The House of Lords' European Union Select Committee published a report on 13 December 2016, Brexit: the options for trade, the second of six reports to be published by the Committee assessing the risks, opportunities and key issues likely to arise before, during and after the conclusion of the UK's negotiations on exiting the European Union.
The Report provides a detailed assessment of the alternative frameworks under which the UK could conduct trade with the EU post-Brexit. The Report challenges the UK Government's public positions with regard to the Article 50 negotiations and the likely shape of any post-Brexit settlement.
The clearest recommendation of the Report is that the UK Government should, from the outset, seek a transitional deal thereby allowing negotiations regarding the EU-UK long-term relationship to extend beyond the two year cut-off point under Article 50.
The UK's trade as a member of the EU
The Report highlights the importance of differentiating between 'access to' and 'membership of' the EU Single Market. Many non-EU countries have 'access to' the Single Market with different levels of tariff and non-tariff restrictions under frameworks including membership of the European Economic Area, Free Trade Agreements with the EU and under World Trade Organisation rules.
The trading environment of the Single Market is only available to members, who are required to accept the "four freedoms" of movement of goods, services, capital and people. This contrasts with the UK Government's stated desire to conclude an agreement with the EU post-Brexit to maintain free trade while limiting the free movement of people. In addition, World Trade Organisation rules prohibit the conclusion of trading agreements focused on a single industry, which has been suggested as a means of safeguarding the UK's financial services industry.
Membership of the EEA
The Report concludes that membership of the European Economic Area would be the least disruptive future framework for UK-EU trade, as Single Market membership for trade in services and partial membership for trade in goods would be retained. Whilst joining the EEA as a non-member of the EU is technically possible, the Report suggests that the mechanics, timing and interplay with the UK's withdrawal from EU membership are unclear.
There continues to be significant doubt as to the willingness of remaining EU member states, and other non-EU EEA members, to agree to the UK joining the EEA post-Brexit. Joining the EEA would require the UK to continue to accept the free movement of people from the EU and still comply with around 75% of all EU legislation, under the authority of the European Court of Justice, while losing voting rights and influence over EU rules.
The Report is clear that there would be several benefits to such a settlement. As a non-EU EEA member, the UK would be free to conclude FTAs on a bilateral basis with non-EU countries, though this may be limited to tariff reductions on goods.
Membership of the EU's Customs Union
The Report recommends that the UK Government decides as soon as possible whether the UK should remain a member of the Customs Union, and recommends that the UK Government considers remaining in the Customs Union, at least as part of transitional arrangements.
Under a Customs Union arrangement with the EU, similar to the agreement Turkey holds, the UK would be required to adopt EU product standards and regulations for goods, and common customs procedures would be retained.
The UK Government's public position has been that it intends the UK to pursue its own independent trade policy post-Brexit and conclude FTAs with non-EU countries. However, as a member of the Customs Union, this would be virtually impossible with respect to goods.
There is particular concern that the UK Government has not yet assessed the likely costs, to both business and the taxpayer, of the increased administrative burdens associated with leaving the Customs Union, including customs checks and rules of origin compliance.
The Report expresses concern that the UK Government has not given this sufficient consideration in view of the considerable implications of leaving the Customs Union, and recommends they undertake an assessment regarding likely costs to both business and the taxpayer prior to triggering Article 50.
A UK-EU Free Trade Agreement
The UK Government is urged to seek clarification from the EU that negotiations for the UK's withdrawal from the EU will also include negotiations on any future trading agreement between the UK and the EU post-Brexit.
The Report concludes that an FTA with the EU cannot be concluded within two years and that this should be a longer-term objective for the UK Government. It is possible that an FTA would be enforced by the European Court of Justice and the extent of market access may depend on the extent of the UK's willingness to accept the EU's four freedoms.
The flexibility of a UK-EU FTA appears attractive, offering greater control over domestic laws and international trade policy. The UK will, however, be prohibited from conducting its own FTA negotiations with non-EU countries during the two year Article 50 negotiation period, and the Report concludes that the UK Government must seek a contingency agreement to ensure reciprocal market access under EU-third country trading agreements continues until the UK can negotiate and replace these with its own trading agreements.
Trade under World Trade Organisation rules
The Report concludes that trading on WTO rules in the absence of a UK-EU trade agreement would lead to the most significant changes to the UK's trading relationship with the EU.
WTO prescribed tariffs would apply to all goods and services and non-tariff barriers would increase greatly, while regulatory measures and product standards largely do not feature among WTO trading rules, except to the extent that the EU's regulations and product standards must be complied with when trading with the EU.
If the UK is to have a trade policy independent of the EU it will need to negotiate its schedules of tariffs and concessions at the WTO. The UK has already begun to engage with the WTO and EU on this, but it may encounter political problems in securing agreement from other WTO countries.
The Report suggests that dispute resolution mechanisms under WTO rules are slow and cumbersome and cannot take place in national courts. Additionally, the Report suggests that the UK Government would need to establish a UK authority to investigate breaches of trading rules to replace the function of the European Commission.
The Government's approach
The Report questions whether the UK Government's level of engagement with stakeholders in order to inform their priorities and negotiating strategy with the EU has been sufficient.
Further, the Report concludes that the UK Government is currently underestimating the level of resource and capacity required to conduct the Article 50 exit negotiations, negotiate a new trading agreement with the EU and to negotiate new trading arrangements with third countries.
The UK Government is urged to provide an estimate of staff numbers required and associated costs to equip the Department for International Trade and the Department for Exiting the European Union with sufficient resources and skills.
The Report suggests that the envisaged timetable of triggering Article 50 in March 2017 will put immense additional strain on UK Government resources.
Evaluating the frameworks
The Report notes that the UK's immediate priorities should be its future trading relationship with the EU and securing its WTO tariff and concession schedules.
The Report, without naming individual ministers, implicitly criticises the "have your cake and eat it" philosophy of certain members of the UK Government, concluding that:
"the notion that a country can have complete regulatory sovereignty while engaging in comprehensive free trade with partners is based on a misunderstanding of the nature of free trade…the deeper the trade relationship, the greater the loss of sovereignty".
The Report argues for the UK Government to seek a transitional agreement with the EU in order to ensure as smooth a transition as possible to a new trading relationship with the EU, whether in the form of EEA membership, an FTA or falling back on WTO rules.
A transitional agreement would allow more time to conduct negotiations which would be in the interests of all parties. To this end, the Report recommends that the UK Government should develop a strategy and priorities for such a transitional agreement before Article 50 negotiations begin, in addition to formulating priorities for its long-term trading relationship with the EU.
The Report suggests that some form of transitional arrangements are essential to avoid the cliff-edge of a drastic change to EU-UK trading relations kicking in in March 2019 and to allow businesses time to adjust to any future changes.
UK Chancellor Philip Hammond has suggested that a transitional deal with the EU is required, claiming that such a mechanism is gaining wide support. Although Secretary of State for Exiting the European Union David Davis continues to publicly state that reaching a final settlement with the EU by March 2019 is both possible and desirable, it appears that a cross-party consensus in favour of some form of transitional arrangements is emerging.
Whilst business should take some comfort from the UK Government's apparent recognition of the need to avoid a cliff-edge in March 2019, there continues to be significant uncertainty as to UK Government's priorities and its prospect of achieving them in the negotiations.