The UK-EU trade deal - a work in progress

30 Dec 2020

Ryan Djajasaputra

Investec economist

Sandra Horsfield

Investec economist

After more than four years since the UK voted to leave the European Union, the two sides have agreed to a trade deal. While the pact averts the threat of a “no-deal” Brexit, frictions remain for businesses and some significant issues are unresolved. Our experts take a closer look at what the deal means for the economy and British companies, and what happens next.

It's a historic deal, but the devil will lie in the detail. The fact it has been struck at all following intense negotiations and missed deadlines is welcome and should help support investment. But it is not comprehensive, nor, in some respects, the final say.
 
The UK-EU Trade and Cooperation Agreement concluded on Christmas Eve consists of three pillars: a free-trade agreement, a framework for cooperation between law enforcement and judicial authorities, and governance arrangements that allow for cross-retaliation. One of the main aspects of the agreement is that while it will enable the tariff- and quota-free trade in goods, it doesn’t apply to the services industry or the financial services sector. Below we summarise some of its key points.

Goods

The agreement between the UK and the EU sees zero tariffs and zero quotas applied to the trade in goods from 1 January 2021. However, this access will be subject to individual goods meeting the “rules of origin” criteria, specifying that a set proportion of a good must represent local content (i.e. parts from either the UK or the EU). Goods not meeting these requirements will face tariffs.
 
One industry which faces special restrictions is the auto sector. Petrol and diesel cars must be made with 55% local content, whilst the rules on electric vehicles see overseas components limited to 60% by the end 2023 and falling to 55% by the end of 2026. This had been a thorny issue, given the high Japanese component content of some cars made in the UK, which the government had argued should be treated differently in light of the free trade deals that both the UK and the EU have with Japan.
 
Ultimately the component content limits may not be as favourable as hoped, but the fact that rules will be phased-in alleviates at least some concerns about a “cliff-edge”. While the free trade deal in goods is welcome news, it should be noted that the UK will no longer be part of the EU’s Single Market and as such the free movement of goods no longer applies. This means extra paperwork and procedures from 1 January, making trade no longer frictionless and potentially adding to business costs.
1,246
The number of pages in the trade deal

Services

The deal would seem to facilitate substantial cross-border trade in services on the surface, committing to market access for services, prohibiting requirements for local subsidiaries and discrimination between each other’s nationals. However, when viewed more closely, the deal is a lot less comprehensive than for goods, curtailing market access through a very substantial number of exceptions that differ at sector and EU member state level. Moreover, visas and work permits will be required for certain business visits, and the mutual recognition of professional qualifications is not automatic. 

Financial Services

However limited the provisions for services are, concerning financial services, the deal is even scanter. The deal means the end of “passporting”, the mechanism through which UK firms can sell financial services across all of the EU without having to meet any additional regulatory requirements on top of those they face at home.
 
Crucially, with some narrow time-limited exceptions (e.g. derivatives clearing for 18 months and settling Irish securities for six months), the EU has not granted “equivalence” to the UK yet. This would give access to EU markets for some, but not all, financial services, albeit with the proviso that it could be withdrawn with just 30 days’ notice – an issue Switzerland had to contend with in 2019. Before deciding on “equivalence”, the EU wants to see how the UK would like to diverge from the EU frameworks. In contrast, the UK has extensively (although not entirely) granted equivalence unilaterally to EU-based financial services. In these circumstances, UK firms will either need to use EU subsidiaries to provide services to EU clients or rely on other contingency plans.
The status quo at the start of 2021 is unlikely to be the outcome. Talks will take place in early 2021, and the aim is to agree to a draft text for a Memorandum of Understanding on future cooperation on financial services policy by March. In time, this could lead to a more comprehensive and more durable solution for the financial services sector.

Level playing field

One of the main challenges in the negotiations was how to ensure neither side gained an unfair competitive advantage over the other through subsidies or changes in environmental or labour standards – thus maintaining the “level playing field” – while allowing for divergence. The general principle adopted is that trade and investment should not be impacted by any lowering in standards – and if they are, that, following an unsuccessful consultation, countermeasures commensurate with the harm caused can be taken by the other party, if an arbitration tribunal upholds the claim of harm.

Dispute resolution mechanism

To oversee this agreement will require substantive bureaucratic structures. A Joint Partnership Council, which will consist of UK and EU officials, will be formed, with over 30 sub-councils, one for each area of the agreement. There is no single dispute resolution mechanism. In some areas, there is a specific process set out, akin to that set out above. If the tribunal’s ruling is not followed, the other party can suspend part of the agreement or cross-retaliate in other areas. In some areas, instead of there being an independent tribunal, parties can impose temporary tariffs on each other.
 
Generally, if the deal fails in a specific part, this does not affect the rest of the agreement's validity. That said, there is an important “rebalancing mechanism”. Should, after four years, one party decide that there have been too many breaches of the “level playing field” provisions, or that a measure with a material impact on trade and investment has been in place for a year, they can instigate a review of the entire trade agreement. Should the dispute not be resolved after a year of negotiations, the entire trade agreement could be suspended, leaving UK-EU trade on World Trade Organization terms.
 
Even a free trade agreement such as this one will introduce substantial trade frictions for businesses in terms of paperwork, even without tariffs, relative to trading in a single market.

Fishing

Despite the fishing industry representing only a tiny fraction of the UK economy – less than 1% – it has consumed an outsized amount of negotiating time, with the UK reportedly still haggling over individual fish species up until the last moment. The eventual landing zone was for the UK to agree to EU fishing fleets handing back 25% of their quotas to the UK, phased in over a five-and-a-half-year transition period. This marked a significant compromise from the UK, which had initially demanded the return of 80% of quotas. From the end of 2026, there will be annual reviews to set the quotas on the amount of fish EU boats can catch in UK waters.

The economic impact

Even a free trade agreement such as this one will introduce substantial trade frictions for businesses in terms of paperwork, even without tariffs, relative to trading in a single market. A range of studies cited by the UK’s Office for Budget Responsibility put the negative impact of that on the UK on average at 4% of gross domestic product in the long run, with estimates varying between 1.8% and 10%. Set against that, of course, will be net gains from any new or better-tailored trade agreements with third countries outside the EU. These will take time to negotiate. 

What happens next?

Although the deal achieves the stated aim of a free trade agreement with the EU, many areas have yet to be ironed out. Of these, financial services are the most prominent, but certainly not the only one, with various political declarations published since highlighting the fact that UK-EU negotiations will continue to take place for some time to come. So, even after full ratification of the deal, the full implications of Brexit for all aspects of trade will not be clear.
 
Overall, the agreement is a welcome end to the UK’s four-and-a-half-year process of leaving the EU and removes a significant source of domestic uncertainty, which has represented a headwind to business investment. Ultimately, the deal and eradication of the “no-deal” Brexit threat should help support the economic recovery through 2021. However, the coronavirus pandemic remains a major downside risk.
-4%
The estimated long-term impact on UK GDP of the deal compared with staying in the EU

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