March 25, 2019

Brexit: Decision Time for the U.K.

For more Brexit analysis, join the authors of this article and other FaegreBD professionals for a March 26 webinar, entitled Brexit: Current State of Play and Implications for U.S. Businesses.

It is another critical week for the Brexit process in the U.K. Following the agreed extension between the U.K. and the European Council, the U.K. is scheduled to leave the European Union (EU) on 12 April (pushed back from 29 March) unless the Withdrawal Agreement is approved by the U.K. Parliament. With no political resolution on the Withdrawal Agreement and fundamental divisions within Parliament on the nature and form of Brexit, this will be a critical couple of weeks for the U.K. and its trading partners. In this summary we set out where we are, how we got here and what the next steps in the process may be.

Where We Are and How We Got Here

On 23 June 2016, the U.K. held a referendum on its membership of the European Union. By a small majority of 51.9 percent, the U.K. voted to leave the EU.

The European Union

The EU is a single legal, political and economic union comprising 28 member states (including the U.K.). It is the world’s single biggest trading block and the largest trader of manufactured goods and services. The EU in its current form is the culmination of a series of agreements and treaties between European nations following World War II.

As part of the EU, the U.K. currently benefits from harmonized trading rules across the European Economic Area (EEA) — the 28 EU countries plus Norway, Iceland and Liechtenstein. The basis of this ‘internal market’ is the four fundamental freedoms of movement of goods, services, capital and labor. Businesses situated in the U.K. and trading within Europe are able to move and sell goods and services throughout the European Economic Area without incurring trading tariffs. There is also a harmonized set of minimum regulatory and product standards, meaning companies often only have to comply with one set of rules. In addition, the free movement of people throughout the EU means that companies can select from a wide pool of skilled labor and redeploy employees in different member states without restrictions.

In joining the EU, member states agree to limit and pool their sovereignty in areas such as trade, commercial policy, antitrust and consumer protection. Freedom of movement rules restrict individual member states’ ability to control immigration from within the EU.

Background to the Referendum

The U.K.’s membership of the EU has been politically contentious for decades, particularly within the U.K.’s governing Conservative party, which contains a substantial minority of Eurosceptic members of Parliament. The previous prime minister, David Cameron, sought to put this issue to rest by promising a referendum on the U.K.’s membership. The question was simple: whether to remain in or leave the European Union. The referendum did not address the form and process of exit and there were no provisions for a super-majority to be applied.

The Article 50 Process

Article 50 of the Treaty on European Union provides for a two-year time period for the negotiation of a withdrawal agreement between the EU and a withdrawing state. If no agreement is concluded within two years of that notification, then membership ends automatically, unless the European Council (acting unanimously) and the member state decide jointly to extend this period. The draft Withdrawal Agreement (summarized in our previous alert) provides for a transition period starting on March 30, 2019, and ending on December 31, 2020. During the transition period, the U.K. would continue to be treated as if it were a member state, except that its representation in the EU political institutions would cease. Accordingly, the disruption to business would be minimized.

Negotiating the Withdrawal Agreement

Following two years of negotiation, the U.K. and EU negotiating teams concluded a draft Withdrawal Agreement which deals mainly with four issues: (1) citizens’ rights, (2) financial settlement, (3) the Irish border, and (4) the framework for the future relationship between the U.K. and the EU. The U.K. government adopted a number of ‘red lines’ in its negotiation strategy, which were perceived to reflect the reasons why the majority of leave voters voted to leave and safeguard the peace process in Northern Ireland.

Among other ‘red lines,’ the U.K. government:

  • rejected membership of the single market (in favor of negotiating a new comprehensive free trade agreement) to avoid single market rules limiting the U.K.’s ability to control intra-EU migration.
  • rejected membership of the EU customs union, to have the freedom to make its own preferential trade agreements with non-EEA countries.
  • committed to avoiding a “hard” border on the island of Ireland (between Northern Ireland and the Republic of Ireland).

The U.K. Parliament has overwhelmingly rejected the proposed Withdrawal Agreement on two occasions.

Remainers — members of Parliament committed to staying in the EU — argue that leaving the EU will sacrifice many of the economic and social benefits of EU membership and fear any form of Brexit will leave the U.K. worse off. Leavers — pro-Brexit members — argue that the Withdrawal Agreement fails to provide a sufficiently clean break with the EU and have criticized the long transition period, elements of the financial settlement and the indefinite nature of the Irish border “backstop.” The backstop is triggered if the U.K. and EU are unable to conclude the terms of a new trade deal prior to the end of the transition period in order to avoid a “hard” border between Northern Ireland and the Republic of Ireland. The backstop arrangement has no express time limit and would essentially continue until superseded by the future long-term trading relationship between the EU and the U.K.

Deal or ‘No-Deal’ Brexit

The threat of a disorderly “no-deal” Brexit has been used as negotiating leverage by both the U.K. and EU. The U.K. government has tried to present the vote on the Withdrawal Agreement as a choice between the Prime Minister’s deal and “no deal.” Economic forecasts view a “no-deal” Brexit as the most damaging outcome for the U.K. in the short to medium term. It would also have a significant impact on the EU and EU member states, notably the Republic of Ireland. There is broad consensus that the U.K. is not sufficiently prepared to mitigate the unavoidable disruption and uncertainty which would result.

With the clock counting down to the deadline of 29 March 2019, the U.K. prime minister sought a short extension until the end of June at last week’s EU Summit to allow more time to gain support for the Withdrawal Agreement while maintaining the political pressure of the prospect of a “no-deal” Brexit.

The New Timeline

The EU countered with a new deadline and process. This has been accepted by the U.K. and the U.K. will need to amend domestic legislation to reflect the new date for “exit day.” The key dates are as follows:

  • if the U.K. Parliament approves the Withdrawal Agreement, the U.K.’s exit from the EU will be delayed until 22 May to allow the U.K. Parliament and the government to attend to administrative and legislative formalities.
  • if the U.K. Parliament does not approve the Withdrawal Agreement, the U.K.’s exit from the EU will be delayed until 12 April, and the EU will expect the U.K. to indicate a way forward before this date for consideration by the European Council. This may be a “no-deal” Brexit or a further (and likely much longer) extension which almost certainly requires the U.K. to participate in elections for the European Parliament to be held in the U.K. on 23 May.

This effectively puts the onus on the U.K. to produce a Plan B. The U.K.’s period of significant political uncertainty is set to continue over the coming weeks, with similar proposals to be further debated. It is likely that Parliament will hold a series of “indicative votes” on options, which could include:

  1. The Withdrawal Agreement.
  2. Continued membership of the EU customs union (resulting in a softer Brexit but limiting the U.K.’s ability to enter into trade deals with other countries).
  3. Continued membership of the EU customs union and the single market, often referred to as “Norway Plus” or “Common Market 2.0” (preserving some economic benefits of membership, but requiring the U.K. to adhere to most of the existing rules, including free movement of people, without a substantive role in EU governing bodies).
  4. Revoking Article 50, effectively canceling Brexit.
  5. A second referendum.
  6. A “Canada-style” free trade agreement (to the extent that this differs from the Withdrawal Agreement in 1).
  7. Leaving the EU without a deal.

To add to the uncertainty, owing to the weakness of the government and its seeming inability to command a majority in parliament for its flagship policy, the possibility of a general election at short notice cannot be ruled out.

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