Twentieth Report of Session 2019–21 Contents

9The cost of the Brexit financial settlement (update)68

These EU documents are politically important because:

  • they contain information on both the EU’s current long-term budget and pensions for EU civil servants, to which the UK has agreed to contribute for the foreseeable future under the terms of the financial settlement in the Withdrawal Agreement. The Treasury published its latest forecast of the cost of the settlement in July 2020, putting the total figure at £32.7 billion.

Action

  • Draw the latest information on the cost of the Brexit financial settlement to the attention of the Committee on the Future Relationship with the EU, the Public Accounts Committee and the Treasury Committee.

Overview

9.1Under the Withdrawal Agreement governing the UK’s exit from the European Union on 31 January 2020, the Treasury is required to make certain financial contributions to the EU to resolve residual obligations linked to the period of the UK’s membership from 1973 until 2020. These include a share of the EU’s spending under its 2014–2020 long-term budget, as well as a contribution to the pension entitlements built up by EU staff and a guarantee in relation to certain contingent liabilities on the EU’s books. In return, the UK also remains eligible for European funding until the end of 2020 and will receive a share of certain EU assets. In spring 2020, the European Commission issued several documents relating to the EU’s spending that are relevant to the financial settlement and its cost to the UK taxpayer.69

9.2Based on these latest figures, combined with its own internal modelling, the Treasury on 13 July published its latest annual “EU Finances Statement“ on the UK’s contributions to the EU. This predicts that the net cost of the Brexit financial settlement to the UK taxpayer is now forecast to amount to €36.9 billion (£32.7 billion).70 The majority of this is likely to have been paid by the mid-2020s. This latest estimate is substantially lower than the Treasury’s infamous initial forecast for the cost of the settlement of £39 billion, made in January 2018. This decrease is due to a large extent to the fact that the UK remained a Member State of the EU for ten months longer than initially anticipated after the Article 50 negotiating period was extended from 29 March 2019 to 31 January 2020. For reasons explained further below, this had the effect of reducing the amount for the UK to pay under the settlement after withdrawal.

9.3However, the definitive cost of the settlement remains uncertain, driven in part by fluctuations in the value the UK’s contribution to the pensions bill for EU civil servants (which amounts for £8.3 billion of the total estimate). The Treasury estimate also does not foresee any costs related to certain contingent EU liabilities for which the UK has assumed partial exposure under the Withdrawal Agreement.

9.4In particular, the Government has granted a conditional guarantee to the European Investment Bank (EIB), capped at £35.2 billion. This requires the Treasury, when certain conditions are met, to share with the remaining Member States the cost of any capital injection considered necessary to stabilise the Bank in relation to its financial operations agreed before the UK left the EU. No call on any part of that guarantee has been made publicly to date, but the impact of coronavirus could make such an eventuality more likely. While materialisation of the need for the UK to pay the EIB the full amount for which it is theoretically liable under the settlement would only occur in extreme economic circumstances, we will continue to monitor the financial situation of the Bank — and its implications for the UK taxpayer — closely and expect the Government to keep Parliament informed promptly of any relevant developments.71

9.5In this Report, we have summarised relevant developments relating to the different components of the financial settlement in more detail, drawing on information provided by the European Commission and the Treasury.

The financial settlement in the Withdrawal Agreement

9.6The UK’s contributions to the EU budget have long been controversial, and the net cost to the taxpayer of the membership dues played a prominent role in the 2016 referendum that led to the UK’s withdrawal from the EU in January 2020.

9.7However, exiting the European Union has not fully laid the issue to rest: the Withdrawal Agreement, ratified by the UK and European Parliaments, contains a complex financial settlement under which the UK has accepted it will pay the EU for a number of residual budgetary obligations for several years to come.72 The logic behind this settlement is that the Government approved successive EU long-term spending plans as a Member State, including the most recent “Multiannual Financial Framework” for the 2014–2020 period (which was agreed in 2013).73 Therefore, in the words of the European Commission, the UK committed itself “to fund a share of the [EU’s] obligations” and it should “honour its share of the financing of all the obligations undertaken while it was a member of the Union”.74

9.8The EU’s financial obligations “undertaken” during the UK’s membership from 1973 until 2020 are multifaceted and complex, and could not be definitively established at the point of its formal withdrawal on 31 January 2020. As such, the precise cost of the settlement is not explicitly set out in the Agreement. Instead, it establishes a methodology for calculating the UK’s contribution to five different types of EU financial obligations to which it has agreed to contribute.75 This forms the basis on which the Government will make payments to the EU twice a year76 until all residual obligations as set out in the settlement are extinguished.

9.9The five components of the financial settlement are described briefly below. The subsequent sections of this chapter discuss the relevance of the recent EU budgetary developments for each of these components in more detail.

9.10The payment of the financial settlement is now a legal obligation on the UK under international law, independent of the outcome of the Government’s negotiations on a new trade agreement with the EU. However, because of the methodology underlying the settlement, the total eventual cost of these various components to the UK is not yet set in stone. We explore this further below, including an assessment of the latest estimate of the costs of the five different components of the settlement as described above in light of information provided by the European Commission and the Treasury.

The fluctuating cost of the financial settlement

9.11As noted, the Withdrawal Agreement does not fix the overall cost of the settlement but sets out a methodology for establishing the UK’s contributions under its various components. As a result, the net cost of the settlement to the taxpayer will be dependent on various factors, including in particular:

9.12In the following section, we have described the Treasury’s latest estimate of the cost of the various components of the settlement in light of recent developments and EU budgetary information published by the European Commission.

The cost of the financial settlement

9.13When the components of the financial settlement were first provisionally agreed between the UK and the EU in the “Joint Report” of December 2017, the Treasury estimated that the net cost of the settlement would fall between £35 billion and £39 billion.96 This was based on the information available at the time, including the scheduled UK withdrawal date of 29 March 2019, at the end of the two-year negotiating period foreseen for departing Member States under Article 50 of the EU Treaty initiated by the then-Prime Minister (Rt Hon. Theresa May MP) on 29 March 2017.97

9.14In its latest annual EU Finances Statement on the UK’s financial contributions to the EU, published on 13 July 2020, the Treasury has provided an update of this estimate. It now takes into account the extension of the UK’s EU membership from March 2019 to 31 January 2020 as required by Parliament98 (which increased the amount the UK paid into the EU budget while still an EU Member State, and therefore decreased the size of the post-Brexit financial settlement). The Treasury also says it has improved its modelling with the Government Actuary Department, and factored in the financial information contained in the EU’s most recent accounts.

9.15The Treasury now estimates that, had the UK left the EU on 29 March 2019 as originally planned, the net cost of the UK’s payments into the EU budget under the settlement would have been €42.5 billion or £37.6 billion, within the £35 billion to £39 billion range set out in the its initial estimate in January 2018.

9.16Removing the contributions made by the UK as an EU Member State during the extension of the Article 50 period from March 2019 to January 2020, which amounted to €8.4 billion (£7.3 billion), its latest forecast is that the actual net cost of the financial settlement to the UK from its withdrawal from 31 January 2020 onwards will be €34.1 billion, or £30.2 billion.99 By comparison, in March 2020 the independent Office for Budget Responsibility (OBR) estimated the cost of the settlement would be £32.9 billion. The Government ascribes the difference to the Treasury’s access to non-public data, the OBR’s use of a forecast of the euro-sterling exchange rate, and a different approach to calculating the EU’s pension liability (see paragraphs 33 to 39 below).100

9.17However, the Treasury’s forecasts of both January 2018 and July 2020 exclude the UK’s continued contributions to the EU’s ‘off budget’ schemes, principally the European Development Funds, since its definition of the settlement for the purposes of estimating its cost only covers those elements which involve payments into the general EU budget.101 Its latest EU Finances Statement does nevertheless include a separate estimate for the likely cost of this component of the settlement, amounting to €2.8 billion (£2.5 billion).102

9.18By including the July 2020 forecast for the UK’s payments to the EU’s ‘off budget’ programmes, the Treasury now estimates the total net cost of the Brexit financial settlement in the Withdrawal Agreement from 31 January 2020 onwards will be €36.9 billion (£32.7 billion).103

9.19We have elaborated on the cost of the different components of the financial settlement, including the ‘off budget’ components, further in the remainder of this Report, and how the likely cost of these separate elements have changed since the original Treasury estimate in January 2018.

The UK’s contributions to the EU Multiannual Financial Framework 2014–2020

9.20The first two components of the financial settlement cover the UK’s contributions to EU spending made under its current long-term budget, the Multiannual Financial Framework 2014–2020.104 They relate, respectively, to the UK’s payments for the remainder of 2020 (i.e. until the end of the current budgetary period) and its contribution to outstanding budget commitments made before 31 December 2020 but which are to be paid in 2021 or beyond.

UK contributions to the EU budget in 2020

9.21The first component requires the UK to pay into the EU budget as if still a Member State until 31 December 2020. In return, the UK remains largely eligible to be awarded EU funding as if it was still in the EU until that date.105 The UK’s payments into the EU budget in 2020 are calculated on the basis of the EU’s pre-withdrawal legislation on Member State contributions,106 which Parliament approved by means of the European Union (Finances) Act 2015. In particular, this means the UK rebate continues to apply to those contributions.107

9.22The UK’s eventual net contribution to the EU budget in 2020 will, as noted, depend on the flow of EU money back to the UK on the basis of funding decisions made by 31 December 2020.108 It can therefore not yet be definitively established.109 However, the Treasury’s latest EU Finances Statement estimates that the UK net contribution to the EU budget from 1 February to 31 December 2020 — i.e. excluding contributions and receipts in the final month as a full Member State of the EU — will amount to €9.1 billion (£8.1 billion).110 This takes into account the UK’s estimated receipts from the EU budget over that period.111

The UK’s contributions to the EU’s ‘Reste à Liquider’ from 1 January 2021

9.23From 1 January 2021 onwards, the UK will pay for a share of the EU’s outstanding budgetary commitments made by 31 December 2020 (known as the ‘Reste à liquider’ or RAL). It will also still receive any funding due to UK recipients made by that date under the budget arrangements for 2020 (see above), but not yet fully paid out. The RAL is the difference between EU spending commitments made by the end of the current Multiannual Financial Framework, which are capped, and what it has actually paid out. It therefore decreases as such payments are made, and where the EU makes so-called ‘decommitments’, or cancellation of planned spending, meaning less money is required to be paid.

9.24In June 2020, the European Commission published its latest long-term forecast for the RAL at the end of the EU’s current long-term budget on 31 December 2020, estimating it will reach €308 billion (£280 billion), but with decommitments expected to reduce this amount by €9 billion (£8.2 billion) from 2021 to 2025.112 The UK’s share of the RAL, in other words what it must pay under the settlement, will be calculated as its average contribution to the EU budget from 2014 to 2020, as a proportion of all contributions by the UK and the 27 remaining Member States over that period. The Office for Budget Responsibility has estimated this share will be 12.3 per cent.113 The rebate will be factored into the payments due under this component of the settlement, because it is reflected in the average contributions used to calculate the UK’s share.

9.25In its latest EU Finances Statement the Treasury estimates that the UK’s net contribution to the EU’s outstanding budgetary commitments (the RAL) from 1 January 2021 onwards will be €23.2 billion (£20.6 billion), to be paid from 2021 to 2026. This takes into account residual receipts from the EU budget for UK recipients, which had already been awarded before the end of 2020, over that period.

9.26The OBR in March 2020 estimated the RAL component of the settlement would represent a net cost to the UK of £19.2 billion.114 In January 2018, the Treasury itself estimated this net cost to fall in the range of €21 billion to €23 billion, meaning its latest forecast is somewhat higher. However, insofar as this increase is due to the larger estimate for the EU’s RAL overall as indicated by the latest Commission figures, this would not imply a higher overall cost of the settlement.115 Instead, it would reflect the fact that the UK paid commensurately less either as a Member State or under the settlement before 31 December 2020, leaving more to be paid from 2021 onwards.116

Increases in the EU budget for 2020 related to the coronavirus crisis

9.27The total amount of spending commitments the EU can make by 31 December 2020, and by extension the maximum size of the RAL to which the UK will contribute under the financial settlement, is capped by the 2013 Regulation establishing the EU’s Multiannual Financial Framework (which was approved unanimously by all Member States, then still including the UK).117 Moreover, the Withdrawal Agreement contains specific provisions that protect the Treasury from having to pay towards funding commitments in 2020 that are predicated on an increase in the EU’s spending limits agreed after the UK ceased to be a Member State.118

9.28This safeguard has had practical consequences in the context of the current coronavirus crisis, which has led the EU to adjust its spending plans for 2020 significantly through seven ‘amending budgets’ and depletion of its financial reserves for the year. In particular, on 17 April 2020 the European Parliament and the 27 Member States in the Council of Ministers formally approved an amendment to the 2014–2020 Multiannual Financial Framework. This modified a reserve known as the ‘Global Margin for Commitments’. In essence, the change allowed the EU to commit an additional €2 billion (£1.8 billion) in funding in 2020 for healthcare-related purposes (whereas prior to the amendment, this money could only have been used for “policy objectives related to growth and employment, in particular youth employment, and to migration and security”). The bulk of this new money is to be used for EU-wide Advance Purchase Agreements for a future coronavirus vaccine, a scheme in which the Government has since decided not to participate.

9.29The EU has asserted that the UK will have to pay towards this additional €2 billion of EU spending under the financial settlement — irrespective of whether it chooses to participate in the vaccine purchase scheme — because the change is “limited to the purpose” of the Global Margin for Commitments. In other words, the EU argued that it could have decided to spend the additional money anyway without the recent legal modification, even if only for a more limited range of public policy purposes, and therefore any such expenditure is covered by the UK’s existing financial obligations under the settlement.

9.30When the Chief Secretary to the Treasury submitted an Explanatory Memorandum on these changes on 5 May 2020, he did not indicate whether the Government accepted this assertion and, by implication, the implied obligation for the UK to pay towards this increased EU expenditure.

9.31We therefore specifically asked the Minister to clarify the Government’s position. On 4 June, before we had received the Minister’s reply, it became clear from press reports that the Government did not in fact agree with the EU’s interpretation of the UK’s obligations under the financial settlement with respect to the €2 billion of additional spending using the amended Global Margin for Commitments.119 We are awaiting information from the Treasury on the outcome of its discussions with the EU on whether the UK will need to contribute towards this extra EU spending.120 The latest EU Finances Statement notes that “the financial effect” of the EU’s amendments to its 2020 budget — including the contested extra €2 billion of spending described above — is to increase the gross cost of the settlement to the taxpayer by “£307 million, with the net effect, after taking account of UK receipts, expected to be lower”.

9.32Separately, the European Commission also proposed to increase EU spending in 2020 by a further €11.5 billion (£10.5 billion) for COVID-related support schemes as part of its overall €750 billion Coronavirus Recovery Fund. The Commission and the Treasury have confirmed that the UK will not have to contribute to this increase, which is yet to be formally approved by the Parliament and Council, and nor will it be eligible to receive funding from the EU schemes to which this additional money would be spent.121

The UK’s contribution to the EU’s pension liabilities

9.33Under the financial settlement, the UK will pay towards certain EU liabilities and also receive certain assets. In this latter category are the return of the UK’s €3.5 billion paid-in capital with the European Investment Bank and the European Central Bank, and a share of the EU’s unused provisioning funds for its programmes where it offers a guarantee against its budget to leverage investment by other organisations such as the EIB.122 Many of the liabilities for which the UK has assumed a share are contingent and may not crystallise, as discussed further in paragraphs 43 to 48 below.

9.34As a result, on the liabilities side, the largest definitive component relates to the EU’s bill for its staff pensions. Under the terms of the financial settlement, the UK will pay for a share of this liability — again calculated using its average proportion of Member State contributions to the EU budget over the 2014–2020 period, likely to be approximately 12.3 per cent — insofar as they relate to entitlements of EU civil servants “accrued on or before 31 December 2020”.123 It can pay for these costs as they fall due with yearly contributions likely to stretch into the 2060s, or — at the Government’s discretion — opt to settle the entire liability early in five large annual instalments.124

9.35The ultimate cost to the Treasury of paying for the UK’s share of the EU’s pensions bill is difficult to estimate in advance, as it is a long-term liability dependent on many factors. In particular, the EU’s post-employment benefits for its employees125 are financed by a notional fund, where contributions, although not actually invested, are “considered to have been invested in the Member States’ long-term bonds” and registered in the EU’s annual accounts. This approach means that valuation of the cost of this liability is affected, among other things, by the yield on sovereign debt issued by EU countries, as well as by the expected rate of inflation.

9.36In the EU’s annual accounts for 2019, the European Commission recorded the estimated net present value of the pensions liability as €97.7 billion. This is up from €80.5 billion in 2018 and €73.1 billion in 2017. Explaining this increase, the Commission notes that the real discount rate last year turned negative for the first time. In actuarial terms, this meant that “any given amount is worth more today than in the future”, which “significantly increases the size of the liability at year-end”.126 As such, the amount recorded in the EU accounts is not definitive and therefore cannot be taken to represent the actual cost of the liability to which the UK will contribute under the financial settlement.127 However, if the Government were to decide to make use of the option to settle the UK’s contribution to the EU’s pension liability early, the amount due would be calculated using the net present value at that point (meaning it is possible there would be a significant difference in the UK’s contribution if settled this liability early, or — the default option — as payments fall due in the coming decades).

9.37In its initial forecast for the cost of the financial settlement in January 2018, the Treasury estimated that the cost to the UK of the EU pensions bill would amount to €8.7 billion.128 In its latest estimate of July 2020, this has been revised to €9.3 billion (£8.3 billion), which it said relied on “more accurate and sophisticated modelling”, and is expected to be paid from 2021 until 2064. The OBR’s estimate in March 2020 for the cost of the pensions liability was significantly higher, putting the UK’s share at £11 billion. The Treasury says the difference is primarily due to the OBR not having taken into account the likely lower actual cost of the EU pensions bill given the historically low current net discount rate,129 whereas the Government has. Given the current high valuation of this liability, the Government has, prudently, not indicated it wishes to exercise its option to settle it early at present.

9.38Taking into account the assets the UK will receive back from the EU, the Treasury estimates that the overall net cost of the component of the financial settlement relating to liabilities and assets — in essence, deducting the value of assets to be received from the EU from the cost of the pension liability — will be €1.7 billion (£1.5 billion). In January 2018, it had forecast the cost to be between €2 billion and €4 billion. Given that the estimated cost of the UK’s contribution to the EU’s pensions bill has risen, this presumably means the value of the assets the Government expects to receive back has also increased.

9.39The OBR in March 2020 put the net cost of the assets and liabilities component of the settlement at £4.8 billion compared to the Treasury’s £1.5 billion, the difference being due mostly to the divergence in the estimate of the pensions liability as described above.

UK contribution to the EU’s “off-budget” programmes

9.40Under the Brexit settlement, the UK has also agreed to resolve certain residual financial obligations to a number of EU programmes and bodies which are not funded by the general EU budget but, for a number of reasons, are financed by the EU’s Member States directly. These are:

9.41Of these, the European Development Fund (EDF) constitutes by far the largest financial liability. The EDF is the EU’s development assistance scheme for over 70 countries in Africa, the Caribbean and the Pacific, largely former colonies of the UK, France and the Netherlands. In 2013, under a separate treaty with the other 27 EU countries, the UK agreed to contribute €4.5 billion (£4.1 billion) to the Fund towards spending commitments over the 2014–2020 period. Article 152 of the Withdrawal Agreement obliges the Government to honour that commitment.

9.42In its latest EU Finances Statement, the Treasury estimates that the combined net cost of the different elements of the ‘off budget’ EU schemes to which the UK will contribute is €2.8 billion (£2.5 billion), of which €2.7 billion (€2.3 billion) relates to the EDF.131 The Treasury’s initial estimate of the cost of the settlement in January 2018 did not include a figure for the overall ‘off budget’ component, meaning it is not possible to compare this latest forecast to an earlier iteration. The OBR’s March 2020 estimate also does not include the UK’s contributions to the above EU schemes.

UK exposure to the EU’s contingent liabilities

9.43The final component of the financial settlement relates to the UK’s exposure to contingent liabilities, principally those that were entered into the EU’s accounts before the UK ceased to be a Member State on 31 January 2020.132 This, as the term implies, is different from the other elements described above because these liabilities may never crystallise, and therefore there would be no UK contribution required.

9.44The contingent liabilities covered by this part of the settlement include, in particular, guarantees from the EU budget to support financial operations both inside and outside the EU like the External Lending Mandate, the European Fund for Strategic Investments (EFSI) and the European Fund for Sustainable Development (EFSD).133 Similarly, it covers outstanding macro-financial assistance loans provided by the EU not only to Member States Ireland and Portugal,134 but also to non-EU countries like Ukraine and Jordan.135 The Withdrawal Agreement stipulates that the UK will receive a share of any associated funds the EU has set aside to meet potential calls on these guarantees, to the extent the UK’s share of these guarantee funds is not drawn upon.

9.45In addition, as noted above, the UK has provided a guarantee in relation to certain financial activities of the European Investment Bank (EIB). The EIB is the EU’s main financial institution, providing support — primarily in the form of loans and equity — in large infrastructure projects. The Withdrawal Agreement states that the UK has a liability towards the Bank, primarily in relation to the latter’s financial operations approved before the UK’s withdrawal on 31 January 2020 and “other EIB risks as long as such risks are not related to post-withdrawal lending”.136 The effect of this provision is that the UK could be required to inject capital into the European Investment Bank if considered necessary in light of the Bank’s “payment obligations, the state of its assets and liabilities [or] its standing in capital markets”.137 A decision to make such a capital call that includes the UK would be made by the Board of Directors of the EIB, without Government input.138

9.46We are aware of concerns that the economic damage caused by the coronavirus pandemic may jeopardise the financial position of the EIB to an extent that it requires a capital injection. However, it is important to note that the EIB’s ability to require additional capital at the expense of the British taxpayer are curtailed by three important legal safeguards in the settlement:

9.47Moreover, the European Investment Bank has other means at its disposal before it makes a capital call on the UK and the remaining 27 Member States, for example by drawing on its accumulated financial reserves.

9.48In June 2020 the Chief Secretary to the Treasury (Rt Hon. Steve Barclay MP) told us that the Government had received “no indication” that the EIB was considering a capital call that would involve a UK contribution under the terms of the Withdrawal Agreement. It should be noted however that the Government is under a legal obligation to keep any such request confidential unless otherwise authorised by the EIB or the capital call is made public.142 While the impact of the coronavirus could make it more likely that the UK’s guarantee could be called on, materialisation of the need for the UK to pay the EIB the maximum amount for which it is theoretically liable under the settlement would only occur in extreme economic circumstances.

9.49With respect to the totality of the EU contingent liabilities to which the UK is exposed under the financial settlement, the Treasury in its latest EU Finances Statement of July 2020 refers to them all — including the EIB guarantee — as “remote” and accordingly does not forecast any cost to the taxpayer associated with them.143 It does indicate that the estimated maximum liability, in the unlikely event that they would all materialise in full, at March 2019 amounted to £40.5 billion (of which £30.6 billion related to the guarantee for the EIB).144 The amounts involved will decrease over time with the underlying EU liabilities, given that the UK is not exposed to most new contingent liabilities created by the EU since 31 January 2020.145

9.50The Committee will continue to monitor any relevant developments in this regard closely, especially with respect to the financial position of the European Investment Bank.

Conclusions

9.51The Treasury’s latest update on the estimated cost of the Brexit financial settlement compared to its original forecast in January 2018 demonstrates the need for continued vigilance on the part of Parliament in monitoring its implementation. In particular, the estimate of the EU’s pensions liability, and the Government’s option to settle the UK’s share of this liability early, deserve close scrutiny. Similarly, whether the Treasury’s assumption that none of the EU’s contingent liabilities to which the UK is exposed under the settlement are likely to crystallise is valid, will require regular reassessment, especially with respect to the financial position of the European Investment Bank in light of the UK’s £35.2 billion conditional guarantee to that institution.

9.52Given the overall cost of the Brexit financial settlement to the UK taxpayer, and the continued political salience of the implementation of the Withdrawal Agreement, the Committee draws this Report to the attention of the Committee on the Future Relationship with the EU, the Public Accounts Committee and the Treasury Committee.


68 (a) Consolidated Annual Accounts for the European Union for the Financial Year 2019; (b) Annual Accounts for the European Union for the Financial Year 2019; (c) Financial information on the European Development Fund European Development Fund (EDF): forecasts of commitments, payments and contributions; (d) Long-term forecast of future inflows and outflows of the EU budget (2021–2025); (a) COM(2020) 288; (b) COM(2020) 289; (c) COM(2020) 235; (d) COM(2020) 298; Legal base: -; Department: (a), (b) and (d); HM Treasury; (c) International Development; Devolved Administrations: Not consulted; ESC number: (a) 41370; (b) 41369; (c) 41345; (d) 41373.

69 See footnote 1.

70 This includes an estimated £2.5bn UK contribution under the settlement to ‘off budget’ EU schemes like the European Development Fund, as we explain elsewhere in this chapter. This amount is not usually included by the Treasury in its headline figure for the cost of the settlement because this money does not flow into the general EU budget.

71 The Treasury told us in June 2020 that it had received “no indication” that the Bank was considering a capital call that would involve the UK under the terms of the financial settlement, but the Withdrawal Agreement requires the Government to keep any such request confidential until the Bank itself makes it public. It should be noted however that the UK’s maximum liability is capped at €39.2 billion, and will automatically decrease over time. This full sum could only be due in the extremely unlikely event that all the remaining 27 Member States also had to fully pay in their callable capital with the Bank.

72 The need for a financial settlement was one of the EU’s first requests when the Government triggered the Article 50 process to withdraw from the European Union in March 2017, reflecting the significant financial consequences for the EU budget of the loss of the UK as a major net contributor.

73 The UK’s vote in favour of the 2014–2020 Multiannual Financial Framework is recorded in EU Council document 17253/13. Parliament also approved a separate “Own Resources Decision”, which establishes how the EU’s spending over that period is financed by its Member States, by means of the European Union (Finance) Act 2015.

75 The financial settlement is contained in Part Five of the Withdrawal Agreement.

76 Article 148 of the Withdrawal Agreement states that the “reference dates for payments by the United Kingdom to the Union or by the Union to the United Kingdom made after 31 December 2020 shall be 30 June and 31 October of every year”. It also contains specific rules for the payment of the amounts due under the different components of the settlement.

77 Article 135 of the Withdrawal Agreement.

78 Articles 137 and 138 of the Withdrawal Agreement.

79 Article 140 of the Withdrawal Agreement.

80 Article 139 of the Withdrawal Agreement.

81 OBR Economic Forecast: Fiscal Supplementary Tables, Expenditure (March 2020).

82 Discussions on the EU’s Multiannual Financial Framework for the 2021–2027 period are on-going, with a view to agreement by the end of the year. They are being held in parallel to negotiations on the EU’s €750 billion Coronavirus Recovery Fund. See for more information our Report of 22 July 2020.

83 See Articles 141 and 142 of the Withdrawal Agreement. The timing of payments varies for the different liabilities. For example, Article 142(6) states that the UK will be contributing to the pensions of regular EU staff from 30 June 2022.

84 See in particular Articles 145, 146 and 150 of the Withdrawal Agreement. The assets to be returned to the UK are fairly limited. They do not include, for example, a share of the money invested by the EU — using the UK’s contributions — to its space programme, or the returns generated by the European Investment Bank using its paid-in capital from EU countries including, until 31 January 2020, the UK.

85 The twelfth and final installment will amount to the residual €196 million.

86 Articles 152 to 157 of the Withdrawal Agreement.

87 See in particular the “Internal Agreement“ of 6 August 2013 establishing the 2014–2020 European Development Fund.

88 Articles 143, 144 and 150 of the Withdrawal Agreement. Aside from the guarantee to the EIB these contingent liabilities include, for example, the EU’s macro-financial assistance loans to a number of non-EU countries like Ukraine and Moldova, and pending legal cases against the EU if these result in the need for compensatory payments. The UK also faces a different kind of contingent liabilities in relation to any financial obligations that may arise for the Government as the result of any EU Court of Justice judgments for failure to correctly apply EU law before the end of the post-Brexit transition period. Potentially the most significant such contingent liability relates to a pending case in which the European Commission is seeking recovery of over €2 billion in evaded duties as part of a claim the UK incorrectly applied EU customs rules to imports of Chinese textiles. This would not be part of the financial settlement, which relates to the UK’s share of the EU’s financial obligations to third parties.

89 This means the UK guarantee relates primarily to EIB lending operations which were approved on or before the UK’s withdrawal from the EU on 31 January 2020, and “other EIB risks as long as such risks are not related to post-withdrawal lending”. The Withdrawal Agreement refers to this as “other such risks that are not associated with specific financial operations and are not attributable to the stock of financial operations built after the date of entry into force of this Agreement”. The European Investment Bank has clarified that this liability exists only where “such risks are not related to post-withdrawal lending”.

90 These include, in the words of the Treasury, “the final salaries of the employees [covered by the EU pension scheme], their years of service and the length of time they live in retirement”.

91 The UK’s obligation in respect of outstanding EU budget commitments by the end of 2020 — the RAL — is based on money that actually needs to be paid out. As the RAL component is the difference between committed EU spending and what still needs to be paid out, decommitments — cancellation of planned EU spending — reduce outstanding budgetary commitments, leading to a lower RAL and therefore decreasing the amount to which the UK needs to contribute.

92 This is the case because the size of the pensions liability is partially out of the EU’s control, for reasons described elsewhere in this chapter. By contrast, how much the EU can spend from its 2014–2020 budget on ‘routine’ funding like the Common Agricultural Policy before the end of the year, which determines the combined UK exposure under the first two components of the financial settlement, is fixed and can therefore not increase beyond the limits set out in the Multiannual Financial Framework for 2014–2020 as it stood immediately before the UK’s withdrawal.

93 Article 139 of the Withdrawal Agreement provides that the UK’s share will be definitively established on the basis of the information received by the Commission by 1 February 2022 on all contributions to the EU budget by the end of 2020.

94 HM Treasury, EU Finances Statement 2019, p. 72. In particular, the Government notes that “Around three quarters of UK receipts are fixed automatically each year, through EU regulations or operational programmes […] and generally less sensitive to year-by-year variation. The remaining quarter of receipts are received through competitive grant programmes such as Horizon 2020 [the EU’s Framework Programme for Research], and by nature vary from year-to-year”.

95 Article 133 of the Withdrawal Agreement.

96 Letter from Philip Hammond, then Chancellor, to Nicky Morgan, then Chair of the Treasury Committee (24 January 2018).

97 This figure excluded the cost of the UK’s contributions to the EU’s ‘off budget’ programmes to which we referred above.

98 European Union (Withdrawal) (No. 2) Act 2019, in particular sections 1(4) and 3.

99 Using the £1:€1.13 exchange rate applicable on 31 March 2020.

100 The Treasury says that, unlike the OBR, it “does not have a target for the Sterling exchange rate and does not generally comment on currency movements”. Its estimate of the cost of the settlement therefore “uses the spot rate at the end of the 2019/20 financial year to align with the rate used in HMT departmental Resource Accounts”. This difference, it says, means the OBR reduced the expected net cost of the settlement by £1.5 billion compared to the Treasury. This is offset by its increased estimates relating to the pensions liability, which adds £3 billion to the OBR’s estimate compared to the Treasury’s, and “modelling and data source differences”, which adds £1.1 billion, resulting the OBR’s overall forecast being £2.7 billion higher.

101 The Government also says that it does not expect to meet the costs of these contributions through authority granted by the European Union (Withdrawal Agreement) Act 2020, but under different statutory authority.

102 The bulk of this amount is accounted for by UK’s outstanding contributions to the European Development Fund, estimated to be €2.7 billion (£2.3 billion). It is not possible to compare this to an earlier estimate because the Treasury’s January 2018 forecast did not contain a specific figure for these payments. The National Audit Office noted in April 2018 that the Treasury, at that point, expected the “UK’s commitments to the European Development Fund (EDF) [to] cost £2.9 billion after the UK leaves the EU”, i.e. from 29 March 2019 onwards. If that figure is broadly correct, it can be inferred the UK paid approximately £400 million into the EDF between March 2019 and January 2020.

103 Taking into account the £2.9 billion estimate for the ‘off budget’ payments in spring 2018 (see previous footnote), the cost of the financial settlement including those payments, had the UK left on 29 March 2019, would have been £40.5 billion.

104 Although Article 140 of the Withdrawal Agreement technically also makes the UK liable for a share of spending commitments outstanding by 31 December 2020 which were made under the EU’s previous Multiannual Financial Framework (for the 2007–2013 period), the European Commission estimates no such commitments will be outstanding.

105 The Withdrawal Agreement specifies, in Article 127(6), that until 31 December 2020, “any reference to Member States […] shall be understood as including the United Kingdom”, which includes eligibility for receipt of EU funding. However, Article 127(7)(b) of the Agreement limits this “where acts of the [EU] provide for the participation of Member States, […] in [a] procedure or programme which continues to be implemented or which starts after the end of the transition period, and where such participation would grant access to security-related sensitive information that only Member States […] are to have knowledge of”. In such cases, the UK is excluded. In terms of programme participation, this bars the UK from receiving certain funding under the Galileo satellite navigation programme and the European Defence Industrial Development Programme. As of 31 January 2020, the UK is also no longer eligible to be treated as a Member State fort he purposes of European Investment Bank (EIB) investment selection procedures since such investment is not funded by the EU budget.

106 As set out in the Own Resources Decision (Decision 2014/335/EU).

107 The Withdrawal Agreement also contains safeguards that prevent the EU from retroactively abolishing the rebate without the UK’s agreement.

108 The EU budget for 2020 estimated that the UK’s gross contribution for this year, including the final month of EU membership in January, would be €18.5 billion (£16.8 billion). See EU budget 2020, Table 7.

109 The UK Government annual EU Finances Statement normally calculates the UK’s net contribution by only taking into account EU funding received by the public sector. The European Commission’s calculation also takes into account EU funding awarded directly to private sector entities in the UK, like research funding for universities. As a result, the UK’s estimate of the net contribution is typically higher than the EU estimate. For the calculation of the net cost of the overall financial settlement however, the Treasury appears to have taken into account both UK public and private sector receipts from the EU budget.

111 In March 2020, the Office for Budget Responsibility estimated that net UK payments to the EU budget in 2020 would amount to £8.9 billion.

112 An increase in the RAL does not as such increase the UK’s financial obligations under the settlement. The estimated outstanding budgetary commitments reflect EU spending decisions that have been (or will be) made by 31 December 2020, but not yet fully paid at that point. A larger RAL is therefore an indication that more of the money the EU, which is legally required to pay, will be disbursed later than anticipated, not that spending overall has increased. As such, an increase in the RAL in relation to EU funding awarded before the end of 2020 — to which the UK will contribute from 1 January 2021 onwards — also means there was a concomitant decrease in EU payments before that date.

113 Because Member State contributions to the EU budget for a given year can be adjusted ex-post, the definitive UK share will be calculated only after 1 February 2022.

114 The difference, according to the Treasury, is due to the OBR using a forward-looking exchange rate forecast for the pound and euro, as well as “modeling and data source differences”.

115 The UK’s net contribution to the EU’s RAL is also affected by other factors we described elsewhere in this Report, such as receipts from the EU budget from 2021 onwards or the exchange rate.

116 Since the RAL is a function of the difference between EU funds committed and actually paid out, where overall commitments are capped an increase reflects a delay in disbursement of EU funding to recipients that has already legally been awarded. Conversely, a lower RAL — assuming no change to the EU’s cap on spending commitments — would have indicated more of the money would actually have been paid out before the end of 2020 (to which the UK would also have contributed under the settlement).

117 The EU is on course to fully commit all its available remaining funds under the 2014–2020 Multiannual Financial Framework by the end of the year, due in part to the increased spending pressures caused by the coronavirus crisis which we describe further elsewhere.

118 More specifically, any changes introduced to the Multiannual Financial Framework spending limits after the UK’s withdrawal on 31 January 2020 — and therefore, without the Government’s approval — do not apply to the UK “insofar as those amendments have an impact on the United Kingdom’s financial obligations”.

119 At a meeting on 19 May of the Specialised Committee on Financial Provisions, a preparatory body for the UK-EU Joint Committee under the Withdrawal Agreement, the Treasury reportedly told the EU that “around two-thirds of what the EU is asking the U.K. to pay into the [Emergency Support Instrument] falls outside the scope of what was agreed in the Brexit deal”. This is clearly a reference to the share of the increased funding for the Instrument from the 2020 EU budget provided via the amended GMC.

120 In July 2020, the Treasury told us that discussions with the EU on this matter were on-going and the Government was hoping to “progress” them at a meeting of the UK-EU Joint Committee in autumn 2020.

121 More information on the EU’s coronavirus-related support schemes is set out in the Committee’s Report of 22 July 2020.

122 This includes the UK receiving a share of any return on these funds where they have been invested and they did not need to be fully depleted in the event the contingent liability to which they relate crystallised.

123 Article 142 of the Withdrawal Agreement. For EU staff who retired on or before 1 January 2021, the UK will pay 100 per cent of its share of the cost. For those who retire subsequently, it will pay pro rata depending on the proportion of entitlements built up before 1 January 2021 and those built up thereafter. In other words, for EU staff who primarily build up their pension entitlement from 1 January 2021 onwards, the UK’s contribution will be proportionally lower.

124 Article 142(6) of the Withdrawal Agreement.

125 These include retirement, invalidity and survival pensions under the Pension Scheme of the European Officials (PSEO), as well as medical coverage provided under the Joint Sickness Insurance Scheme (JSIS).

126 The Commission’s accounts also attribute the increase in the liability to “the rights accrued during the year due to service are higher than the benefits paid out during the year, […] an increase due to the annual interest cost (unwinding of the liability discounting) as well as actuarial losses from experience”. The lower discount rate has had a similar effect on the other smaller employment benefit schemes operated by the EU..

127 The unpredictability of the total cost of the UK’s contribution to EU staff pensions has been clear for some time. The UK-EU Joint Report of December 2017, in which the UK Government first signalled its provisional agreement for the different components of the financial settlement, noted that this particular liability “has a long time-span and the forecast of its net present value (NPV) depends on a number of assumptions and is sensitive to, in particular, the real discount rate, which has a historically low value at [this] time”. Similarly, in January 2018 the then-Chancellor (Rt Hon. Philip Hammond) told Parliament that there was “significant uncertainty over the actual value that will be paid”, in particular because of the “abnormally low Eurozone interest rates” which resulted in a “high valuation for the pension liability in the EU’s accounts”.

128 As recorded by the National Audit Office in its Report, “Exiting the EU: the financial settlement“ (April 2018). In early 2018, the Treasury forecast the EU’s total pension liability to stand at €76.1bn by the end of 2020.

129 In its forecast in March 2020, the OBR took the latest available valuation of the pensions liability from the Commission — €97.6bn (£89.1bn) at year-end 2019 — and applied the UK’s estimated share of 12.3 per cent, resulting in a cost to the UK of £11bn.

130 The WEU was an organisation for military cooperation whose tasks have been taken over by the EU.

131 The Treasury makes the following estimates for the other ‘off budget’ schemes: £102m for the Facility for Refugees in Turkey; £23m for the CSDP agencies and operations; £16.9m for the pension costs of staff of the EUSS and the liquidation of the WEU; and £1.7m for the EU Emergency Trust Fund for Africa. It also notes that there will be an “additional cost” for the UK’s share of the pension liabilities of the EDA and EUSC.

132 The Treasury’s EU Finances Statement notes that “the exception will be costs associated with legal cases related to the [EU] budget and linked policies and programmes, which will be limited to cases where the facts relate to the period of the UK’s participation in the EU budget (before the end of 2020)”.

133 Signed guarantees from the EU budget under these three schemes amounted to €53.4bn at end-2019, according to the EU’s consolidated accounts. The aim of these Funds is to leverage high-risk investment by the European Investment Bank and other financial intermediaries in pursuit of EU public policy purposes by offering a guarantee from the EU budget, in effect partial indemnity, for certain investments. It also includes contingent liabilities related to EU guarantees for financial operations under its Multiannual Financial Framework 2014–2020, like the EU’s “InnovFin“ investment facility for research conducted by small companies under the “Horizon 2020” Research Framework Programme.

134 Ireland and Portugal received financial support from the European Financial Stability Mechanism following the sovereign debt crisis, with the funds borrowed by the EU and guaranteed against its budget if these countries do not repay. €46.8bn of these loans was outstanding at the end of 2019. Other ‘bail-outs’ made to EU Member States, under the European Financial Stability Facility (used for Greece) and the European Stability Mechanism for the Eurozone, are not guaranteed against the EU budget and therefore the UK is not exposed to them under the financial settlement in the Withdrawal Agreement.

135 At the end of 2019, the EU’s outstanding macrofinancial assistance loans to non-EU countries amounted to €4.7bn. Since then however, the EU has authorised a further €3bn assistance package under this programme for 10 non-EU countries to help them address the economic fall-out of the COVID-19 crisis.

136 Such “other risks” may, for example, relate to asset-liability management risks and operational risks.

137 Article 150(6) of the Withdrawal Agreement.

139 Article 150(1) of the Withdrawal Agreement defines the UK’s liability towards the EIB as “financial operations approved by the EIB before the date of entry into force of this Agreement […] and […] other risks assumed by the EIB”. It goes on to state that “the liability of the United Kingdom shall extend to the EIB financial operations and to asset‐liability management risks and operational risks attributable to the EIB financial operations”, while “for other such risks that are not associated with specific financial operations” the UK only has a liability were these “are not attributable to the stock of financial operations built after the date of entry into force of this Agreement” (i.e. 31 January 2020).

140 This consists of the UK’s €3.5bn of paid-in capital with the EIB, which is being repaid in twelve annual installments, and its subscribed but uncalled capital of €35.7bn. See Article 150 of the Withdrawal Agreement, paragraphs 3 and 5.

141 Article 150(3) and (5) of the Withdrawal Agreement.

142 Article 150(8) of the Withdrawal Agreement requires the EIB to “provide the United Kingdom with timely information regarding any upcoming triggering of the liability of the United Kingdom […]. The United Kingdom shall treat that information as strictly confidential until the EIB lifts the confidentiality or until the liability of the United Kingdom is triggered, whichever occurs first”.

143 This position is unchanged from the Treasury’s original forecast in January 2018.

144 The remainder of the Treasury’s EU-related contingent liabilities as at 31 March 2019 was made up of £6.3bn for the European Financial Stability Mechanism (in relation to outstanding bail-out loans for Ireland and Portugal after the sovereign debt crisis); £2.1bn for outstanding EU macrofinancial assistance loans to non-EU countries; £875m relating to EU budget guarantees under the European Fund for Strategic Investments; £411m for the EU’s “Balance of Payments Facility”, which offers financial support to non-Eurozone EU countries; and £210m for ‘other’ EU contingent liabilities.

145 The exception is the aforementioned “costs associated with legal cases related to the [EU] budget and linked policies and programmes, which will be limited to cases where the facts relate to the period of the UK’s participation in the EU budget (before the end of 2020)”. The Treasury is due to provide further information on the contingent liabilities related to the financial settlement in its Departmental and Consolidated Fund Accounts for 2019–2020.




Published: 16 September 2020