Cabinet agreement on draft Brexit paper results in May-hem as ministers resign

15 Nov 2018

Philip Shaw, Victoria Clarke, Ryan Djajasaputra and George Brown

Investec economists

The Investec economics team gives its verdict on the draft brexit agreement and what it could mean for a future relationship with the EU

UK Prime Minister Theresa May’s Cabinet agreement on the Brexit deal during a fraught five-hour session last night has already been overtaken by events. Thursday's continuously shifting landscape began with the resignation of a junior Northern Ireland Minister, Shailesh Vara.
More significantly, Cabinet members Dominic Raab and Esther McVey also quit later in the morning. Indeed, Raab’s departure marked the loss of the second Brexit Secretary in four months. At the last count, a total of seven members of the government had resigned.
The most appropriate word we can find is "unravelling". This seems to apply not just to the deal reached earlier in the week between the UK and EU, but also the UK government.
The number of resignations today highlights the extent of the opposition to the shape of the deal within the ruling Conservative party which, with the support of 10 DUP MPs, has an effective majority in Westminster of just 13. Accordingly it now seems virtually impossible that the government will be able to pass the deal through parliament.
Effective majority that the Tories have in Parliament, with the support of the DUP
Below we outline the defining features of the agreement. Is this still relevant if it cannot pass parliament? In our view, yes. Bearing in mind the limited amount of time available before the UK’s EU exit date of 29 March 2019, we suspect that it will remain the baseline for further negotiations.
But as we have mentioned above, the government seems hamstrung and we suspect that it will take cross party co-operation to force a deal through the Commons. 







Cabinet's 'got your back'...

Prime Minister Theresa May convened a meeting of her Cabinet yesterday to discuss the draft Withdrawal Agreement which had been agreed in technical level talks with Brussels earlier this week. She described the debate as “impassioned” which looks to have been a euphemism for very divided, with the Brexit proposal facing considerable criticism.
The Prime Minister indicated afterwards that the Cabinet had collectively backed the proposal, but in reality the Cabinet as a whole was far from united behind the proposals.
The extent of discontentment has been laid bare this morning, with the resignations we have seen. Adding to PM May’s headaches are the media reports that the 1922 Committee Chair Sir Graham Brady may have the 48 letters of no confidence lodged required to trigger a vote of confidence in the Prime Minister.
Meanwhile, with this political circus still playing out, PM May has given a statement in Parliament on the draft technical agreement and on the short political declaration on the UK’s future relationship.
Domic Raab outside 10 downing street
‘I cannot reconcile the terms of the proposed deal with the promises we made to the country in our manifesto at the last election.’

Dominic Raab, former Brexit Secretary, in his resignation letter




Withdrawal agreement raises red flags

The draft withdrawal agreement, which is separate from the seven-page political declaration, focuses on the process of the UK’s divorce from the EU only, in 585 pages of legal text. It deals with two key phases. Firstly, the UK enters a transition phase and secondly it lays out the terms of a “backstop” solution, which may or may not follow.
In the transition period running through to the end-2020, the EU will treat the UK as if it were a Member State, that is with the exception of participation in the EU institutions and governance structures (i.e. the UK would not vote). It is there to provide the UK and EU with the time to settle on future trading arrangements and for the UK to progress trade discussions with other nations.
The UK and EU can jointly agree to extend the transition period beyond the initial end-2020 end date, however if no extension is agreed nor a new future trading arrangement settled by January 2021, the “backstop” would apply.

Backstop solution

In the "backstop solution", there would be a single EU-UK customs territory with no tariffs, quotas or checks on rules of origin between the EU and the UK. However for Northern Ireland the Union's Customs Code, which sets out the provisions for releasing products into free circulation within the EU, would continue to apply.
Northern Ireland would also remain aligned to a limited set of rules that are related to the EU's Single Market (including legislation on goods, sanitary rules for veterinary controls, rules on agricultural production/marketing, VAT and excise in respect of goods, and state aid rules).
As such the draft treaty effectively places a border on "rules" drawn down the Irish Sea.
DUP leader Arlene Foster and deputy leader Nigel Dodds address the media at Stormont following talks with the UK Brexit secretary Dominic Raab on November 2, 2018 in Belfast, Northern Ireland

DUP leader Arlene Foster and her deputy leader Nigel Dodds expressed concern over the draft agreement




Irish reaction

The Conservative Party’s confidence and supply partner, the DUP, is clearly unhappy with even a partial border down the Irish Sea. Both the Prime Minister and the EU’s chief Brexit negotiator’s efforts to stress that the backstop is not intended to be used have not helped to settle these concerns.
Nor has the Protocol on Ireland and Northern Ireland in the exit treaty, which states that the Northern Ireland economy would retain “unfettered access” to the rest of the UK.
One issue of discontentment amongst a broader group is that the UK’s exit from any Brexit backstop is not within the UK’s own power.
Beyond the views of the DUP, note that one issue of discontentment amongst a broader group is that the UK’s exit from any Brexit backstop is not within the UK’s own power. In the Protocol, it states that “the EU and the UK may decide jointly that the Protocol, in whole or in part, is no longer necessary to achieve its objectives”.
One further sticking point is that for issues related to EU law concepts in the Withdrawal Agreement, including aspects of the Ireland-Northern Ireland Protocol, the European Court of Justice remains the ultimate arbiter. This is also not seen as consistent with the UK gaining adequate control of its own fate. 

Future relationship

Alongside the publication of the draft Withdrawal Treaty, we received a draft of the ‘political declaration’, which is meant to provide the framework for future arrangements (after any transition and/or “backstop” phase) between the UK and the EU.
The draft ran to just seven pages, with the full draft reportedly set for publication next week. This short document on the proposed end state alludes toa framework based on July’s Chequers agreement, although it does not commit to it in its entirety.
The draft agreement lays out a tariff free trade area for goods, which will be accompanied by a common rule book, with plans for ambitious customs arrangements. With regard to Northern Ireland, the draft sets out the intention to replace the backstop with alternative arrangements to ensure the absence of a hard border.
Chequers had envisaged the collection of EU tariffs at the UK border and the use of technology to determine the ultimate destination of goods and therefore the applicable tariff in order to avoid a hard border, but the draft does not include any detail. 
There is an agreement on a so called ambitious, comprehensive arrangement with some further detail on financial services.
On services there is an agreement on a so called ambitious, comprehensive arrangement with some further detail on financial services. However there is not a complete commitment to an ‘equivalence’ regime (as previously reported), whereby UK based financial services firms would have continued access to EU markets based on a system where each party recognises that the other’s systems are up to scratch.
Nor is there any mention of the reported arbitration mechanism which would prevent the EU suspending equivalence at a month’s notice (‘equivalence plus’). There is nevertheless some movement towards some kind of equivalence agreement with an endeavour to complete equivalence assessments before June 2020.
It is worth remembering that the political declaration, even in its final form will only represent a vague blue print of the UK-EU’s future arrangements, with the real details still set to be negotiated during the proposed transition period. 
Scottish fishing in Peterhead

Talks on the fisheries sector will begin only after the UK has left the EU on 29 March 2019




Fishing for Scottish votes?

Another bone of contention is the future treatment of the fishing sector. Previously the UK government has pledged to depart from the Common Fisheries Policy (CFP) once the transition period ends in December 2020.
However, the Withdrawal Treaty shows that the two sides have yet to reach an agreement on the arrangements for fisheries. Instead it states that talks on the sector will only begin once the UK has left the EU in March 2019, raising the possibility that the UK’s withdrawal from the CFP could be delayed, or even canned altogether.
These concerns prompted all 13 Conservative MPs in Scotland to write a letter to the Prime Minister in which they warned that they could not support an agreement that would prevent the UK from “independently negotiating fishing access and quota shares”.
Scottish Secretary David Mundell subsequently appears to have been assuaged by yesterday’s Cabinet meeting, saying that it had been made clear to him that the UK will leave the CFP as originally promised. Still, the Prime Minister may have to secure a more concrete assurances from Brussels if she is to rely on the support of the Scottish wing of her party when the agreement is put to Parliament given the tight arithmetic.

Immediate timetable

Clearly the timetable to carry the withdrawal agreement forward is in a state of flux after the political developments of the past 24 hours. The plan had been for:
  • The European Commission to work towards a finalised form of the political declaration on future arrangements by Tuesday (20 November).
  • For an EU Summit to consider the withdrawal agreement and future arrangements text on 25 November.
  • Reports yesterday had pointed to PM May having been planning to hold the “meaningful vote” in the UK Parliament on the Brexit deal package on 18 December.

Immediate timetable

If May is now to be forced back to Brussels to renegotiate, ousted, and/or Parliament takes greater control of the process, we could well see elements of this process pushed out. It also remains to be seen whether the 25 November EU Summit would consider the draft text, at least in its current form.
This should become clearer over the coming days as we gain greater insight over the extent to which PM May’s plans to return to Brussels to try and gain greater concessions and of course whether we see further personnel shifts within government.
The UK Government is able to go back-and-forth between Westminster and Brussels until 21 January. If the legislation to implement the Brexit deal is not passed by then, or MPs are informed that no deal can be reached, then the Government would have to make a statement to Parliament setting out what it intended to do next.
18 Dec
Accepted final date after which a deal under the current timeframe is highly unlikely
25 Nov
Date of EU summit to discuss the draft withdrawal agreement
This would be a motion in “neutral terms”, which ordinarily would mean that no amendments could be tabled to it, though the Speaker would have the final say.
Finally note that any final proposal must then be ratified by a simple majority in the European Parliament, before then securing the approvals of at least 20 of the remaining 27 EU nations representing a minimum of 65% of the bloc’s population. 

How can a deal get through Westminster?

A critical point is that the PM is under fire from both the eurosceptic and europhile wings of her party and that the extent of the disquiet is material. So a shift in the government’s position in either direction is unlikely to be successful.
Of course circumstances can change, and some compromises can be struck. But as things stand, the government will face defeat if and when, as planned, the Commons votes on the deal on 18 December. So what might happen then?
As we have mentioned on a number of occasions before, the Withdrawal Act specifies that parliament instructs the government to renegotiate with Brussels.
We could not completely rule out the Brexit date being pushed back beyond 29 March, if all EU27 countries agree.
If the Tories remain so divided, then Labour votes are critical. One feasible route forward could be via a cross party motion which could command a majority in the House. Labour would have won a major victory in defeating the government.
Subsequently a number of their MPs could be willing to co-operate with a groups of Conservatives to make sure the UK does not leave the EU without a deal. If the first vote takes place in December, this timetable could work, providing that the existing agreement forms the basis of a new deal.
If not, we could not completely rule out the Brexit date being pushed back beyond 29 March, if all EU27 countries agree. Of course, if Theresa May is deposed, the UK’s direction becomes very uncertain indeed. 

Market reaction

Markets have taken this morning’s news poorly, particularly the news of Dominic Raab’s resignation, as concerns rise over the stability of the UK government and the rising probability that the draft agreement will not make it through Parliament.
Sterling is currently on track for a two cent intraday fall against the US dollar (currently $1.278), and a weakening to 88.4p against the euro.
Interest rate markets have rallied with the curve flattening to price out a 2019 hike from the Bank of England. Meanwhile a 15bp surge in gilt breakevens, point to concerns over the possibility of no deal and a collapse in the value of sterling.
Given developments in the last 24 hours, it seems likely that the agreement will not pass parliament in its current form. However, given our view that there will ultimately be a deal, we still see sterling rising in the medium term. However that could be following a considerable amount of volatility in the near term.