Brexit: A new economic reality fast approaching
The Brexit transition deadline is rapidly approaching and the window for a post-Brexit trade deal is closing fast. At the beginning of 2020, just before the pandemic hit, the UK left the EU with the Withdrawal Agreement, which sets out how the country will exit the union, but not the terms of the relationship going forward.
This means that the new relationship needs to be negotiated, with trade deal terms attracting the most attention among many areas of the divorcing process, which comes as no surprise given how many aspects of the economic reality will be affected by it.
Impact on trade
As the UK’s largest trade partner, the EU is accounting for around half of its trade. If the UK leaves without a trade deal, it could cost the country more than the pandemic. A recent study found that in the long-run, Brexit – even if followed by a trade deal – would decrease UK’s GDP by 3.1% and exports by 6.3% compared to a scenario where the UK remained in the EU. However, without a trade deal, the cost would increase to 3.9% of GDP.
By leaving the EU, the UK left trade agreements, including the single market and customs union, which were the foundation of the member countries’ relationship. The single market agreement means that countries share the same rules on product standards and access to services, while the customs union allows goods to travel among EU countries without border checks and taxes (tariffs).
Without these or any other agreement in place, British goods exported to EU countries will be subject to tariffs, which will make them more expensive relative to domestic European tariff-free goods.
However, there are also non-tariff barriers to trade to consider. They include a wide range of factors that raise trade costs, including border controls, dealing with different regulations, rules of origin checks, etc.
The Northern Ireland protocol
Due to the sensitive historical legacy, the border checks between Northern Ireland and the Republic of Ireland – the only land border between the UK and the European Union – will not be imposed.
Under the Northern Ireland protocol, effective from January 2021, Northern Ireland will continue to enforce the EU’s customs rules and follow the single market rules to prevent border checks with the Republic of Ireland from becoming necessary.
However, goods from other parts of the country traveling through Northern Ireland to the Republic of Ireland as the final destination will need to be checked and taxed. That means that a regulatory and customs border in the Irish Sea will be necessary to enable checks on goods entering Northern Ireland from Great Britain (England, Scotland and Wales) to ensure that any taxes, known as tariffs, on EU-bound goods are paid and that products comply with EU standards. If the goods stay in Northern Ireland, the taxes will be refunded. The extent of these checks is still to be agreed upon.
The Northern Ireland protocol will be necessary even if the UK and the EU reach a trade deal that eliminates tariffs on each other’s goods because EU law requires some product-standard checks, even if tariffs are eliminated.
Impact on financial markets and financial services sector
The UK’s departure from the European Union will have a considerable long-term impact on the UK and the EU’s financial services sector. From 31 December 2020, when the transition period comes to an end, if there is no Brexit trade deal for financial services, no concessions and no equivalence determinations, the UK will be treated like any other so-called “third country.” This will burden the UK’s financial system as the EU regulatory framework imposes additional registration, equivalence and other criteria on third-country regimes and entities.
For example, the London Stock Exchange’s Main Market will no longer qualify as an EEA regulated market, which will impact the eligibility of debt securities listed there as ECB (European Central Bank) collateral.
Also, prospectuses for public securities issuance approved by the UK FCA after 31 December 2020 will no longer be able to take advantage of passporting, a beneficial feature that allows a prospectus approved by a relevant authority in one EEA jurisdiction to be used to make a public offer or to admit to trading on a regulated market in another.
Equivalence, or the concept that one jurisdiction’s regulatory or supervisory regime is of an equivalent standard to that which applies in another jurisdiction, may serve as one of the solutions. It allows the authorities in one jurisdiction to rely on supervised entities’ compliance with equivalent rules in another jurisdiction. Applied in the Brexit case, it would allow the UK to retain some privileged rights to access the EU market in certain areas. Still, this privilege could become conditional on other concessions from the UK in the trade negotiations such as fishing.
Although the focus remains on the impact of Brexit on financial services in the City of London, given its role as a global financial centre, there are significant clusters of financial services in other UK cities such as Edinburgh, Leeds and Bristol that will also be affected by decisions on issues such as equivalence, regulatory alignment and the ability of UK firms to access the single market. Also, the ease with which closely related professionals such as lawyers are able to travel to the EU for work will be affected. But compared to the City, regional financial clusters may find it harder to adjust to financial services trading relations outside of the single market.
How European producers will be affected
After the United States, the UK is the EU’s biggest export market for goods. With the UK as their second-largest export market, European exporters also need a deal with the UK – most notably car manufacturers. According to official trade figures, road vehicles were the biggest item on the list of EU goods imported into the UK last year. Valued at €53 billion, road vehicles represent almost 20% of all UK goods imports – and around half of all UK’s vehicle imports came from the EU.
Another sector is agriculture, food and drink as the UK is the top destination for the EU’s agri-food exports since 73% of UK agri-food imports come from the EU. Both sides’ pharmaceutical sector will also be affected, especially if a mutual recognition agreement (MRA) on inspections and testing doesn’t become a part of an EU-UK free trade agreement.
Preparing for the Post-Brexit world
The beginning of the next year will bring major changes regardless of the post-Brexit deal’s nature, with tariffs and regulatory red tape kicking in once the country leaves the EU’s Single Market and Customs Union. Jobs will be lost, but jobs will be created. Recent research reports that demand from the EU countries makes around 12% of the final demand for UK goods and services, translating into around 3.3 million jobs. Not all of these jobs are necessarily at risk from Brexit, but in some sectors like financial services, job losses are likely, while in others, Brexit could see an increase in jobs.
While UK businesses need to be as prepared as possible, the final outcome and its implications to business will depend on the specifics of the deal that will replace the current arrangements. Given that the UK economy has grown increasingly reliant on the service sector, both as the main driver of job creation and as a source of export demand, the country’s access to export markets in services will be crucial going forward.