Following the momentous decision by voters for Brexit in last month’s referendum, many business leaders were left asking: what next? Allie Renison, head of trade and Europe policy at the IoD, outlines the alternatives for a post-EU Britain and examines the steps UK businesses should be taking now
On 23 June, the UK took a monumental step towards changing its future direction of travel. Despite widespread predictions that it would choose pragmatism over principle, the principle of [self] control won out over most other considerations for British voters. For businesses, assessing the consequences of a Leave vote is a much taller task. But the Institute of Directors is committed to assessing its full implications, and ensuring that business not only feels as prepared as possible for it, but also stands equipped to capitalise on any opportunities that may accompany it.
In the wake of the referendum, the most pressing concerns for businesses are responding to the short-term consequences stemming from disruption to financial markets and preparing for longer-term ramifications and maximising any opportunities that a post-Brexit landscape stands to offer. We are already beginning to see some of the more immediate negative fall-out in the aftermath of the vote to leave, with more than £120bn being wiped off the value of Britain’s biggest companies, the pound plunging to a 31-year low against the dollar and the UK being stripped of its AAA credit rating since the referendum.
Among IoD members too, trends are beginning to emerge, although it is still far too early to draw any dramatic or sustained conclusions about which way business is headed. A snap poll following the vote found that more than a third of directors plan to cut investment in their business, a quarter intend to put a freeze on recruitment, and one in five are considering moving some of their operations abroad.
Only time will tell if business leaders follow through on any of this, but there is clearly no room for complacency, even at this early stage. While much is still unknown about the shape of EU negotiations and indeed of the government that will be leading them, firms need to be in stock-taking mode at the very least to assess how, if at all, changes might affect them.
The narrative in respect of Brexit has often been to divide businesses along a line between big and small, trading and domestic-facing. But IoD research has found that the reality is much more complex, with 83 per cent of its membership having at least one form of commercial link to the EU – be it direct exports, integration into an EU-facing supply chain, employing European nationals, importing from the bloc, or operating as the subsidiary of an EU-based parent company (and vice versa).
With such a high degree of integration into EU markets, it is vital that the IoD provides information to its members about the alternative scenarios to EU membership and what fundamental changes, if any, this could spell out for firms across a range of sectors. Politics will play an important role in shaping the outcome of these negotiations, and as such constrains our ability to predict economic and business outcomes with any degree of finite certainty. However, there are a number of areas where we can forecast a range of potential changes to policy that firms should take into account when making any adjustment plans in the wake of Brexit with both short and longer-term perspectives in mind.
This article examines possible implications and outlines some steps that businesses should be taking now. It calls on companies to assess their commercial links and exposure to the EU, sets out potential timescales, and examines the possible consequences for taxation, regulation, immigration, trade and commercial contracts.
What are your links to the EU?
The impact of Brexit is going to be felt well beyond exports; there is a wide array of commercial links (direct and indirect) that companies have with the EU across the B2B and B2C space, as well as with the EU itself. The IoD has surveyed its members to gain a better idea about the degree of business inter-linkages – these are set out below. One of the critical lessons of the 2008 financial crisis was that the scope and scale of linkages between businesses in a globalised world are often underappreciated.
As such it is imperative to have conversations now with suppliers, clients or customers (especially those in the EU) to ensure you are clear about your contractual relationships with them post-Brexit, rather than leaving any unexpected surprise to materialise down the line. As far as possible, get to know your supply chain to determine where there are potential vulnerabilities – sterling’s current volatility means that changes to import costs in particular are likely to be passed along to firms which are domestic-facing only.
Simply having links – direct or indirect – to the EU does not, however, automatically mean businesses are fundamentally at risk from Brexit. Indeed, it is primarily demand for goods and services which drives trade, rather than simply being a member of a formal trading bloc like the EU. At this stage, however, it is important for firms to understand the full extent of their engagement with this bloc in order to minimise the potential for any unexpected disruptions.
Process and timescales
There are two ways of exiting the European Union:
• Repealing the 1972 European Communities Act – immediate impact but entails no negotiations with the EU and would leave the UK defaulting to membership of the World Trade Organisation (WTO). Politically unlikely and would be incredibly messy from a legal point of view.
• UK government triggers Article 50 in the Lisbon Treaty by notifying the European Council of its intention – this provides for a two-year timescale in which to negotiate a new arrangement with the EU, which can only be extended with the unanimous consent of all other member states.
Before the trigger is pulled on exiting, much thought will undoubtedly be given to what kind of ongoing relationship the UK will seek with the rest of the EU:
• UK could join the European Economic Area (EEA), comprising Norway, Iceland and Liechtenstein, to preserve its existing levels of access to the single market – best solution for trading businesses in terms of continuity, but removes UK’s formal negotiating voice in the EU and means free movement continues.
• The Swiss government has over many years negotiated a complex series of bilateral agreements, dubbed the ‘Swiss model’. It is highly unlikely that such a framework is going to be appropriate or desirable for the UK; it is more of a description of an iterative process rather than a model as such.
• Dependence on WTO rules. This is a comprehensive set of rules, but the guarantees on goods are much more ambitious and comprehensive than on services. If no agreement could be reached between the UK and the EU before the negotiating time ran out, trade would revert to WTO rules. It should be remembered that significant amounts of global trade take place under these rules, albeit with higher trade costs for market access and penetration.
Ultimately, three agreements are likely: one to formally relinquish the UK’s legal obligations to the EU; a final withdrawal agreement laying out new terms of bilateral trade; and a transitional agreement to provide for a graduated step-down in terms of market access before the new terms come into effect. Voting on the final agreement takes place on the basis of qualified majority voting in the Council of Ministers and requires a simple majority consent from the European Parliament.
Our research has shown us that a majority of IoD members consider comprehensiveness – getting a ‘good deal’ – to be more of a priority than speed. Given that for the duration of the negotiations the UK remains a full member of the EU, there is reason enough to argue for taking the necessary time to ensure an appropriate level of ambition. This is also why neither the government nor business appears to want to rush the formal triggering of Article 50 to begin the negotiating process.
However, unless the UK opts for the EEA route (which requires rejoining the European Free Trade Association first) under its current structures, there is a potential risk that waiting too long may involve a trade-off in the content of the EU’s negotiating offer with respect to a bilateral trade agreement.
Opting for membership of the EEA, unless the UK seeks to negotiate some kind of amended EEA option (which is without legal precedent), is likely to be relatively straightforward. Negotiating a new bilateral trade deal with the EU would, in contrast, be unlikely to be completed within the two-year window provided, looking at the average length of negotiations with other major economies (which is about five-to-seven years).
In the event of a Brexit, the UK would no longer be bound by the EU’s VAT directives, and the government would have far more flexibility to set its own rate of sales tax along with the items subject to each rate. This has been a particular issue of late, with the so-called ‘tampon tax’ fuelling debate about the UK’s EU constraints in being able to reduce VAT below a certain minimum threshold.
But the administrative burden for businesses whose products travel through the EU would be likely to rise, given that they would no longer have access to the EU’s co-ordinated VAT collection system, and depending on post-Brexit arrangements, import duties would kick in. Businesses selling digital content to customers anywhere in the EU would still be bound by new place-of-supply rules, but would no longer have access to its VATMOSS system, which keeps firms from having to register for VAT in every single member state where a transaction is processed.
There is also the question of whether the UK no longer having to give effect to rules such as the EU’s Parent-Subsidiary Directive could lead to UK businesses with a parent company elsewhere in the EU, and vice versa, becoming subject to double taxation with respect to their profit distributions. The reality is that the UK has quite a high number of double tax treaties with many countries, including from the EU, although they are not as comprehensive in scope as the aforementioned directive.
It is very likely that the UK’s regulatory landscape in the wake of Brexit will not change significantly, certainly not for some time. The UK remains a full member of the EU until the terms of its new arrangement (assuming one is actually struck) come into force, which is likely to take years to negotiate. Even then, a transitional agreement is likely to soften the blow to some extent, and it is inconceivable that the government would not draw up legislation to give continued effect to much of the existing body of EU law that has been transposed into UK statute. For many businesses, regulatory stability and predictability are fairly important, even if there are some pieces of EU-derived law that proved problematic at the time of implementation.
The government may well use the period of its negotiations to undertake an ‘audit’ of that existing stock of transposed legislation and to decide – following engagement with various stakeholders, including the business community – what they intend to preserve and what might be stripped out going forward.
This will be a crucial time for the IoD to outline to government on behalf of its members where business wishes to see rules and standards maintained, to ensure some measure of regulatory stability and predictability, or removed to reduce any ongoing administrative burden. Whitehall civil servants have been reticent to remove much of the gold-plating that had crept into the regulatory framework over the years, for fear of breaching “non-regression” clauses in EU directives. Once out of the EU, the government would have no such grounds to fear judicial redress in stripping out some of the gold-plating that continues to exist.
Whether in or out of the EU, the reality is that the UK is likely to maintain and continue following most EU product standards as they develop to facilitate cross-border trade, particularly for regulated industries such as chemicals, pharmaceuticals and financial services. For these sectors, regardless of firm size, the lack of a formal influencing voice at the EU table (as well as in expert working groups and regulatory agencies where much of the substantive work on standards development takes place) is likely to be felt.
Once – and only once – the terms of the UK’s new relationship with the EU come into force, the UK could indeed negotiate its own trade deals as it chooses without having to worry about agreement from 27 other countries on the areas covered and level of ambition. However, it is likely that the UK may have to renegotiate trade agreements with more than 50 third-party countries that it currently enjoys preferential access to through membership of the EU. Under this scenario, the government may not have the capacity to open many new, large-scale negotiations with other countries for some time, as the immediate and shorter-term priorities will be the UK’s new EU arrangement and preserving its existing preferential access to the aforementioned third-party markets.
Any trade deal with the EU is likely to achieve substantive market access on goods, with some significant exceptions likely around agriculture, machinery, automobiles and chemicals. Implementation of a single market in services has proved difficult and will only become more difficult with the UK’s withdrawal, with British firms subsequently unable to rely on the European Commission or Court to enforce non-discrimination when operating across the EU.
Passporting for financial services firms (not having to face additional licensing requirements to operate across the EU once approved in member states) has been for the UK one of the most significant advantages of the single market. There are likely to be remaining EU members who are keen to shift this business from London to their own markets and so will seek to deny passporting. Difficult negotiations are likely to ensue over this issue, unless the UK opts for the EEA, in which its existing level of access in goods and services to the EU is preserved.
There will inevitably be consequences for commercial contracts. The IoD suggests looking into the following:
• Re-read all existing contracts This is where assessing the extent of your business’s direct and indirect links to the EU is essential.
• Pricing Exchange rate volatility could significantly alter the value of your importing (and/or exporting) costs and make the originally negotiated pricing mechanism too costly. New tariffs and changes to cross-border VAT could also add to these. These costs may be passed along the supply chain, so knowing where in the chain your business is situated is essential.
• Territorial scope Some firms (especially in financial services) may have contractual provisions referencing the EU and/or its right to operate within it. Clarification may be needed to ensure the parties can fulfil the terms of their agreement post-Brexit.
• Dispute resolution Where cases are heard in the event of a Brexit could start to matter for firms engaged in cross-border activity, at least with respect to enforcement.
In conclusion, it is clear the UK’s vote to leave, a momentous step in its own right, has unleashed far more questions than answers about the country’s economic prospects – few of which look close to being answered before a new prime minister is chosen this autumn.
This is a crucial time for business to engage with the government – and indeed with the EU – to shape its priorities in both European and domestic context. Important decisions around infrastructure, taxation, digital policy and immigration cannot be ducked just because of ongoing negotiations with Brussels.
Ensuring that Whitehall and Westminster adopt a liberal, outward-looking approach to its trading relations with the EU and the world is an imperative for business. While two-thirds of IoD members may not have voted for Brexit, they are aware of the need to make the best of the situation at hand. Business has no time for political recriminations – a testament to its resilience, determination and ability to adapt to new and changing circumstances where risk and uncertainty have become the norm. The IoD will do its part to make sure the politicians do the same.
Allie Renison is the IoD’s head of trade and Europe policy. Follow her on Twitter @AllieRenison
Immigration was easily the most heated area of debate in the referendum. Director outlines the various possibilities for free movement of people in the wake of the result
• Depending on the agreement reached, there may be a continuing commitment to free movement of people but it cannot be guaranteed. Free movement is one of the four central freedoms of the EU and continued access to the single market is almost certain to require it to continue. Trade-off between political/public pressure and certainty for business makes this hard to predict.
• There is likely to be protection for existing EU migrants. The government in seeking to provide reassurance to business is likely to reiterate its adherence to protecting acquired rights of EU nationals already in the UK. Which system would operate for new potential migrants in the transition from the existing EU system to a new regime is open to question.
• Long term, there may be a points-based immigration system. This would see points allocated for certain skills or qualifications, with parliament and/or the Home Office regularly reviewing point allocations depending on perceived business and economic need.
• The eventual immigration settlement may well turn out to be more neutral vis-à-vis EU and non-EU nationals settling in the UK, but that cannot be ascertained at this stage.
• The government’s continuing efforts to reduce net migration to the UK “to the tens of thousands” mean it is very unlikely to make any real liberalising changes to Britain’s immigration policy in the event of a Brexit.
• Eighty-three per cent of IoD members have some link with Europe, whether via export, import, supply chain, staff or operating as a subsidiary.
• It is imperative to begin conversations with EU clients and supply chain now, rather than leave nasty surprises lying in wait.
• Joining the EEA would be relatively straightforward and would preserve single market access, but would also remove the UK’s negotiating voice in the EU and means free movement of people continues.
• The administrative burden for businesses whose products travel through the EU would likely rise, given they would no longer have access to the EU’s coordinated VAT collection system, and depending on post-Brexit arrangements, import duties would kick in.
• Passporting for financial services firms has been for the UK one of the most significant advantages of the single market. There are likely to be remaining EU members, including France, Germany and Ireland, who are keen to shift this business from London to their own markets and so will seek to deny passporting.
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1 This gives direct effect to the primacy of all EU law
2 The European Council is composed of the heads of state or governments of all 28 EU members
3 Some have suggested the EEA as a temporary reverse stepping stone while the UK negotiates a new trade agreement with the EU. This would first require the UK to rejoin Efta, which it left in 1973 to join the European Community
4 Greenland, which left the then-EC in 1985 after three years of negotiations following a referendum, secured both a transition and withdrawal agreement – largely dealing with issues around trade in fish
5 For further exploration of gold-plating issues, see the IoD’s 2013 report The Midas Touch at iod.com/influencing