UK: Softening Up a Hard Brexit

Published on July 25, 2017
After a rather uneventful second preliminary round of Brexit talks last week, United Kingdom and European Union negotiators broke off for the summer recess, postponing the most politically sensitive topics until after the September 24 German elections.
But despite the occasional bad press, we believe the odds for an orderly UK exit from the EU, followed by a transition period and an eventual trade deal remain high.
*** Despite the poor showing in the June 8 elections, Prime Minister Theresa May and her allies have not veered away from pledges to exit the Single Market and the EU Customs Union, control EU immigration, repeal EU law supremacy, and extricate the UK from judicial control by the European Court of Justice. But we understand that under pressure from the City of London, British negotiators might be open to further concessions on EU citizens rights and accepting European Securities and Markets Authority supervision as trade-offs to retain some of the euro clearing business, even if that eventually entails ceding some level of control to the ECJ. ***
*** On a purely strategic level, London has for now decided to focus on transitional arrangements, which the British government would like to last for as long as possible given the early March 2019 negotiations deadline, and insists on an “implementation phase” with Ministers, notably Philip Hammond and David Davis, debating publicly on the length of the transition. In order to defuse delaying tactics, the European Commission has decided to put new financial regulation proposals, and especially the one on third-country “equivalence,” as a “loaded gun” on the negotiating table. ***
*** The other hot topic, the issue of the border between the Republic of Ireland and Northern Ireland, is being dealt with by the Irish government’s revenue service, which is conducting studies and tests on how to allow a smooth transit without having to put in place a “physical” border. For the time being, we have been told, infrared scans and computer could do the trick, but we have also been warned that companies will still need to fill customs IN/OUT filings and pay VAT somehow, and that keeping the border as open as today is all but impossible. It is widely accepted by all sides that some controls will be introduced, the idea is to try and limit disruptions, hence the ongoing research. ***
From Harsh Rhetoric to Negotiations Realities
Brussels officials have been unanimous in portraying the British negotiating team as showing a lot of goodwill, but also as rather clumsy and unprepared. While this is understandable as trade has been for years a “Brussels’ only” competence, May’s election debacle, and changes in Downing Street’s power structures, have made things even tougher for the UK team.
But despite the difficulties, British sources assure us there is still significant Parliamentary support to respect the outcome of the referendum (see SGH 1/24/17, “Brexit: Sailing Ahead”). As we understand, the UK is pushing for immediate concessions on ending ECJ supremacy and ending or limiting free movement as part of any phased process of implementation, and certainly as quickly as during the transition period.
Failure to achieve these concessions will be difficult for May to sell to her backbenchers and the public as genuinely leaving the EU.
That being said, further down the road, both the UK and the EU are in agreement that a future trade relationships should be governed by a CETA++ type of deal (see SGH 1/24/17, “Brexit: Sailing Ahead”) that would ensure a minimal negative impact on trade flows.
And the real issue, and where the talks will become highly political, is with the free flow of financial services from the UK to the continent and vice-versa. EU officials say Britain could eventually make some limited concessions even on these so-called “red lines.”
For instance, we believe the British government is ready to allow European Securities and Markets Authority supervision of the non-systemic euro clearing houses, which might allow them to stay in London, even if that entails judicial control by the ECJ. EU negotiators have been pleased to see that their British peers, who were always opposed to a bigger role for the ESMA (a view they shared with the Germans, nonetheless), are now prepared to accept it in order to keep some of the financial services business in the City of London.
The Commission is also using planned reviews of existing financial legislation to score political points in the negotiations.
Specifically, EU officials point to the recent proposal to define the terms of the “third country equivalence clause,” an EU rule that allows fund managers based in third countries to “passport” funds in the Single Market on the condition that the third country in question is declared “equivalent” by the Commission. Brussels is currently drafting legislation that excludes automaticity even when in the presence of a very similar regulatory environment between the EU and a third country.
The commission is indeed now proposing that equivalence only be awarded on an ad-hoc basis at the request of a third country, and only after a thorough analysis that would take into consideration several other factors – not only the similarities in regulation, but also elements such as the size of the market, which would tend to penalize the UK.
Ironically, the clarification of conditions under which equivalence can be awarded had not been a priority for the Commission for years, at least until Brexit.
A “Frictionless” Border
The other major issue, which currently has a dedicated team dealing with it, is how to make the border between Northern Ireland and the Republic of Ireland as “frictionless” as possible.
After the 1998 Good Friday agreement, and the implementation of the UK-EI Common Travel Area, border controls between Ireland and the North  were removed entirely, not only boosting cross-border trade but also in the process helping maintain peace within the region – a peace of which the EU is one of the international guarantors.
Any disruption to the free flow of trade is feared to have potential disastrous effects not only on the fragile Northern Irish economy, but more broadly on the stability of the entire region.
While a German member of EU’s Chief Negotiator Michel Barnier’s team is handling the technical details, the Irish government has been conducting several ground experiments and running tests and scenarios to find the best solution to keeping the border relatively free of controls even after Brexit.
From what they have concluded, technology seems to be the only answer to keeping trade flows as smooth as possible, as customs controls – even if only a light version – will have to be reintroduced.
EU national governments have in any case been unanimous in delegating the issue to the Irish government, and have pledged to be as accommodating as possible.
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