensible, pragmatic deal is put together in the event that there is not an implementation period.

WiIlie Walsh, Chief Executive of International Airlines Group, said he was optimistic that an agreement would be reached that ensured “that the world will continue as it has”.91 Tim Hawkins, Corporate Affairs Director for Manchester Airports Group, said that “we recognise the theoretical risk at the end of a long process, but we are confident that there are a range of practical and pragmatic ways of addressing that risk, which mean that we do not end up there”.92

59.The Chancellor told the Treasury Committee that while it was “theoretically conceivable that, in a no-deal scenario, no air traffic will move between the UK and the European Union on 29 March 2019 […] “I don’t think anybody seriously believes that that is where we will get to”. He added that “even if talks break down and there is no deal, there will be a strong compulsion on both sides to reach agreement on an air traffic services arrangement”.93

Accountancy

60.As the UK’s competent authority for statutory auditor regulation, the Financial Reporting Council (FRC) is recognised as an appropriate regulatory authority throughout the EU. This recognition allows auditors that it regulates some involvement in audits for overseas entities. In written evidence, the Association for Chartered Certified Accountants (ACCA) stated:94

It is not clear whether the UK regulators/competent authorities, such as the FRC, will continue to be recognised as such once the UK leaves the EU. This could significantly curtail the ability of UK professionals to provide services to EU clients.

[…]

Even if negotiations offer a favourable outcome in terms of mutual recognition of professional qualifications/competent authorities there is a strong risk of a period of several years after exit from the EU before any new agreement takes effect, during which UK businesses would be at risk of being excluded from the single market in services. Unlike the trading of goods, this would not simply entail a mere raising of barriers (e.g. tariffs), but in many instances effective exclusion from practice altogether.

Cross-sectoral issues

Data transfer

61.The ability to transfer data across borders is central to cross-border trade, particularly in services; it is estimated that about half of all trade in services is enabled by digital technologies and the related data flows, and three-quarters of the UK’s cross-border data flows are with EU countries.95

62.The rules and principles governing the cross-border flow of data in the EU are being updated. At the point the UK leaves the EU, data protection rules will be set by the General Data Protection Regulation (GDPR) and a Police and Criminal Justice Directive (PCJ Directive), also known as the “Law Enforcement Directive”), both of which are set to take effect from May 2018. Also relevant are the EU-US Privacy Shield and the EU-US Umbrella Agreement, which provide frameworks for transfers of personal data between the EU and the US.

63.The Government intends to incorporate the provisions of the GDPR into UK law through the EU (Withdrawal) Bill. But outside the EU, UK data controllers that wish to continue receiving personal data transferred from the EU will have to demonstrate that they provide an adequate level of protection. The UK could seek an adequacy decision from the European Commission, involving a review of domestic data regime to determine how the UK’s data protection landscape matches the requirements of EU law. Such a decision could only be reached after the UK had left the EU and become a “third country”. In written evidence, Eversheds LLP described how businesses might ensure the free flow of data in the absence of an adequacy decision:96

Lawful transfers may be achieved by use of European Model Clauses (EMCs) between exporters and importers. Businesses will need to identify all affected data flows and put in place the necessary EMCs and keep them up to date. Binding corporate rules (BCRs) can also make data transfers lawful. However, UK businesses and organisations cannot make BCR applications from the UK and are unlikely to be able to maintain control of existing BCR arrangements from the UK post-Brexit.

64.The Chancellor said that “one of the scenarios we have to plan for is no data sharing […] That could be because of a bad-tempered breakdown of negotiations or equally because, in the absence of a common framework of law, we may not have a legal framework for data sharing”.97

65.In its November 2017 Financial Stability Report, the Bank of England commented specifically on the implications of barriers to the flow of personal data for financial services:98

These barriers could, for example, impact firms’ ability to service EEA clients from their data centres, which are typically located in the United Kingdom, as they do now. This could in turn disrupt service provision to those customers.

Box: the EU Customs Union and border checks

As a Member State of the EU, the UK is part of the EU Customs Union. The defining feature of the Customs Union is the common external tariff (CET). The CET means, first, that goods produced in the EU are not liable for further duties as they cross Member States’ borders; and second, that goods entering from outside the EU can, on payment of the relevant duties, move around within the Union without being liable for additional tariffs.

The Customs Union was envisaged in the 1957 Treaty of Rome, and was completed in 1968. But before the “creation” of the Single Market in 1993, Member States still inspected goods at borders to ensure that they met relevant domestic standards. The “regulatory union” created by the Single Market obviated the need for such inspections, and the right of free circulation of goods within the EU was fully established. Member States still retain the right to stop and inspect EU goods crossing borders for the purpose of combatting crime.

The EU provides the legislation and framework under which the UK operates its customs regime and manages the flow of international trade. In particular, the EU sets requirements for the declaration of goods entering or leaving the Union. These are contained in the Union Customs Code (UCC), a package of legislation that sets out the arrangements for managing the EU’s external borders.

The Code, which replaces previous 1992 Community Customs Code, took effect on 1 May 2016, although it contains transitional provisions that mean some elements do not enter force until 2020.

Like its predecessor, the UCC delegates extensive powers to the European Commission to specify the precise details of how Member States should operate their customs.

Customs declarations

66.In the absence of an agreement, the UK would apply, from 30 March 2019, the same customs controls to imports from the EU as it does to those from the rest of the world. Likewise, EU Member States would apply customs controls to UK exports.

67.As part of these changes, businesses will be required to make customs declarations on trade between the UK and the EU. HMRC estimates that the total number of customs declarations in a ‘no-deal’ scenario would increase fivefold from its current level, and that the number of traders having to go through customs processes would rise from 170,000 to around 300,000.99 Jim Harra, Tax Assurance Commissioner and Director General, Customer Strategy and Tax Design, HMRC, said that a ‘no-deal’ scenario presented a “significant challenge”, and that the Department’s existing IT system for making and processing declarations, known as CHIEF, was not capable of handling such an increase. CHIEF, which is 25 years old, is in the process of being replaced with a new system, known as the Customs Declaration Service (CDS).100 This replacement was originally developed in order to accommodate changes to EU customs legislation, which take effect in 2020.

68.CDS is scheduled to enter service in January 2019, a timescale Jon Thompson, Chief Executive and Permanent Secretary of HMRC, told the Public Accounts Committee he was “reasonably confident” would be met.101 Sir Amyas Morse, the Comptroller and Auditor General, told the Treasury Committee that he interpreted Mr Thompson’s remarks to mean that “there were still significant things that had to happen towards the end of the project that could disrupt its final delivery”. He added that “this is a substantial IT project and it is not unheard of for them to run over, let us say. We all know that, so why not say it?”

69.Before the referendum, HMRC described the CDS project as “business critical”.102 In evidence to the Committee, Mr Harra said it was a “high-risk programme”.103 Jon Thompson made the point that CDS was being implemented alongside other Brexit-related changes—to indirect taxation, data and information sharing, and welfare—and 250 existing projects. He said that “you cannot run an organisation at this scale with this level of transformational ambition and just subsume all this”.104

70.130,000 firms conduct international trade only with the EU, and will, from 30 March 2019, be dealing with customs procedures for the first time in a ‘no-deal’ scenario. Mr Harra told the Committee that there was “a big challenge in reaching and supporting them and getting them able to comply with their obligations, certainly on a transitional basis, as well as an ongoing basis”.105 Mr Thompson noted that customs declarations forms contained 55 data fields.106

71.Ian Howells, Senior Vice President of Honda Motor Europe, told the Committee that the change in customs procedures was a “very definite cliff edge […] on the 29th, you have one set of rules; on the 30th, you have another set of rules and you are not entirely sure how they are going to work”. He added that:107

we can take whatever HMRC might put into place for customs, for example, but then we have an internal processing time in which we need to change our own systems. It is not just our systems, but those of our supply chain, which is very extensive and includes a lot of very small and medium-sized entities.

72.Nana Evans, Fashion Designer and microbusiness owner, said:108

Even doing custom forms takes up time in your day […] I do not have the time to put in a day to do extra paperwork. It is very different from when you could pass that on to another employee or even hire somebody else to do the extra paperwork that may come along.

73.By contrast, Will Butler-Adams, Managing Director of Brompton Bicycle Ltd. described new customs formalities as “not a big issue” and said that the “small problem” of delays in customs could be managed by pre-positioning stock in the EU: “we will stuff some stock into Europe if nobody has made their mind up, which is the most likely outcome”.109

Border checks

74.To ensure the correct taxes and duties have been paid, and to ensure that goods comply with relevant standards, goods entering the UK from outside the EU are subject to checks at the border. The Committee took evidence on how these checks are conducted currently, which is considered below. It also took evidence on the scope for unilaterally relaxing or disapplying these checks, considered in the following section of the report.

75.The Committee in the last Parliament asked about checks made by HMRC to customs declarations at the border. Bill Williamson, Customs Director, HMRC, said that “96 per cent of customs declarations [made to HMRC] are cleared within seconds”.110 Jim Harra clarified in correspondence that 99 per cent of export declarations were cleared within 20 seconds. 96 per cent of import declarations were cleared within the same timescale, although this figure includes up to 10 minutes “dwell time” for businesses to make amendments to submitted declarations. Three per cent of import declarations lead to documentary checks, 96 per cent of which are completed within two hours (or overnight in respect of maritime traffic after 3pm). Less than one per cent of imports are subject to physical checks as a result of HMRC’s processing of customs declarations.111

76.Asked about the number of extra staff required to deal with additional customs work after Brexit, Mr Harra gave an estimate of 3,000–5,000 officials, based on a “crude extrapolation” from the fivefold rise in the number of customs declarations. He said that he did not think so many would be required in practice because “even if the number of declarations grows, a large number of those will be made by existing international traders whose compliance we already manage”.112

77.Other agencies at the border also carry out checks to ensure compliance with EU rules. For instance, almost all commercial imports of animals and products of animal origin into the EU are subject to inspection at designated Border Inspection Posts.113 In the UK, these checks are carried out by the Port Health Authorities (which are usually the local authority). In correspondence with the Committee in the last Parliament, Mr Harra listed 17 government agencies operating at the border.114 In oral evidence, Mr Thompson emphasised most physical inspections were carried out not by HMRC, but by other agencies:115

if you go to many ports, the majority of interventions that happen at the local port are from the local district council or other local authority responsible for animal health. To be specific, I went to Felixstowe the other day. Approximately three quarters of the interventions on containers there are from Suffolk Coastal District Council, who are looking at it from an animal and plant health perspective. So we all think about it as Border Force and HMRC and Transport, but it is actually the local authority that is implementing some aspects of European Union legislation. They are the people who mostly open the containers.

78.The number of documentary and physical inspections is minimised by an intelligence-led approach that identifies higher-risk consignments, thereby balancing revenue compliance with the free flow of trade; as Mr Harra put it, “we use intelligence and other risk assessment to identify the ones we want to zero in on”.116 Risk assessments rely in part on data sharing between the customs authorities of EU Member States. Mr Harra emphasised the importance of this arrangement:117

One of the ways that fluidity between the UK and the rest of the Member States works so well now is because we have very good systems that share information and intelligence. To manage the risks on day one without disrupting trade, it is important that we secure those for the future as well.

79.Concern has been expressed about the infrastructure and space available in ports dedicated to trade between the UK and continental Europe, where current inspection rates are very low. 99 per cent of freight arriving by ferry into Dover, or by shuttle through the Channel Tunnel, does not require customs clearance. Freight movement through the Eurotunnel accounts for 25 per cent of goods trade between the UK and the EU, and transit between the Port of Dover and the continent accounts for a further 31 per cent. Jon Thompson described the Dover-Calais loop as a “major concern”, adding that “we need to make sure that that system is balanced, because it only takes something like two hours to stop”.118 Mr Harra said:119

The key challenge, for example, in ro-ro [roll-on, roll-off] ports, in contrast with container ports, is that in a lot of them there are no port inventory systems in place. Although someone can make a customs declaration to us under CHIEF or CDS, understanding which vehicle the goods are on that that declaration relates to is not possible without those port inventory systems. Therefore, you would rely on much less ideal, much more manual processes to try to manage the risks at the border.

80.The Road Haulage Association estimated that current customs systems applied at Dover and the Channel Tunnel would “slow the movement of vehicles by between 20 minutes and 4 hours”.120 It also expressed concern that there was insufficient space to handle the volume of traffic requiring customs clearance.

81.The Rail Delivery Group made similar points in respect of delays and capacity:121

One of the primary concerns about potentially defaulting to a World Trade Organisation arrangement due to lack end-state agreement or without a transitional arrangement, would be the impact of additional customs controls on borders. Primarily this would have a significant negative impact on international passenger services and freight being transported through the Channel Tunnel. It could also increase delays at ports, having a knock on impact on capacity and planning of rail freight services across the network. Anecdotal evidence from discussions with colleagues in Switzerland suggest that imposing customs at rail borders can create delays of over an hour and depending on density this can create queues of 30km.

82.The CBI noted that border delays would be “extremely problematic for short life-span goods like food and plants”, and that “delays in the trade in goods also result in pressures on working capital for small businesses, who do not receive payments until goods are received”.122 Allie Renison, Head of Europe and Trade Policy at the Institute of Directors, told the Committee:123

It has been estimated that, for every extra day that goods sit in customs, it is equivalent to a two per cent to six per cent tariff. It is the uncertainty around knowing how much longer things might have the potential to be held up in goods sectors that the question mark around planning comes from, not so much the idea that they cannot trade on those terms.

Options to mitigate the impact of ‘no deal’

“Mini-deals”

83.In evidence to the Exiting the EU Committee, the Secretary of State for Exiting the European Union said that the most disruptive consequences of a ‘no-deal’ scenario would be likely to be mitigated through a “bare-bones deal”, covering specific areas:124

There are various sorts of no deal. There is a no deal where we go to WTO arrangements but we have a bare-bones deal on other elements. I listed them to the Chairman: aviation, data and maybe nuclear—or not—and so on. Then of course there is a complete failure to agree and a hostile outcome. That is so incredible that it is off the probability scale. But in those circumstances, it is conceivable there will be no deal of any sort.

84.The Chancellor made a similar point in evidence to the Treasury Committee, stating that in respect of aviation:125

it is very clear that mutual self-interest means that, even if talks break down and there is no deal, there will be a strong compulsion on both sides to reach agreement on an air traffic services arrangement.

However, he did acknowledge the possibility “of a bad-tempered breakdown in negotiations”, in which “people are not necessarily acting in their own economic self-interest”.126

85.Sir Ivan Rogers was sceptical that economic self-interest would inevitably prevail, stating that in the event of a “breakdown of trust”,127

There is then not a guarantee that the two sides come together in some affable moment at the end of 2018 and say, “You know what? The world might end if we do not do a deal which is not really a no-deal”. It might be so bloody by then that both sides are looking to knock chunks out of each other and to start a trade war.

Unilateral action

86.In a ‘no-deal’ scenario, the Government will have greater flexibility to decide the terms on which goods are shipped, and services provided, from the EU to the UK. The Committee heard that this flexibility could be used to mitigate some of the potential disruption to cross-border trade.

87.In relation to customs, Jim Harra told the Committee that the principal objectives of HMRC were to ensure security at the border, maintain the free flow of trade, and collect revenue. He said that there could be “flexibility” about how those three priorities were balanced.128 In particular, HMRC could increase its risk tolerance at the border, in order to facilitate trade (although its discretion to do so in respect of EU trade alone may be constrained by WTO rules).129 Jon Thompson said that:130

One of the ultimate contingencies we could take […] is to say: “Forget the revenue. Hypothetically speaking, we have three objectives. Forget the revenue; just let everything in.” Now, that is a theoretical position that we could take. There is £3bn on the line for that position, but it is theoretically possible.

88.The Chancellor ruled out such a radical approach, telling the Committee that “on day one, we will not accept trucks rolling through Dover packed with dangerous goods […] we will have a system in place that protects our vital interests—our national security, our homeland security and our revenues”.131

89.Although on leaving the EU, HMRC would have the flexibility to alter its risk tolerance at the border in order to preserve the free flow of goods, UK exports to continental Europe will be subject to customs control and inspection processes at EU ports according to EU rules. This would include the requirement for live animals and animal products to pass through Veterinary Border Inspection Posts (there are none in Calais). Jon Thompson said that “it takes two parties to dance […] We are not in control of what happens on the other side of the border, which is a significant element of the risk”.132 Jim Harra said that there was as yet little understanding in Government about the preparations being made by other customs authorities for a ‘no-deal’ scenario:133

when it comes to post-Brexit arrangements, other Member States have been clear that that is a matter for the Commission and the Commission’s negotiating team to deal with. So we are not having significant discussions with other customs authorities in the EU about what their arrangements will be post-Brexit […] More insight into their preparedness for that will be very useful to us, but we don’t currently have it.

90.Mr Harra added that “based on past experience, the European Commission will expect the customs authorities of France, and the authorities of other countries with UK-facing borders, to administer their controls and collect their revenues”.134 Although the UK ranks highly on the World Bank’s international comparison of the efficiency of customs processes, along with some other EU countries (such as the Netherlands, which ranks third), the same cannot be said of Belgium, which ranks 13th, France, which ranks 17th, and Spain, which ranks 24th.135

91.Just as the authorities operating at the border could mitigate the disruption of a ‘no-deal’ scenario by relaxing the terms on which goods to enter the country, so the financial regulators could be flexible about the terms on which they allowed EU firms currently relying on inbound passports continue to do business. Talking about the options available to allow contracts to continue to be serviced in a ‘no-deal’ scenario, Andrew Bailey, Chief Executive of the Financial Conduct Authority (FCA) said that, with secondary legislation, the FCA could “create a regime that effectively preserved the authorisation, at least for the period in which the contracts are in some form—running to their end, as it were”.136

Government spending on Brexit preparations

92.To date, the Government has committed to £3.7 billion in spending on Brexit preparations. Thus far, £412 million has been allocated, to the Department of International Trade, the Foreign and Commonwealth Office, and the Department for Exiting the European Union. £250 million will be allocated before the end of the 2017/18 financial year. It is intended that £1.5 billion will be allocated to Departments in 2018/19, and a further £1.5 billion in 2019/20.137

Firms’ contingency plans

93.The Committee received evidence from firms (predominantly in the financial services sector) about their contingency plans in the event of ‘no deal’, and the timetable over which those plans would be put into effect. It also asked the financial regulators about the state of firms’ contingency planning.138

94.A recurring theme in respect of the contingency plans for UK banks and insurers is the creation of “optionality” that allows them to continue to operate in the EU27 on the conservative assumption that no deal is reached. Typically, this involves the establishment of a new subsidiary within the EU27 (or the expansion of an existing one), and the acquisition of relevant regulatory permissions currently provided by UK outbound passports.

95.In terms of the scale of activity that might be relocated, Douglas Flint, then Group Chairman of HSBC, told the Committee:139

in the first instance what people are thinking about is that you need to move your relationship managers into the European Union for the products that would need to be licensed within the European Union. The question that then follows is whether the middle and back offices need to be co-located with the front office, or whether you could continue to service the flows in an outsourcing arrangement, the way that many of us do to other parts of the country, not in the EU.

[…]

The question would be whether the negotiation would allow the middle and back office the settlement, the risk management, the accounting and so on to be done outside EU27 and whether EU27 as part of the negotiation says, “No, if we are going to give you a licence, we want everything in our country.”

96.For firms in the rest of the EU using inbound passports to provide services into the UK, contingency planning is less advanced. Mark Carney, Governor of the Bank of England, told the Committee that “there has been a difference in terms of the depths, level of sophistication and advancement of contingency planning of outbound firms versus inbound firms”. By way of explanation, he added that “there has been some assumption by inbound firms that there would be some form of transition arrangement put in place and, therefore, the urgency of this type of planning was less important”. He also added that, in general, preparation for ‘no deal’ was less advanced in the rest of the EU than in the UK.140

97.The Association of British Insurers wrote that insurers’ contingency plans “usually involve the establishment of a subsidiary in an EU-27 jurisdiction”. The ABI described the implementation of such plans as “expensive, cumbersome and capital-inefficient”, but noted that, among most insurers, such plans were “well advanced”.141 Lloyd’s of London wrote that the contingency plans entail “moving operational activity and therefore jobs from the UK to the EU-27, a process that will have its own momentum”.142

98.Asked when contingency plans would be put into effect, Andrew Bailey told the Committee:143

we tend to take the view that the end of this year/beginning of next year is the point at which these sorts of things will start happening. Each firm will no doubt give you a slightly different date if you push for precision, but that is the sort of date to have in mind when things start to happen that have much bigger consequences.

99.Sam Woods, Chief Executive of the Prudential Regulation Authority, said that:144

Contingency planning is a sliding scale of increased commitment, investment and momentum through time. It is much more prudent and prosaic than hovering over the relocate button or rushing to the exit door […]

If we get to Christmas and the negotiations have not reached any agreement on this topic, diminishing marginal returns will kick in. Firms would start discounting the likelihood of a transition in the central case of their planning.

100.Katherine Braddick, Director General, Financial Services, HM Treasury, told the Committee:145

Those firms [in the financial services sector] have been planning for some time and have a timescale. They have had a number of decision points about progressing those plans, but they harden or become more certain at the point at which they start to alter contractual paperwork with clients. For most of the firms that we talk to, that will fall at some point in the first quarter of next year.

101.According to Mark Carney, financial services are the sector in which contingency planning “is the most advanced”, and in which decisions are likely to be taken earliest: “the first quarter starts to be quite crucial on transition. For other businesses, there is a bit of a lag”.146

102.Dr Carney’s evidence is borne out by survey data from the Institute of Directors (IoD), which found that a third of firms had not yet drawn up any contingency plans, 19 per cent had drawn them up but not yet implemented them; and 8 per cent had put them into effect. A further 37 per cent had no plans either to draw up or implement contingency plans.147 Allie Renison of the IoD said:148

if we have to wait until March for phase two to be discussed, you will see people putting in place their contingency plans, because the financial year ends shortly thereafter. We have found that a good majority of businesses are still holding off both implementing and drawing them up, and you will see that accelerate in the first quarter.

103.Ms Renison added that financial services had more flexibility to move activity into the EU27 than capital-intensive manufacturing:149

For manufacturing, you are talking about disruption to supply chains, although not always, and the movement of production and operations outside of the UK, so they need a bit longer to plan. It is a much more substantial operation to move that kind of physical infrastructure outside of the UK.

104.Ian Howells echoed this point, stating that “we have a huge plant in Swindon; 4,500 people work there. It [moving jobs and activity] is certainly not something that is easily done in a very short space of time”.150

105.Ms Renison also noted that many firms’ contingency plans did not involve relocation (“only 25 per cent are either moving or looking at moving operation”), with others “looking at setting up shadow supply chains, sitting on cash flow or not holding on to as much stock”.151 Mr Howells said that Honda’s ‘no-deal’ contingency involved “increas[ing] the amount of inventory that we hold on the UK mainland, as opposed to importing it on a more regular basis” and seeking new type approvals to replace those issued by the VCA, which he expected would take 9 to 12 months. He stated that these plans would be put into effect by March 2018, in the absence of any agreement being reached on transition.152

106.Asked about the nature of the commitment required to avoid the activation of contingency plans, Mr Howells said that it would take an “assurance” from “both sides”.153 Andrew Bailey said that the commitment to transition “has to be strong and it has to be strong on both sides” to avoid the activation of contingency plans.154 The City of London Corporation acknowledged that a “detailed, legally binding agreement will not be in place until the Withdrawal Agreement is signed”, but called for a “strong political agreement at the December European Council or early in first quarter 2018”.155

107.Martin McTague, Policy Director, Federation of Small Businesses, expressed concern that smaller businesses were less likely to prepare for the changes that might occur in a ‘no-deal’ scenario:156

If the past is anything to go by, it will probably be the back end of 2018 before some people wake up to what is going to happen. If we are about to drop off a cliff in April 2019, they will be completely ill-prepared for that and it will almost certainly result in business failures.

108.Neil Warwick, Partner at Square One Chambers, a Newcastle-based law firm, agreed that “the vast majority of businesses are not making plans”.157 Will Butler-Adams, Managing Director of Brompton Bicycle Ltd., was amongst them, telling the Committee that “I am just ignoring it all and I will find out what you all decide you are going to do in about two years’ time”.158

109.Mr Butler-Adams added that SMEs should not be should not be reliant on Government “which moves along at zero miles per hour and changes its ideas every five minutes”, and should not hold out hope for a deal: “in business, you prepare for the worst”. But even in a ‘no-deal’ scenario, he was confident that there would be no problem for his business in selling into the EU.

Will Butler-Adams: […] Europe is no problem at all, because we are trading into Europe; therefore we need a European type approval. That is their type approval. As long as we pass it, we trade into Europe. […]

Chair: [What if] the Europeans decide to play really rough?

Will Butler-Adams: They cannot, because we pass the European type approval along with any other country in the world with which we trade, just like we pass the American type approval, the Japanese type approval, the Argentine type approval. They cannot. That is their type approval. We already pass the type approval, so all our work is around the European type approval.

110.In contrast to motorised vehicles, there is no EU law that mandates specific standards for pedal bicycles, or requires that they be type approved by a notified body located within the EU before they can be sold.159 The General Product Safety Directive places the onus on the manufacturer to demonstrate that their product is safe. However, pedal bicycles that comply with the appropriate construction and safety standards adopted by the European Committee of Standardisation (CEN) are presumed to be safe, and can be sold across the EU.

Conclusions

111.It is overwhelmingly in the economic interests of both the UK and the EU to reach an agreement on a ‘standstill’ transition. The alternative—a sudden reversion to a trade relationship based on WTO commitments—would be damaging for both sides. The basis for trade in a number of sectors—including financial services, chemicals, vehicles and air services—would abruptly become more restrictive. The Committee intends to continue its scrutiny of the Brexit preparations, including through an evidence session with the WTO Secretariat to consider their perspective.

112.More generally, goods and services trade would be affected by changes to data sharing arrangements and customs procedures. Many of these changes would occur anyway as a result of leaving the Single Market and Customs Union. But an unplanned ‘no-deal’ scenario leaves firms with insufficient time to adapt. This is particularly the case for the 130,000 firms—mostly SMEs—that trade only with the EU, and have no prior experience of dealing with customs formalities.

113.A ‘standstill’ transitional arrangement would also mitigate the major risk that HMRC’s Customs Declarations Service (CDS) is not ready in time for 30 March 2019. The Committee remains to be convinced that robust contingency plans exist to avoid the severe disruption to goods trade that would occur in an unplanned ‘no-deal’ scenario were this project to fail, or even be modestly delayed.

114.Irrespective of the delivery of CDS, the abruptness of the change to arrangements for cross-border trade in an unplanned ‘no-deal’ scenario will also have major consequences for the operation of borders and ports. The principal routes for UK-EU trade are not currently designed to cope with such arrangements. The decision to leave the EU Customs Union and the regulatory union of the Single Market will inevitably require large-scale investment in these ports. But the Committee remains to be convinced that the people, infrastructure and space required on both sides of the Channel to avoid major delays and disruption will be available by 30 March 2019.

115.CDS is just one example of the swift administrative preparation needed for an unplanned ‘no-deal’ scenario. To take another, functions currently performed by a number of EU regulatory agencies, including the European Supervisory Agencies, the European Aviation Safety Agency, the European Chemicals Agency, and the European Medicines Agency, will have to be repatriated and allocated to domestic regulators. Their resources would have to be expanded, and the legal framework amended, to reflect these new functions. It is a vast undertaking for Government and Parliament to complete in less than sixteen months.

116.The Chancellor has allocated £3bn in the Autumn Budget for Brexit preparation measures. The Committee, like the Comptroller and Auditor General, is in favour of insurance. But there is not yet any clarity as to what those measures entail, nor how the money will be allocated between Departments. If it is to bolster the UK’s negotiating position as the Government intends—by demonstrating to the EU27 that the UK is prepared for any eventuality—more detail will be required.

117.The Government and regulators can take other steps to mitigate some of the consequences of an unplanned ‘no-deal’ scenario. For instance, HMRC and other agencies operating at the border could radically scale back their inspection regime, and the financial regulators could allow firms currently passporting into the UK to carry on doing so, while they process applications for domestic authorisation. These actions have attendant risks—to revenue, to consumer safety, and to financial stability—that would grow over time. And they do not mitigate the risk of disruption on the other side of the border, which will remain subject to EU rules.

118.Mitigation of an unplanned ‘no-deal’ scenario may also be provided through agreements between the UK and the EU in specific sectors, such as aviation, where the potential for disruption is most severe. The Government appears to consider it inevitable that such arrangements would be reached in the dying days of the Article 50 process. But the history of international trade diplomacy is replete with examples of short-sighted political considerations prevailing over economic self-interest. And the conclusion of such agreements may come too late for firms that are intending to activate their contingency plans in the first quarter of 2018.

119.Some firms may be able to take action to adapt to the changes to the legal and operational environment arising from a sudden reversion to WTO rules. However, doing so will be costly. It may involve a relocation of jobs and economic activity from the UK to the remaining EU. And it may in the end be unnecessary if a trade agreement is eventually concluded that restores some of the rights and market access that existed while the UK was an EU Member State.

120.There is evidence, particularly in the financial services sector, that adaptation to a WTO rules environment is happening already. This process will gather momentum over time, and will only be stopped if sufficient certainty is provided by the negotiating parties that this outcome will be averted. It is not only the materialisation of a ‘no-deal’ scenario that has damaging economic consequences, but the anticipation of such a scenario. It is for this reason that the Committee agrees with the Chancellor that transitional arrangements are a “wasting asset”, the value of which will diminish the longer they take to negotiate.

121.The commitment to preserve, through the EU (Withdrawal) Bill, the substance of EU law in the domestic legal system provides a sensible basis for the negotiation of a future UK-EU trade relationship that provides comprehensive market access. But it does not obviate the need for such access to be negotiated and agreed by both sides. In the absence of any agreement on these issues, the mere fact of regulatory alignment on the day after the UK leaves the EU will provide no mitigation to the consequences described above; the UK will have the status of a third country, and WTO commitments will form the basis for cross-border trade.


58 Treasury Committee, Economic and financial costs and benefits of the UK’s EU membership, First Report of Session 2016–17, HC 122, para 166

59 Oral evidence taken on 13 July 2016, HC (2016–17) 483 Q199

60 Q55

61 Oral evidence taken on 13 July 2016, HC (2016–17) 483, Q175

62 Central counterparties stand between the buyers and sellers of derivatives and equities, guaranteeing the terms of the trade even if one party defaults on the agreement. The CCP collects enough money from each buyer and seller for covering potential losses incurred by not following through on an agreement.

63 Q18

64 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2017, Cm 9530, para 3.150

65 Mark Carney, [De]Globalisation and inflation, 2017 IMF Michael Camdessus Central Banking lecture, 18 September 2017

66 Both UK-headquartered banks and foreign-owned UK subsidiaries.

67 Generally, references to the EU in rest of this Chapter also refer to the wider European Economic Area (i.e. Norway, Iceland and Liechtenstein).

68 Lloyd’s of London (FCR0026), para 2.4

69 BBA (FCR0032), para 4

70 UK CCPs would become “non-qualifying CCPs” under the Captial Requirements Regulation. EU banks seeking to clear on such CCPs would see the capital requirements attached to such activity increase by between 25 times (for non-direct clearing members) and 50 times (for direct clearing members). See, for instance, FCR0012, Para 1.5.5

71 JPMorgan (FCR0029), para 14

73 Ibid, p.8

76 Bank of England, Opening remarks by the Governor at the Financial Stability Report press conference, 30 November 2016

78 SMMT Issue paper on Type Approval, November 2016, p.1

79 SMMT, Press Release, 26 January 2017

81 SMMT (FCR0048), p.1

82 Q180

83 Honda Motor Europe (EUN0011), p.1

84 CTPA (FCR0046), p.2

85 BASF (FCR0047), p.3

86 ECHA website, Q&A on The UK’s withdrawal from the EU [accessed 4 December 2017]

87 Airport Operators Association (FCR0019), para 6

88 Ibid, para 16

89 Q30

91 Ibid

92 Ibid, Q8

94 ACCA (FCR0034), p.3

95 Frontier Economics, The UK digital sectors after Brexit, 24 January 2017

96 Eversheds LLP (FCR0027), para 5.10

102 HMRC, Major Projects Portfolio data, September 2015

107 Q185

108 Q268

109 Q257

113 100 per cent of live animals have physical, documentary, and identification checks. For products of animal origin and animal by-products not for human consumption, 100 per cent of imports have documentary and identity checks, and 1–50 per cent have physical checks

120 Road Haulage Association, Brexit Policy Paper – Unimpeded access for international road haulage, February 2017, para 6

121 Rail Delivery Group (FCR0005), p.4

122 CBI (FCR0041), para 5.5

123 Q231

126 Ibid, Q52

127 Q34

129 GATT Article I:1 – With respect to customs duties and charges of any kind imposed on or in connection with importation or exportation or imposed on the international transfer of payments for imports or exports, and with respect to the method of levying such duties and charges, and with respect to all rules and formalities in connection with importation and exportation [...] any advantage, favour, privilege or immunity granted by any Member to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other Members.

137 PQ 115138 (answered 30 November 2017)

138 The Prudential Regulation Authority has conducted an exercise to analyse contingency plans of 401 banks, insurers and designated investment firms undertaking cross-border business between the EU and UK. This includes contingency planning for a scenario in which there is no agreement at the point of exit and no transitional period.

139 Oral evidence taken on 10 January 2017, HC (2016–17) 483, Qq259, 277

141 Association of British Insurers (FCR0042)

142 Lloyd’s of London (FCR0026), para 3.10

144 Sam Woods, speech at the Mansion House City Banquet, 4 October 2017

148 Q189

149 Q191

150 Q198

151 Q199

152 Q193

153 Q195

155 City of London Corporation (EUN0008), para 5

156 Q279

157 Q286

158 Q257

159 In written evidence, Honda listed the EU regulatory acts that set requirements for 71 different aspects of a car’s construction. (EUN0011).




13 December 2017