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Brexit Update: Deal done?

Economic Report

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  • The EU council approved the deal agreed between the EU and the UK on 25 November, thereby concluding almost 20 months of negotiations
  • The deal means that the EU and the UK have reached an accord on the withdrawal agreement
  • The withdrawal agreement describes the divorce conditions, such as the financial settlement and the rights citizens have built in the past; it also describes the terms of the transition period and the Irish backstop
  • During the transition period that lasts until December 2020 doing business between the EU and the UK remains the same; the transition period can be extended once by a maximum of two years
  • The Irish backstop will prevent a physical border emerging between Northern Ireland and the Republic of Ireland by keeping the UK in a Customs Territory with the EU, bar the fishing sector, and keeping Northern Ireland in the EU Customs Union and parts of the EU Single Market. The UK will also follow EU legislation relevant for maintaining a level playing field
  • The deal also contains an appendix on the future relationship between the EU and the UK
  • This political declaration sets out the intentions for future negotiations, an ambitious, wide ranging and balanced economic partnership that is at core a comprehensive Free Trade Agreement with some arrangements on customs. The declaration also reveals areas on which the EU and the UK envisage maintaining close ties, such as aviation and short term mobility
  • However, given the non-binding character and the role to appease to various Brexit factions in the UK Parliament, we should take the political declaration with a grain of salt
  • Having passed the approval of the EU council, the deal now moves to the UK Parliament for approval. Getting the deal through the UK parliament looks very challenging but still possible. Moreover, the threat of a leadership challenge by the Conservative party persists
  • Meanwhile we still see an orderly Brexit as the most likely outcome, but the chances of a ‘hard Brexit’ remain almost as high

EU Council says yes

On 25 November the EU council approved the deal that the EU and the UK had been negotiating for almost 20 months. This approval seemed to be endangered by political noise from several EU members in the week preceding the Brexit dedicated emergency EU summit. However, the necessary strong qualified majority (+20 countries, +65% of the EU27 population) was reached in the EU council and the deal was thereby signed off. On the EU side the deal still requires the approval of the EU Parliament where a simple majority will suffice. As we highlighted in our most recent update, the main obstacle on the way to an orderly Brexit however is the approval of the UK House of Commons.

The final deal

The withdrawal agreement

The main document the EU and the UK agreed upon is the withdrawal agreement. From the start of the negotiations the two have negotiated on three components (Figure 2): 1) the past (the divorce conditions), 2) the future (the envisaged relationship between the EU and the UK post Brexit) and 3) the period in between (the transition period). To get a deal done the EU and the UK needed to agree on 1 and 3, which together make up the withdrawal agreement. The 584 pages document contains the conditions on which the UK will leave the EU, namely: the financial settlement between the EU and the UK, the rights that UK citizens have built in the EU and that EU citizens have built in the UK, other separation issues such as the protection of intellectual property rights and geographic indications, and the governance of the agreement. The document also sets out the terms of the transition period and of the so called ‘Irish backstop’.

The transition period

As agreed in March 2018, the UK will de facto remain part of the EU during the transition period which will last until December 2020. According to the final agreement this transition period can be extended one time by a maximum of two years. A Joint Committee in which both the EU and the UK are represented will decide on this extension before 1 July 2020. This means that the UK will remain part of the EU Single Market and of the EU Customs Union all this time, so doing business between the two blocks will remain unchanged. However, some things will change. The UK will no longer have a say on new EU legislation, though it will have to abide by it. The UK can start negotiating trade deals with other countries, but it cannot implement them during this period. One can wonder whether such negotiations will be feasible as long as the final relationship between the EU and the UK remains undefined. Moreover, as the UK will no longer be an EU member, all economic agreements the EU has with the rest of the world will no longer apply to the UK. The EU cannot unilaterally extend these agreements and needs the consent of the counterparties for an extension, which is not for granted. Hence, the trade relationship between the UK and some countries could fall back on WTO rules and that could also impact the costs of UK throughput.

The Irish Backstop

A large part of the 584 pages document is dedicated to preventing a physical border between Northern Ireland and the Republic of Ireland, the so called ‘Irish backstop’. The Irish backstop kicks in if the EU and the UK fail to have a new deal by the end of the transition period or if the deal they agree erects a physical border between Northern Ireland and the Republic Ireland. The backbone of the ‘Irish Backstop’ is keeping the UK in a simplified EU customs union (Figure 1) and keeping Northern Ireland in parts of the EU Single Market. The EU-UK Customs Territory will ensure there will be no tariffs, no quotas and no rules of origin checks. Northern Ireland on the other hand will remain in the whole EU Customs Unions, as they also apply the Union Customs Code. The ‘Irish backstop’ also leads to some alignment with EU’s single market regulations. The alignment of the UK is meant to maintain a level playing field in the new Customs Territory and will be limited to specific directives on taxation, environmental protection, labour and social standards and state aid. Northern Ireland alignment of regulation will go further than that and will comprise those rules of the Single Market that are essential for avoiding a hard border. The customs territory excludes the fishing and aquaculture products until further agreements on access to fishing waters are made. It is the intention to reach such agreements before July 2020.

Figure 1: Overlap EU-UK customs territory and EU membership
Figure 1: Overlap EU-UK customs territory and EU membershipSource: Rabobank

The future relationship

As the EU has pointed out from the start, negotiations on the post-Brexit UK-EU relationship can only start once the UK has left the EU. Hence, the transition period will not be just a period of adjustment but also a period in which this future relationship will be fine-tuned, thereby extending the period of uncertainty with respect to the final Brexit outcome. Nevertheless, the withdrawal agreement does include an appendix that sets out the contours of what the EU and the UK envisage as a future relationship between them. The non-binding character of this political declaration means that we should take the 36 pages with a grain of salt. The appendix is regarded by some as a tool for PM May to appease to various Brexit factions at home. That can explain the vague language and the specification that the EU and the UK are determined to find an alternative for the Irish backstop before the end of the transition period. It also explains the setting of objectives which in light of the Irish conundrum are contradictory, such as preserving the “autonomy of the Union’s decision making …and the integrity of the Single Market and the Customs Union” while at the same time “ensuring the sovereignty of the UK …and the development of its independent trade policy”.

Despite all these, the document does for the first time define the intentions of both the EU and the UK and therefore creates a basis for future negotiations. This basis is an “ambitious, wide ranging and balanced economic partnership”, augmented by cooperation in other areas such as security. With respect to goods the intention is to “create a free trade area, combining deep regulatory and customs cooperation, underpinned by provisions ensuring a level playing field for open and fair competition”. The EU and the UK consider UK cooperation with Union Agencies such as the European Medicines Agency (EMA), the European Chemicals Agency (ECHA), and the European Aviation Safety Agency (EASA). The two intend to reach a new fisheries agreement that also concerns access to fishing waters and that is to be concluded by 1 July 2020.

On services, the EU and the UK intend to go beyond WTO obligations and build on other FTA’s the EU already has in order to facilitate services and investment. The intention is to have a broad sectoral coverage that includes “professional and business services, telecommunications services, courier and postal services, distribution services, environmental services, financial services, transport services and other services of mutual interest.” The basis for services will be host state rules and in some cases, such as financial services, equivalence. The EU and the UK intend to agree on provisions that enables free movement of capital and payments and that facilitate electronic commerce. Short term mobility will be visa-free and arrangements will be sought to facilitate entry and stay for specific purposes such as research and study. On aviation and railroad the intention is to reach bilateral agreements maintaining close ties, while road and maritime transport is to fall back on international agreements. The EU and the UK also intend to cooperate on electricity and gas, nuclear energy and carbon pricing. The UK still intends to participate in some Union programmes in areas such as science and innovation, education, defence capabilities and space.

Figure 2: Brexit timeline
Figure 2: Brexit timelineSource: Rabobank

Next steps

The approval of the EU Council pushes the deal into the phase with the most uncertain outcome, namely the vote on the deal in the British parliament, probably the toughest battle PM May has had so far. It looks like this phase will commence around 10-12 December after a two week campaign to promote the deal in the UK by PM May. The agreement needs the vote of 320 MP’s out of 639 to pass (the House of Commons has 650 seats but only 639 can vote currently), though abstentions can reduce this number. The arithmetic in the House of Commons is not very encouraging, but getting the deal approved here is still possible. For one, there is no majority for a ‘hard Brexit’ in the UK Parliament. Hence, we still expect a deal to be ratified by March 2019. This might only occur after several voting rounds and high political and financial markets volatility. There is a lot of talk in the financial markets about the possibility of a second parliamentary vote, but PM May understandably is trying to push back on this in an attempt to win support for her deal. The threat of a leadership challenge by the Conservative party will persist all this time, but a new PM would face the same options. A (definitive) rejection of the deal or a PM change are likely to lead to a political chaos with several possible outcomes: general elections or a referendum. An extension of Article 50, leading to a delay in the Brexit process, could also be in the cards. Meanwhile the odds of a ‘hard Brexit’ remain almost as high as those of an orderly Brexit.

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Author(s)
Alexandra Dumitru
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 60441

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