Wednesday, November 15, 2017

Europe would be mad to let Britain leave without a deal

Published on CapX
It’s hardly suprising that Brexit isn’t the top priority of the EU27 . There is the attempted Catalonian secession from Spain, Greece and Portugal have become financial protectorates of its fellow Eurozone member states, banks in Italy and elsewhere are still struggling with very high levels of bad debt, the governments of Poland and Hungary are on a constant clash with Brussels, and all over Western Europe, eurosceptic populist parties have done well in elections.
Still, as much as they may regret the British decision, the remaining EU member states should step up their game to prevent the UK leaving without a deal. Indeed, Brexit is already having a profound effect on the EU – and things, as I discuss below, can only get worse.
The “financial transaction tax” has been frozen
In 2011, the European Commission proposed this tax, which didn’t garner much enthusiasm. A limited number of member states decided to pursue the idea, with only Austria, Belgium, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain still at the table. The proposal has been widely criticised for various reasons and even before the Brexit vote led to warnings that it would endanger pensions.
Brexit has now sounded the FTT’s death knell. In July, the French Finance Minister, Bruno Le Maire, said that Brexit could bring “thousands of jobs to Paris” and that this opportunity could be lost if the tax were imposed, effectively announcing a pause.
Wolfgang Schaeuble, the then German Finance Minister, said that “quite a bit speaks in favour of the French argument to look first at how the Brexit negotiations are going”. By September, however, French President Macron seemed to have changed his mind about suspending the FTT, pledging to “relaunch” the initiative. Whatever happens now: the important thing is that it shows how future regulatory competition, which will probably only start in 2021, is already having an effect on current policy.
The rules on banker bonuses are being questioned   
The desire to lure the financial industry away from London after Brexit is not only affecting possible future legislation, such as the FTT, but also existing regulation. Ireland may revisit caps on banker salaries and bonuses at bailed-out banks, while the Dutch Economy Minister has saidthat the Dutch limit on bonuses puts the Netherlands at “a disadvantage” when attempting to attract companies from abroad. The new Dutch government has pledged to relax bonus rules in order to attract business from London.
The Netherlands has reduced its dividend taxation to 0 per cent
Dutch Prime Minister Mark Rutte has explained that Brexit is behind his government’s decision to reduce dividend taxation to 0 per cent. The logic is that when companies know that they won’t have to pay any tax on dividends they will be more likely to keep their decision making centres in the Netherlands. London-based companies may also look at the Netherlands more favourably when considering relocation.
The Northern-Ireland debate is flaring up
The Brexit referendum has given new impetus to those keen to unite Northern Ireland with the Republic. The Irish make the fair point that they didn’t ask for Brexit and aren’t wild about having a border imposed. Most British politicians, not least the Northern Irish Unionists, also want to avoid a hard border too and are keen to sort out the issue. Meanwhile, the EU Commission has showed goodwill by making the Northern Irish question one of its three priorities to make progress on before trade talks could commence.
To secure a soft border, the British government has basically agreed to Irish-European demands of a common customs union and no regulatory divergence, at least for the transition stage. Given that Ireland has been making these demands before the EU has started trade and transition talks, it does look like it won’t be possible to sort out Northern Ireland before the negotiations move on.
Naturally, Britain can’t outsource its trade policy to Brussels for ever so a technical agreement to aim for an “invisible” border when the UK exits its common customs union with the EU needs to be worked out.
A hard border in Ireland could be avoided by letting only Northern Ireland stay in the EU’s customs union, but this would effectively split the UK. It’s troubling that not only Sinn Fein, but also the Irish government and even the European Commission have proposed this.
As if Brexit weren’t divisive enough, vested interests are now trying to use it to split up the UK.
The EU’s Common Agricultural Policy is failing
Brexit could blow a 20 billion euro hole in Europe’s budget, according to the EU Commission. It’s well known that about a third of the EU’s long-term  budget, is spent on agriculture. Less well-known is the fact that more than 270 billion is spent in “direct payments” to owners of agricultural land – banks, for example, or the Queen – regardless of whether they produce or not. To put that in perspective: that’s almost seven times the amount the eurozone bailout fund used to bail out the Spanish banking system a few years ago.
We won’t have to look far to find ways to deal with the “Brexit hole”. Agriculture is an area that urgently requires pruning. The EU27 should be grateful Britain is forcing politicians in mainland Europe to finally do this.
Indeed, as Politico reports, many in Europe’s food industry expect cuts to be made to the EU’s Common Agricultural Policy (CAP) following Brexit. Propping up companies and individuals who own agricultural land isn’t high on your average Euro-citizens list of priorities.
Direct CAP subsidies have often acted as an outright disincentive for farmers to modernise. French farmers in particular have been on the receiving end here. After milk quotas were abolished in 2015, allowing more production, the French government, aided by an EU scheme, has been handing out cash to farmers not to produce milk, effectively contributing to a butter shortage in France in 2017.
Brexit and the CAP cuts it’s likely to inflict effectively reduce the EU’s scope for failing economic planning schemes like this. A new EU measure which would allow farmers more leeway before being considered as engaging in cartels in their negotiations with bigger players such as supermarket chains, has been explained by an industry source as being the result of Brexit as “the real story is about money and what happens to finance in the future. That’s really what has changed, not the debate about the supply chain”.
Fears of a cliff-edge Brexit are increasing amongst European industry
Some might be bored by the tale of the German car manufacturer who would push the German government to make sure there’s a good deal for the UK, eager to keep market access – especially as tactic was used in the British EU debate in the 1970s.
Still it’s a good example. The Association of German Chambers of Industry and Commerce DIHK just published a study revealing how a cliff-edge Brexit would result in 2.35bn euro in tariffs alone for Germany’s car industry, irrespective of the damage it would do to sales. Of course, it added that the UK shouldn’t be allowed to “cherry pick” but it’s clear who’s getting nervous here.
Ulrich Hoppe, the Director of the German-British Chamber of Commerce has stated that “an outcome without a deal would be fatal for the [Germany] economy”, explaining that “German chemicals and car industry as well as all other exporters to UK” would be hit, calling a transition very important. Also the Confederation of German Employers’ Associations has come out stressing that “we need clarity”.
Emma Marcegaglia, president of pan-EU business federation BusinessEurope, has warned after a meeting with Theresa May on Monday that “business is extremely concerned with the slow pace of negotiations and the lack of progress only one month before the decisive December European Council…”Business aims to avoid a cliff edge and therefore asks for a ‘status quo-like’ transitional arrangement with the UK staying in the customs union and the single market, as this will best provide citizens and businesses with greater certainty.”
Now guess what: the UK has practically suggested such an arrangement, but the EU is still haggling over the details of what can constitute “sufficient progress” in ongoing negotiations on the divorce bill and citizens rights. Some on the EU side assume that time is on their side, but given how trade benefits both sides, one cannot really “win” here by going against the interests of the other side.
WTO tariffs threaten 1.2 million job losses in the EU27 alone, according to one estimate by KU Leuven University. Even if this may be inflated and even if Britain may be hit relatively harder: such stats are slowly focusing minds on the Continent.
As I’ve argued before, Brexit could happen without major disruption for citizens or businesses. The UK has already made major concessions, effectively suggesting solutions that the EU isn’t likely to oppose. Now the EU side must also move if it wants to minimise the disruption that Brexit is about to inflict on the member states.

Friday, November 10, 2017

How close are we to a Brexit deal?

Published on BrexitCentral

In about one month's time, EU27 leaders will decide whether the UK has made enough progress on Brexit divorce talks to move to “stage 2” of the Brexit negotiations. This is when both sides would start discussing the UK’s trade status after Brexit and a possible transition period from the end of March 2019, when Britain formally leaves the EU.

Despite the fact that the EU hasn’t formally agreed to many of the UK’s proposals, we actually have a pretty decent idea of what Brexit will look like, due to the fact that the UK has already proposed many things with which the EU side is unlikely to disagree.
What follows is my overview of where we're at...

1.The Divorce Stage

1.1 The money

With British Prime Minister Theresa May having already made clear during her speech in Florence that Britain would “honour [its] commitments", there are now rumours that the UK Government would be prepared to pay approaching €60 billion: about €10 billion to keep market access for both 2019 and 2020 and €42 billion for past EU budget commitments and pensions payments. It looks like Britain won’t even have to agree to a set amount for now, with EU officials said to have told May’s Brexit advisor Oliver Robbins that they only needed a “single sentence” in writing guaranteeing the UK would pay its share of “other liabilities” – meaning the €42 billion.

1.2 Citizens

Both sides agree that both EU citizens in Britain and UK citizens in the EU should be allowed to stay where they currently are, but some haggling is still continuing about the conditions. The role of the ECJ is still unresolved but, in recent weeks, the UK has been making a number of concessions on sickness insurance and family reunification, even conceding that EU27 nationals moving to Britain at any point before Brexit day in 2019 will have their rights protected. Last week, the UK Government declared it was “within touching distance” of a deal here.

The EU now merely wants the UK to agree to “pay due regard to” ECJ judgements so that shouldn’t be so impossible either. Theresa May told Parliament last month that Britain may “start off with the ECJ governing the rules that we are part of” during the transition, awaiting a deal on some joint EU-UK arbitration mechanism - something that Brexit Secretary, David Davis, already endorsed. If the UK could allow the ECJ to police the transition, it may as well allow it to police the rights EU citizens enjoy due to the divorce settlement, but only to the point where a new bilateral judicial body would take over.

1.3 Northern Ireland

Here, the goal is to merely achieve a “political understanding” that the emergence of a hard border is unacceptable, I understand from a top Commission official. In any case, the Commission's Brexit negotiator, Michel Barnier, considers “flexible and innovative solutions” to only be a matter for phase 2. This topic isn’t seen by senior diplomats as an obstacle to making “sufficient progress” to move to talks about transition and trade. Irish Taoiseach, Leo Varadkar, has pointed out what is obvious to everyone: that it is “not going to be possible” to definitively settle the question of the border with Northern Ireland until the shape of the future EU-UK relationship emerges.

2. The Transition

2.1 Market access

The so-called “guidelines” which constitute the mandate given by the 27 EU member states to Michel Barnier to conduct these negotiations mention that a transition arrangement can be agreed, but only if it is “limited in time” and “subject to effective enforcement mechanisms”. Importantly, it mentions that if the UK wants to continue to enjoy the EU’s “acquis” or the rights and obligations that EU membership entails (such as market access), “this would require existing Union regulatory, budgetary, supervisory, judiciary and enforcement instruments and structures to apply.” In other words, the UK would need to become a full rule-taker in order to keep market access during the transition period, during which a long-term trade arrangement could be negotiated.

It looks like the British Government is willing to accept this offer. In her Florence speech, Theresa May stated that “we are proposing that for this period access to one another’s markets should continue on current terms.” As noted above, she even declared that Britain would be willing for a period to accept ECJ rule until a putative joint EU-UK arbitration mechanism would take over.
Is it really feasible that Britain, a country that just voted to leave the EU, would temporarily take a step back in sovereignty, effectively becoming a rule-taker, for “how long it will take to prepare and implement the... future partnership”, as Theresa May said in her Florence speech? Apparently yes. Moreover, May did point out that for Britain it shouldn’t take as long as for Canada to agree a long-term trade arrangement because Britain already has all the rules in place. That can be used as an argument against those demanding the right for the UK to already diverge in terms of regulation during the transition period, as this would be “devaluing an asset” in the long term trade negotiations.

2.2. Customs

Even if UK companies would still enjoy market access to the EU, they would face customs, simply because Britain would also have left the EU’s Customs Union. Also here, a solution is in sight. This because the UK Government has proposed joining a temporary common customs union with the EU immediately after it has exited in March 2019. This would help to sort out the Northern Irish border question at least for the transition, as the UK’s tariffs would match Ireland’s: Britain would effectively be similar to Turkey during the transition. Sure, the EU has not formally agreed to it, but wouldn’t eurocrats enjoy Britain outsourcing its trade policy? According to rumours picked up by German newspaper Handelsblatt, the EU27 may propose that the UK stay in the Customs Union for two more years. Not a big surprise, as the Irish Government has specifically proposed this (albeit as a permanent fixture). The only thing the UK is demanding is to be able to negotiate trade deals with third parties during that period.

Michel Barnier seems to have the same thing in mind as he could imagine that for “a short time after the [UK’s] formal exit from the EU, the economic status quo would continue to apply, which besides the internal market also includes the Customs Union and [the UK being subject to] collective political decisions [of the EU27]”. He confirmed his team was working on transition, while EU27 Ambassadors have also begun internal preparatory work on the second phase of Brexit negotiations.

2.3. Citizens

The UK Government has just published a paper setting out the details of how it wants to register around three million EU citizens and their families after Brexit, claiming that the new system for applying for 'settled status' will be "streamlined, low-cost and user-friendly". The UK seems to have agreed that any EU citizen  entering Britain before the end of March 2019 will get the right to obtain such 'settled status'. In August, there were rumours that EU citizens would still be allowed to enter freely during the transition, but that they would need to comply with new immigration restrictions if they wanted to work. In Florence, however, May stated that EU27 citizens would “continue to be able to come and live and work in the UK” but only have to register - something that the EU may well agree to as it already looks like being permitted by EU law and therefore complies with the idea of “standstill”. 

2.4. Money

As discussed, Britain is prepared to contribute to the EU budget in 2019 and 2020. In the spirit of organising a “standstill” or “status quo”, it can be assumed that the UK will also demand the right to receive payments from the EU budget and that it would be ready to continue payments in case the transition period – expected to take “around two years”, according to Theresa May, and lasting “until 2020” according to Barnier - were to be somehow prolonged.

2.5. Hurdles

Of course there are issues with all this. Specific transition solutions will be necessary for agriculture and fisheries. A paper prepared by agricultural policy expert Alan Matthews for the European Parliament notes that for agriculture - and thus also specifically for Northern Irish farmers - "a customs union with full and consistent adoption of the EU regulatory acquis (a regulatory union) would replicate the status quo with respect to trading conditions." So the UK’s Government’s solution should work.

Another issue is that the EU has concluded trade deals with countries like South Korea and Mexico and in theory these aren’t rolled over automatically after Brexit. A common EU-UK customs union does not safeguard this either and may even be challenged by some WTO members, who could claim the EU and the UK should expand these benefits to others. However, article XXIV(5) of the General Agreement on Trade and Tariffs (GATT), may be helpful here, although under the condition that the interim arrangement is the antechamber of a broader Free Trade Agreement (FTA). Indeed, both sides aim to have a deal by 2019 on at least a “framework for future relations”, which according to some officials should constitute “20-odd pages of non-binding principles to frame a post-Brexit trade negotiation”, according to the FT. This should then buy time to negotiate the future relationship during the transition stage, which ardent Brexiteers, but also many on the EU side, don’t want to last longer than three years.

The transition manages two different goals: to secure stability for businesses and citizens while at the same time reassuring Brexiteers that the UK is pretty much irrevocably leaving the European Union. At Open Europe, we’ve urged the UK Government to now provide much more clarity on the details, which are indeed far from sorted, as much as we may have a pretty good overall picture of what the transition is going to look like.

3. The Future Relationship

3.1 Market access

After the Swiss voted not to be part of the EU’s Single Market in 1992, in the sense that they refused to enjoy full EU market access in return for accepting all the EU’s rules without being able to vote on them, it took the Swiss and the EU at least five years – from 1994 to 1999 - to work out a deal. What needed to be agreed was which market access restrictions would apply and which rules would be applied, sector by sector, as well as what would happen if either the EU or the Swiss side would materially change its legislation.

Apparently, some EU officials believe it will take until the early 2020s to negotiate such terms for the UK. A lot of grand statements have been made here by both sides, but the truth is that this is only really a matter to be negotiated during the transition period so there is no need to work this out yet. Once the cliff-edge of March 2019 is avoided through the transition arrangement, the new cliff-edge could be much scarier, as the UK may become quite nervous if trade talks with the EU would get cumbersome, as they can be. For how long would Britain accept remaining a “rule-taker”? Perhaps one way to deal with the criticism that it is taking longer than the two years that were promised, would be to let the UK gradually exit its rule-taker status.

A key challenge here will be how to secure market access for the UK financial services sector while avoiding Britain having to be subject to EU rules automatically. In this regard, London’s financial industry representatives have suggested to agree an arrangement of “mutual recognition”: if a firm or product is regulated in the UK, the EU27 must trust it and vice versa. An alternative approach would be to engage in advanced “regulatory cooperation”, whereby it would often be the EU accepting financial rules from the UK rather than the other way around. This is because, often, complex financial products are likely to first appear in London.

At Open Europe, we’ve pointed out that not all UK financial service providers are as dependent on Single Market access, simply because the Single Market hasn’t been implemented for all financial services. For banks, it’s important and they have a lot to lose, but that is less the case for asset managers and even less so for insurers. Even for banks, an industry practice called '“back-to-back” trading, which allows bank entities in the UK to carry out a 'duplicate transaction in EU27', has been cited as a possible way out, in case no proper deal is agreed. Either way, the City of London is very much the “financial bloodline” of mainland Europe. That makes it likely that some arrangement will be agreed, which is why EU regulators have already promised some flexibility for London’s financial industry to continue providing its services in the EU27 after Brexit.

3.2 Customs

If Britain is indeed allowed to negotiate trade deals with third countries during the transition - while it is in a common customs union with the EU - the UK won't be able to exit before it has secured a number of trade deals with third countries. This is also because Britain may need some time to adapt its customs procedures and to work out a technical deal which softens the new customs border that will unavoidably appear in Northern Ireland.

Specifically for Northern Ireland, the Swiss and Norwegian precedents are worth looking at: both Switzerland and Norway are outside of the EU’s Customs Union and both share a long border with the EU - in the case of Switzerland with ten times as much traffic as between Ireland and Northern Ireland. Speaking to the UK Parliament’s Northern Ireland Affairs Committee, Christian Bock, the head of the Swiss customs service, has suggested it is possible to maintain an "invisible border" in Ireland after Brexit, pointing out that there could be customs "control points" at locations away from the border and that only about 2% of consignments crossing the Swiss border have to be subject to physical checks.

Bock also added that “we in Switzerland are 'a little jealous' of the agreement Norway has with Sweden - their system is more efficient”. Sure, there are differences - the Swiss are in Schengen and accept a lot of EU product standards - but this should at least give a bit of hope to those most sceptical about securing a “soft” border in Ireland after Brexit.

3.3 Freedom of movement

It’s still a little early to know what kind of restrictions Britain ultimately will implement, but clearly the idea is to negotiate restrictions. One thing people need to keep in mind, however, is that Brexiteers were mainly concerned about the lack of control over migration rather than migration itself. One poll has revealed that four in five people who voted for Brexit would accept migration of high-skilled workers from the EU staying the same or even increasing. So far, the UK Government has continued to say that the UK will remain open to migration but that it will be less open than today for EU citizens.

3.4 Other fields of cooperation

Theresa May has proposed "a bold new strategic agreement that provides a comprehensive framework for future security, law enforcement and criminal justice co-operation: a treaty between the UK and the EU", on top of existing bilateral arrangements. She has stressed that "the United Kingdom is unconditionally committed to maintaining Europe’s security".

It still needs to be resolved whether this will be all part of one comprehensive agreement or whether there will be separate treaties in areas such as trade, defence and security. The importance of Britain as a security partner should definitely help it to secure an arrangement with EU countries, despite the fact that there is some bad blood in mainland Europe as a result of the Brexit vote.

Friday, October 20, 2017

EU leaders mustn’t squander this Brexit momentum

Published on CapX
This week’s meeting of EU leaders concluded with the verdict that there had been insufficient progress in the negotiations to move onto discussion of a future trade deal. That was to be expected. But the Brexit talks finally appear to have some momentum.
Why, then, are EU27 leaders ready to waste almost two months, until the summit of December 14th to progress further? That is when they will hopefully decide to start talks on Britain’s future trade relationship with the EU and a transition agreement to avoid a “cliff edge” scenario when the UK leaves the EU in March 2019.
During those two months, they will at least sort out their vision for the transition and a mandate for Barnier if discussions ever get to trade. This feet-dragging is another example of the EU27 hoping that the UK may not leave after all when they should be agreeing on what their objectives and red lines are at the negotiating table.
Before Europe’s leaders met in Brussels yesterday, the summit conclusions had been amended – at the request of France and Germany – to make clear to the UK it is by no means guaranteed that there will have been “sufficient progress” on the financial settlement, citizens’ rights and the “Irish border, as requested by the EU side.
The latter shouldn’t be an obstacle and is being discussed to create a political understanding that there can’t be a hard border. But the border issue cannot be resolved until the trade relationship is being discussed.
On citizens’ rights, a lot of progress has been made and the UK made further concessions yesterday, clarifying that EU citizens settling in Britain will no longer need to have Comprehensive Sickness Insurance and that post-Brexit family reunification would be possibleafter all. Still, the EU27 insist on a role for the European Court of Justice. Here, the EU has already watered down its initial firm demand for the UK to completely submit itself to the court. Now it only wants Britain to agree to “pay due regard to” ECJ judgments. 
The money was the tricky part before this week’s summit. And it remains tricky now. But even here some clarity is emerging, and it is becoming clear what the sticking points are.
While the UK has made clear that it is happy to pay for its share of the final two years of the EU’s long term 2014-2020 budget, it’s not convinced it should pay up for what can be considered the EU’s “debt” – or “reste à liquider” in Brussels talk. (Over the years, the EU has ignored the fact that it was never supposed to go into debt.)
Britain also thinks the EU’s pension liabilities for its eurocrats are only one third of the EU’s estimate, which would mean Britain would only need to pay 3.5 billion euros instead of around 11 billion euros.
Meanwhile, Angela Merkel’s government’s stance is far from consistent. Having prevented Michel Barnier from making a gesture to the UK after Theresa May’s Florence speech, it has now started a charm offensive.
One German government source declared: “We believe that a whole lot has already happened and, regarding an issue which is of particular importance to us, that of the rights of citizens, we’ve advanced considerably”, adding that “I believe that the big questions about the future relationship between Britain and the European Union are of far more importance than the current dispute about finances.”
Merkel herself stated yesterday: “In contrast to how it is portrayed in the British press, my impression is that these talks are moving forward step by step…I have absolutely no doubts that if we are all focused … that we can get a good result. From my side there are no indications at all that we won’t succeed”
A French government source also struck a conciliatory note, stating: “We must not give in to a confrontational mindset. We are not in a mood for punishment or presents.”
Furthermore, the German foreign ministry is working on proposals for a “comprehensive free-trade accord” with the UK. Merkel hasn’t signed off on it yet but the aim is to have a broad partnership in areas including security, counter-terrorism, agriculture, energy and aviation, basically including everything that Germany wants, omitting access for UK banks, something that the UK will without doubt put on the table. 
Is it the German fondness for procedure or is it because Merkel first wants to agree her “Jamaica” coalition with the liberals and the greens? According to the FT, “EU diplomats also think France and Germany see no harm in prolonging economic uncertainty that may make UK-based companies move to the continent.”
In any case it looks more likely now that the EU will effectively agree to start talking about the things that matter in December: the transition after Brexit and the UK’s future trade status. Theresa May is said to be pushing for an emergency dinner of EU leaders in November to prepare this.
Fourteen European trade and business organisations yesterday warned that an agreement on a period of transition after Brexit is urgently needed. They think a failure to reach a deal would send “costly shock waves” through established trade flows and supply chains. Signatories include the European Shippers Council, the Community of European Railways and the European Association of Automotive Suppliers, but expect this list to grow as we get nearer to 2018.
There’s broad acceptance that “no deal” would hit the UK hard. But more and more in the German media are raising the alarm the dangers for Germany of “no deal”. The Cologne Institute for Economic Research has stated that German companies’ supply chains would “burst” if there were WTO-tariffs, with the automotive, metal and chemical industries hard being hit particularly hard.
How happy would these industries be to see the German government refuse to start crucial negotiations over this until December, letting the talks break up over a few billions for the notoriously wasteful EU budget? The Brexit negotiations finally have some momentum. Why take two months off?