Conclusions and recommendations
Introduction
1.The UK is leaving the EU. The Government has said that it intends to give effect to this by leaving the EU Customs Union and Single Market. But the means by which this is achieved, and the likely end-state relationship between the two parties, remains uncertain. This Report is the first in what is intended to be a series that seeks to make constructive recommendations in these areas. It deals primarily with a specific, albeit important and urgent, point of process: how can the UK move from its position within the EU to its end-state relationship in a smooth and orderly way, particularly when that final relationship might not be fully agreed on 30 March 2019? (Paragraph 4)
2.Equally important questions about what the UK’s long-term economic relationship with the EU might be, and the opportunities, risks and changes that will arise as a result of Brexit, will be addressed in future work. (Paragraph 5)
Objectives
3.The Committee supports the Government’s proposal for a time-limited arrangement after the Article 50 negotiations conclude, and welcomes the alignment between the UK and EU27 on the core objective of this arrangement; namely, that the same common rules of trade should continue to apply in the UK and the EU as existed at the point of the UK’s formal exit. (Paragraph 26)
4.This ‘standstill’ transitional arrangement must be sufficiently simple to negotiate within a matter of weeks, to provide early certainty about the legal framework for trade from 30 March 2019, and maximise the time available for subsequent discussions on the future framework for trade. (Paragraph 27)
5.There remain differences between the two sides as to the purpose of transitional arrangements. The EU27 use the term “transition” and envisage negotiations on a long-term trade deal continuing during the interim period, while the UK is a ‘third country’. The Government uses the term “implementation”, and maintains that the purpose of this period is to provide time to adapt to a trade relationship that will be known and agreed by the end of 2018, when the Article 50 talks are expected to conclude. (Paragraph 28)
6.The Committee strongly supports the Government’s objective of maintaining, “the freest and most frictionless trade possible” through a “bold and ambitious” trade deal with the EU. However, it considers it very challenging for the completed details of the ‘bespoke’ free trade agreement envisaged by the Government to be fully agreed within the Article 50 process, particularly when negotiations on the future framework for trade are not yet underway. More importantly, businesses do not have confidence that the future relationship will be known and agreed by March 2019. The Government should seek, by the end of the Article 50 process, an agreed framework for the future trade agreement and a clear direction of travel. (Paragraph 29)
7.Taking this into account, it is highly likely that, for certain sectors, including financial services, the ’standstill’ transition period will have to be followed by an adaptation period that provides time to adjust to changes to the legal and operational environment under the future trade relationship, once it is known with clarity. At this stage, the Committee makes no recommendations about the design or duration of this subsequent period, except that, unlike the ‘standstill’ period, it need not involve the UK applying the existing framework of EU rules across all sectors.
Taking into account the challenges of concluding a trade agreement during the Article 50 process, and the alignment between the two sides on the objectives for the interim period, there are in practice two broad categories of outcome for the UK’s economic relationship with the EU on 30 March 2019: a reversion to a trade relationship based on WTO commitments (sometimes called a ‘no-deal’ scenario), or the preservation, on a temporary basis, of the status quo. In terms of their economic impact on both the UK and the EU27, the difference between these two outcomes is dramatic. (Paragraph 30)
8.There is also scope for differences between the two sides on the governance of the interim period, and in particular how “the existing structure of EU rules and regulations” can be given effect in the UK after the EU Treaties have ceased to apply and the European Communities Act 1972 has been repealed. (Paragraph 31)
9.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. (Paragraph 111)
10.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. (Paragraph 112)
11.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. (Paragraph 113)
12.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. (Paragraph 114)
13.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. (Paragraph 115)
14.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. (Paragraph 116)
15.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. (Paragraph 117)
16.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. (Paragraph 118)
17.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. (Paragraph 119)
18.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. (Paragraph 120)
19.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. (Paragraph 121)
Design and governance issues
20.An agreement between the UK and EU27 on transitional arrangements is now urgent. In his evidence to the Committee, the Chancellor argued that:
a transition arrangement is a wasting asset. It has a value today; it will still have a very high value at Christmas and early in the New Year. But as we move through 2018, its value to everybody will diminish significantly. Our European partners need to think very carefully about the need for speed in order to protect the potential value to all of us of having an interim period that protects our businesses and our citizens and allows investment and normal business activity.
The Committee supports this view. (Paragraph 144)
21.In her Florence Speech on 22 September 2017, the Prime Minister outlined the Government’s objectives for a transitional deal, namely that: “people, businesses and public services should only have to plan for one set of changes in the relationship between the UK and the EU”; that “during the implementation period access to one another’s markets should continue on current terms”; that there should be a “strictly time-limited period” under “the existing structure of EU rules and regulations”; and that “how long the period is should be determined simply by how long it will take to prepare and implement the new processes and new systems that will underpin that future partnership”. If an agreement on these terms can be reached quickly, the Committee believes that such an arrangement will give people, businesses and public services the certainty they need to plan for the future and will also mitigate against the risk of a regulatory ‘cliff edge’ occurring during talks on the UK’s future relationship with the EU. (Paragraph 145)
22.The operation of Article 50, the objectives of the negotiating parties, and the imperative for an early agreement, all constrain and condition the design and governance of transitional arrangements. In particular, the ‘standstill’ transition period must be sufficiently simple to negotiate within a matter of weeks. It must be consistent with the referendum result, in the sense that the UK should no longer be a Member State of the EU. It must also address concerns among the EU27 about preserving a balance of rights and obligations. (Paragraph 146)
23.The Government has taken a pragmatic approach so far. It has accepted that the ECJ’s jurisdiction may continue; that the ambit of the arrangements may extend beyond EU law relating to the Single Market and Customs Union; and that the UK may follow new EU law implemented during transition. (Paragraph 147)
24.The precise scope of transition, and whether the principles of direct effect and supremacy will continue to apply to the EU, are questions the Government has yet fully to address. The best outcome would be for transition to apply only to EU law pertaining to the Single Market and Customs Union, and for the transitional arrangements, along with the rest of the Withdrawal Agreement, to be implemented using domestic legal concepts, rather than in a way that retains the principles of direct effect and supremacy in the UK’s legal order. (Paragraph 148)
25.But the best must not be the enemy of the good. The costs arising from the deferment, on a strictly temporary basis, of the repatriation of domestic powers to alter EU law, are outweighed by the economic benefits of avoiding a sudden reversion to WTO rules. The Government should not rule out a transition arrangement that encompasses EU rules beyond those pertaining to the Single Market and Customs Union, and retains, on a temporary basis, the principles of direct effect and supremacy, if that expedites the negotiations. Visible disagreement between the parties on points of principle would lead to a loss of confidence among businesses, and diminish the value of whatever is eventually negotiated. To prevent the arrangements becoming a ‘transition to nowhere’, and to address legitimate concerns over sovereignty, the Committee recommends that any transition should be capable of being unilaterally terminated by either side. Termination on the UK’s part should be subject to the approval of Parliament. (Paragraph 149)
26.The two options presented by legal experts from whom the Committee heard—either to append relevant Treaty provisions to the Withdrawal Agreement, or for the Agreement to specify which provisions will continue to apply—are both reasonable ways of giving effect to ‘standstill’ transition. The other options available for the preservation of the ‘status quo’—the extension of the Article 50 period or the delaying of the entry into force of the Withdrawal Agreement—are not compatible with the Government’s objective of leaving the EU on 30 March 2019. (Paragraph 150)
27.A core purpose of transitional arrangements is to allow planning for the UK’s future outside the EU to take place in an environment of stability and certainty. Given that the EU has exercised exclusive competence over trade policy for over 40 years, a key aspect of that planning is for the UK to establish independent trade relationships, both with countries which have an existing trade agreement with the EU, and those which do not. Notwithstanding that no trade agreements can enter force until the transition period has come to an end, nothing in the Withdrawal Agreement should prevent the UK from undertaking this work. (Paragraph 151)
13 December 2017