Brexit - One Year On. What this means for the EU and the UK.

By Sean O'Sullivan (Managing Partner, SOS-Consult GmbH, Zug, Switzerland).

On 23 June 2016 two simple referendum options were put to the UK electorate – whether the UK should remain in, or leave the EU. The British people were not however, given the chance to express a preference as to the sort of Brexit they wanted.

The UK Context

Britons voted to leave the EU by 51.9% to 48.1% for remaining on a turnout of 72.2% of the eligible electorate. Much of the subsequent political discussion given over to post-referendum Brexit in the UK is tied up in the closeness of that vote, which while decisive, was not overwhelming.

When former prime minister David Cameron stood on the steps of Number 10 Downing Street on 24 June 2016 to announce his resignation following the loss of the referendum vote, his Conservative government enjoyed a slim but workable overall majority of 17 or so seats in the House of Commons.

When Theresa May, took over as prime minister on 13 July 2016, she inherited that majority which then enabled her to trigger Article 50 of the Treaty of Lisbon on 29 March 2017. This is the legal route permitting a member state to leave the EU. With the support of most of the opposition Labour Party she garnered 494 votes in favour with 156 abstentions/votes against triggering Article 50. The two-year countdown process to the UK’s withdrawal from the EU was thus launched. The UK will officially withdraw from the EU on 29 March 2019… or will it?

Theresa May called a "surprise" general election on 8 June in order to “strengthen her hand” in forthcoming Brexit negotiations and fully expected to win a significantly increased majority. However, this radically backfired on her, with the Conservatives losing 22 seats, resulting in a hung parliament (no party with an overall majority). With the support of the Northern Irish DUP, she was able to form a slim “confidence and supply” majority (not a coalition) with which to govern. Following this disastrous loss, which was due to a mixture of hubris and political miscalculation, the delayed formal launch of the Brexit negotiations finally occurred with the European Commission on 19 June 2017. This meant that 3 of the 24 months of the official withdrawal period had already been lost The talks, once started, reflected the weakened political state of the UK.

At the start of the talks, the UK made a significant concession to the EU by agreeing to talk first about the terms and cost of the divorce, before moving on to the subjects that really interest the British – trade and the future relationship between the two sides. In the so-called ‘Brexit bill’ the EU is demanding a figure as high as €100bn, which some commentators see as unrealistic; a figure of between €40-80bn is being touted as more likely. This divorce settlement will have a crucial impact on everything else, because unless “sufficient progress” is made with the financial settlement and on other core negotiations such as EU/UK citizens’ rights and the Irish border question (the only land border the EU has with the UK), the EU says it is not willing to move on to other things such as trade negotiations and the future relationship.

Britain may now have a government but how much control it exercises over Parliament remains to be seen. On 29 June 2017, Members of Parliament (MPs) voted 323 to 309 – a majority of 14 – in favour of The Queen’s Speech (government programme) setting out the government’s pared-back, Brexit focused agenda for the next two years.

It is clear that the weakened government will have to call on all parties to work together on Brexit for the sake of the country as a whole, whilst sacrificing some of their own political aspirations.

It remains to be seen what type of Brexit will emerge from this current situation.

The EU context

The European Commission’s chief Brexit negotiator Michel Barnier famously quipped in June that he cannot negotiate with himself and needs a partner. This was a side-swipe at the UK for having triggered Article 50 back in March but then made little or no substantive progress by June. What does this process mean for the remaining EU27 and what is at stake for them?

The first point to note is that time is on the EU’s side, despite the challenge of maintaining the unity of the remaining 27 member states throughout the process as the negotiations progress into uncharted waters over the next year or so.

It is also important to note that each of the EU’s main institutions (Parliament, Council and Commission) have their own Brexit negotiators mandated by their own bodies. This in itself could slow down the process, as it will entail harmonising the respective positions of the different elements within the EU institutions.

A flavour of what to expect from the EU side came on 10 July, when a cross-party group of European parliamentarians (MEPs) called the UK’s offer made on EU citizens’ rights in the UK a “damp squib” and threatened to veto any Brexit deal in 2019 if the UK does not improve its terms. This it can do. The European Parliament’s chief negotiator, MEP Guy Verhofstadt (and former Belgian prime minister) said on BBC Radio 4: “[it] creates a type of second-class citizenship for European citizens living in the UK”. Asked about the European Parliament’s role in the Brexit negotiations, Verhofstadt said: “At the end, it is the European Parliament who will say yes or no on it…“ ”…and I can tell you it will not be a ‘yes’ if the rights of the EU citizens – like also the rights of the UK citizens living on the continent – will be diminished”.

In a speech to the European Economic and Social Committee in Brussels on 6 July, Michel Barnier gave a stark warning to the UK about the painful economic consequences of leaving the club. He bluntly stated that even under the best circumstances, a future relationship providing “frictionless trade” was not possible, suggesting very clearly that the UK cannot expect to be better off outside the club than within it. He further cautioned that the consequences of failing to reach an agreement for an orderly withdrawal from the EU by 29 March 2019 would mean restoring stiff customs duties, imposing expensive new costs and “very cumbersome” controls and procedures on British firms wanting to do business in the EU. These remarks seem to reflect a clear concern on the EU side about what they see as “unrealistic expectations” emanating from the British side as to what they expect to achieve from these talks.

He went on to say that without a withdrawal agreement, this would necessitate a return to the status quo ante 1973 (UK’s entry into the EEC) and therefore to the UK trading with the EU27 under World Trade Organisation (WTO) rules. In Barnier’s words, these would impose: “customs duties of almost 10% on vehicle imports, an average of 19% for alcoholic beverages, and an average of 12% on lamb and fish for which the vast majority of British exports go to the EU”.

Michel Barnier did acknowledge that the UK had set out a number of “red lines” for its future relationship with the EU including that of no free movement of EU citizens (a Swiss concern as well following their referendum on immigration in 2014); full autonomy over UK laws; the autonomy to conclude its own trade agreements and ending the jurisdiction of the European Court of Justice (ECJ) in Luxembourg. He also acknowledged that those conditions therefore meant the UK leaving not only the EU’s single market but also the customs union.

At the same time, Barnier also laid out the EU’s own immutable positions including the free movement of people, goods, services and capital (the ‘Four Freedoms’), which he said were indivisible. In other words, no cherry-picking by the UK on what it wants to keep; it has to either accept all or nothing, in order for the EU to maintain in Barnier's words, “common standards”.

Barnier further added: “The decision to leave the EU has consequences and we have to explain to citizens, businesses and civil society on both sides of the Channel what these consequences mean for them”. By that, he meant that for the UK leaving the customs union, this would involve border formalities, and a “no deal” by 29 March 2019 would mean “cumbersome procedures” and controls without facilitation. This would be particularly damaging for companies that operate on a just-in-time basis (e.g. perishable food producers, car parts suppliers etc).

In Barnier’s view, “rapid and sufficient progress” and “creating a climate of trust” in tackling these three indivisible immutable EU positions by say the autumn of 2017, namely, the Irish border question, EU citizens’ rights and the financial settlement, might then allow progress to begin on addressing the UK’s chief concerns, namely, building a new post-Brexit trade partnership between the UK and EU to the benefit of both sides.

The reality is that the window for real, hard negotiation is extremely tight. Having already lost 3 of the 24 negotiating months afforded under Article 50, the window now lies somewhere between the end of September 2017, following the German federal elections and the autumn of 2018. Under this scenario, the exit negotiations should be wrapped up by December 2017 and the terms of the post-Brexit relationship should then be agreed sometime between January and September-October 2018. This then allows sufficient time for any deal to be ratified by the EU and UK parliaments (plus the EU27’s national parliaments and in certain cases, sub-national parliaments, e.g. the Belgian Walloon region), all in time for the UK to leave the EU on 29 March 2019. By any account, this is an ambitious agenda and for some, such a timetable requires a suspension of disbelief.

What do we understand by the political phraseology of a “hard" and “soft"-Brexit?

HARD-BREXIT

A “hard” or “clean” Brexit would mean the UK being out of the EU and out of the single market (the free movement of people, goods, services and capital between all EU and certain non-EU member states). It would mean the UK exiting the customs union whereby all EU member states plus Turkey can buy and sell from each other without paying import taxes as they all charge the same taxes on incoming goods coming from outside the rest of the world into the customs union (common external tariff).

Such an arrangement would allow the UK to regain control over its borders and immigration from the EU as well as over employment rights and trade rules. It would also allow the UK control over its own trade deals with other countries such as the USA, China, Japan, India, Australia, New Zealand and Canada etc.

However, some commentators believe this option could cause “significant economic dislocation” to both the UK and EU economies where the UK’s economy is currently the second biggest EU economy after Germany’s.

Free trade agreements (FTAs) do not happen quickly even when agreements are reached between like-minded friends and allies operating under similar political and economic conditions. For example the EU recently concluded two major FTAs – the first with Canada (eight years in the making) and more recently a trade and strategic partnership deal with Japan (five years in the making, still to be ratified, and likely to contain long transition clauses of up to fifteen years). Negotiating these types of FTA highlight the significant challenges facing the UK in going it alone albeit that the EU now has to ensure under Commission president Juncker at least, unanimity amongst its member states (including where relevant, sub-national agreement) for any FTA to be fully ratified.

In July, the UK also announced it was pulling out of EURATOM (European Atomic Energy Community) regulating the EU’s nuclear safety, transport, research, and waste policies. This is an inevitable consequence of the UK not wanting to be subject to ECJ jurisdiction or being part of the tariff-free borders for the nuclear industry’s skilled workers and equipment, which continued membership entails. Aware of the consequences of withdrawal, the UK might be looking into some form of “associate membership” similar to that held by Switzerland or paying money into an international agency to set up an independent arrangement.

SOFT-BREXIT

Under this scenario, jobs and the economy would take priority over controlling immigration or regaining sovereignty. The UK could gain special access to the single market in return for making it easier for EU immigrants to live and work in the UK.

Separately, the UK could stay in the EU customs union, allowing free movement of goods but crucially not of people (UK “red line”). EU trade laws would still apply, which would prevent the UK government from signing its own separate trade deals with other countries thus making MP Liam Fox's Department for International Trade effectively redundant. This would be politically tricky for the British government to pursue given the current political climate in the UK.

What are the UK's options?

Whatever the Brexit options facing the UK government, none of them are particularly clear-cut or carry the full support of the House of Commons. Added to this is the instability and uncertainty over whether the minority British government elected on 8 June can even survive long enough to see out these negotiations to anything like a successful conclusion.

On 11 July, as a sign of how desperate her position had become, Prime Minister May extended an unprecedented invitation to the opposition Labour Party to help her create policies for a post-Brexit Britain as she attempts to quell a Conservative Party plot to replace her. Ironically, this announcement fell on the first (and possibly last) anniversary of her coming to power. She has been forced to acknowledge that she would need the support of the Labour front bench (shadow cabinet) to implement Brexit including passage of the “Repeal Bill” or more accurately to give it its official title, “The European Union (Withdrawal) Bill” published on 13 July, which sets out how EU law will be transposed into UK law. This ensures legislative and regulatory continuity following Britain’s departure from the EU on 29 March 2019. Following that departure, the UK can then decide which pieces of EU legislation to keep, amend or scrap. By ending the supremacy of EU law, which this Bill does by repealing the European Communities Act (1972), Britain is sending the first real signal since the referendum a year ago, that the UK is on the road to Brexit. MPs should get to vote on it in September.

A soft-Brexit approach would be a rethink of strategy, and indicates that the previously imagined hard-Brexit may not only be impossible but also undesirable. The government anyway does not have the numbers to legislate for a clean break. Nor does it have the time or administrative capacity to negotiate a bespoke Norway-style European Economic Area (EEA) agreement or Swiss-style bi-lateral agreements with the EU.

The answer maybe lies in having a two-stage process. In the first lasting perhaps three or four years beyond 2019, Britain would remain in the customs union and single market through an arrangement within the EEA - similar though not identical to that enjoyed by Norway (or Switzerland which is anyway outside the EEA) - including a zero-tariff interim deal. Britain could also temporarily become a member of the European Free Trade Association (EFTA) while both sides transition into their future relationship. This three to four year stop gap, perhaps including a two-year notice clause if either side wished to withdraw, would allow for talks on a subsequent permanent association pact, embracing security and foreign policy (perceived UK strengths) as well as on trade.

In reality, this would be the UK swapping a significant voice and influence in the shaping of European affairs for a small measure of autonomy. But this is the nature of the Brexit decision. The choice is not between a “good” and “bad” Brexit per se, but one of a sensible trade-off to be fully negotiated between the EU and UK to each other's mutual benefit.

A two-stage plan would also have attractions for the EU27. It avoids the shock of a chaotic Brexit and would guarantee Britain's continued contribution into the Brussels budget for several more years post 2020. Put crudely, Germany and France would not have to pay more into the EU budget, and the likes of Poland and Slovakia would not be obliged to accept less in EU support funds. This may even become part of the trade-off to be negotiated over the financial “divorce settlement” between the UK and EU.

A smooth Brexit for the EU would also give Germany and France (under its new pro-EU president) and others, the space to press ahead with deeper integration of the eurozone economies and closer collaboration in defence and foreign policy by adding economic and political dimensions to the present monetary union.

The EU emerging from such a process would be one of concentric circles of members radiating outwards according to their willingness to agree on more or less co-ordination of national policies. There might well be space in one of the outer circles for a Britain anxious to maintain autonomy over economic policies, but willing to contribute more say, to a European foreign or even defence policy.

For hardline Brexiteers, accepting none of this would be delusional. Negotiating such a softer-Brexit deal would not be trouble-free either. Britain would secure only limited concessions on free movement of workers for example, but measured against the inanity of the hardcore Brexiteer's “have-your-cake-and-eat-it” approach or the certain chaos of a cliff-edge departure, this looks like the best choice. There is also the added advantage of there being a majority in the new parliament for just such a type of deal to be voted through in the House of Commons. Theresa May (or her successor) must now decide whether to put country above party.

On 9 July, Sir Vince Cable MP, and now the new leader of the pro-EU Liberal Democrats told the BBC’s Andrew Marr Show that he is: “beginning to think Brexit may never happen” due to the enormous divisions within the Labour and Conservative parties. In his view, a “deteriorating economy” may make people think again: “People will realise that [the UK] didn’t vote to be poorer, and [I] think the whole question of continued membership [of the EU] will once again arise”, he said.

As far-fetched as Sir Vince’s suggestion might seem to some, it cannot be ruled out should the Brexit negotiations break down or flounder in the coming months. Business investment requires a degree of certainty in order to perform. It is continued immediate uncertainty that could do longer-term economic damage to the health of the UK economy post-referendum as much as speculating on what result might come about in just under two years' time.

On 16 July, again on the Andrew Marr Show, the UK Chancellor of the Exchequer (finance minister), Philip Hammond MP suggested that a transitional Brexit was the most plausible option for the government to pursue. 

In July, amid increased concern that London’s status as a European financial hub will be badly hit if the UK leaves the single market, a high-level delegation of City of London business leaders went to Brussels to press for a post-Brexit deal on financial services. The UK government has promised to fight to maintain the City’s position where currently, nearly 80% of foreign exchange trading and 30% of all bank lending in the EU flows through the UK. This is a response to the revelation in June of a draft EU law giving the European Commission the power to move the lucrative euro-clearing business out of London and into the eurozone after the UK leaves the EU. Whilst Brexit is a “massive issue” for the financial industry based in the UK, it is also an important issue for European corporates wishing to access the UK market post-Brexit in 2019 and beyond.

Many firms, including some Swiss banks and insurance companies, may have plans in place to move their staff and operations presently domiciled in London out of the UK and into the eurozone. This would allow them to still take advantage of (and for the Swiss at least, limited) “passporting rights” - which enable financial service firms to operate throughout the EU – under the single market.

This is but one problem for the Swiss business community to deal with, due in part to the level of uncertainty surrounding what the final outcome of the Brexit negotiations will be.

The other is political, namely, the knowledge that London is eyeing Bern very closely when it comes to seeing what type of deal is being offered to the Swiss by the EU as the bi-lateral accords between Switzerland and the EU are being updated. The hope in London is to get something similar.

Such attention is unwelcome in Bern, knowing as it does that the EU can afford to give the Swiss a little more wriggle room on questions such as the free movement of people whereas for a larger, more awkward state such as the UK, this becomes a whole lot more complex an issue all round. Indeed, on 13 July, the Scottish and Welsh first ministers, along with Labour Party leader Jeremy Corbyn met with Michel Barnier in Brussels, auguring possibly even more problems for the passage of the “Brexit Bill” through the House of Commons in September.

The overriding fear in Bern must be that the efforts being made by the Swiss in negotiating their own arrangements with Brussels, may well make them a hostage to fortune to London’s Brexit issues, and that they might therefore find themselves getting involuntarily caught up in the much bigger jet stream of the Brexit negotiations now underway between Brussels and London.