The chances of a no deal Brexit are increasing by the day.
Boris Johnson has signalled that he would be willing to walk away from the negotiations without a deal if a trade agreement between the UK and the EU has not been not finalised by the next meeting of the European Council on 15 October 2020. The EU for its part does not seem to be wanting to walk away. However, the likelihood of the UK leaving the EU without a deal and reverting to World Trading Organisation (WTO) trading terms has increased. Investment bank Morgan Stanley increased the probability of no deal from 25% to 40%; Japanese bank Nomura predicts the chances of a no-deal could be as high as 60%; and the ratings agency Fitch has made no deal its most likely outcome.
Without a free trade agreement (FTA) with the EU, trade between the UK and the EU will be conducted on WTO terms. The UK will become a "third country" in the EU's eyes, which means that the import and export of goods and services between the UK to the EU will face new customs and regulatory barriers for the first time in over 40 years. In addition, the UK would lose the benefits of FTAs between the EU and third countries which have not been ‘rolled over’ (which currently includes Mexico and Canada).
It is now more important than ever to prepare your business for trading on WTO terms. But what does trading on WTO terms actually mean? Here we answer that question by outlining the key principles of the WTO, what trading on WTO terms means for the goods and services sectors, and how you can best prepare your business for the end of the transition period.
What is the WTO?
The WTO is a multilateral international organisation dealing with the rules of international trade. It also provides a forum through which to negotiate trade agreements and settle trade disputes. It currently has 164 members – including the UK – and its members account for 98% of world trade.
If a WTO member does not have a free trade agreement (FTA) with other countries, then they trade under the framework created through various WTO agreements that establish the general rules applicable to all WTO member states - what we colloquially refer to as "WTO terms".
Key principles of trading on WTO terms
Trading on WTO terms is underpinned by two key principles of non-discrimination:
- Most-favoured nation (MFN) principle – in the absence of an FTA between two or more WTO members, countries cannot discriminate between their trading partners. For example, if Country A allows Country B to have preferential treatment (e.g. through a 5% reduction in their tariffs for agricultural products), unless an exemption applies, Country A would be required to afford all other WTO members with the same tariff reduction.
- National treatment (NT) principle – when goods or people from another WTO member state enter the territory of a member state, they must be treated in the same way as domestic goods and local people. For example, if Country A provides tax breaks for its struggling domestic automotive industry, all automotive companies that have operations in Country A will be entitled to such tax breaks, regardless of whether the company is domestic or foreign i.e. from Country B.
Individual commitments and the schedule of concessions
In addition to the general rules and principles, WTO members make individual ‘commitments’ which are outlined in ‘schedules of concessions’. These schedules set out specific tariff and trade concessions in respect of goods e.g. maximum tariff levels; as well as market access commitments (i.e. how much access will be granted to foreign entities to establish and operate in the domestic market).
As an EU member state and during the transition period, the UK's concessions and commitments on goods and services were contained within the schedule of concessions and commitments for goods and services of the European Union. However post-Brexit, and as a WTO member in its own right, the UK will have its own schedule of concessions with respect to goods and services. The UK circulated these schedules on goods and services to the WTO on 24 July 2018 and 3 December 2018 respectively. At present, both schedule of concessions are broadly similar with the EU schedule of concessions and commitments, but it is envisaged that the UK will make more substantive changes in due course following negotiations with other WTO members.
What does the import and export of goods between the UK and EU (and vice versa) look like under WTO terms?
The WTO agreement that governs WTO terms in respect of goods is the General Agreement on Tariffs and Trade (the “GATT”).
Whereas goods may currently be exported from the UK to the EU with minimal or no customs requirements, under WTO terms, there will be a customs border between the UK and EU. Goods traded between the UK and EU member states will be subject to tariffs. The UK will also leave the EU's Single Market, with the consequence that free movement of goods and harmonised regulatory standards come to an end. The benchmark for these tariffs between the UK and EU will be determined based on their relative tariff commitments to the WTO. However, business should not assume that trade with ‘friendly’ English-speaking countries will necessarily be conducted on preferable terms. As the MFN principle dictates, all trading partners with whom the UK does not have an FTA should be treated consistently.
In practice, reverting to WTO terms will have the following effects:
Importing goods from an EU member state to the UK
From 1 January 2021, importers from the EU to the UK will need to make import declarations as well as needing to register for an Economic Operator Registration and Identification (EORI) number with HM Revenue and Customs in the UK. In addition, the rules for importing some types of goods will change with respect to required licenses, regulatory standards and labelling.
Importers will also need to pay customs duties on all imports, but this will vary depending on the classification of the relevant goods being imported. The UK Government has created a website where businesses can check the UK Global Tariff that will apply to specific goods they import from 1 January 2021 (see here).
Exporting goods from the UK to an EU member state
From 1 January 2021, exporters from the UK to the EU will need to make export declarations, as well as needing to register for an EORI number with HM Revenue and Customs in the UK. As businesses have already been complying with EU licenses, regulatory standards and labelling when exporting to the EU from the UK, in order to continue doing so, UK businesses will need to comply with these same requirements.
Exporters will also have to pay customs duties on all exports, but these will be at the same rates as currently applicable on exports from countries outside the EU (third countries) into the EU and pre-Brexit UK. In practical terms, this is likely to impact upon the timelines for delivery to customers in the EU as well as the costs of shipping given the additional administrative burdens involved. UK businesses should liaise with logistics providers to estimate the procedures, increased time, and costs, including customs agents' costs, for delivery of its goods from the UK to the EU in the event of a no deal.
What changes to cross-border market access will there be between the UK and EU (and vice versa) under WTO terms?
Given that over 80% of UK’s economic output stems from services, this is particularly important to consider. The WTO agreement that governs WTO terms in respect of services is the General Agreement on Trade in Services (the “GATS”). In applying this agreement, there are general obligations that bind to all 164 WTO members including the obligation to treat all other members on an MFN basis.
Importantly, unlike under the GATT, national treatment is opt-in for services. Unless a WTO member has decided to commit itself to national treatment in relation to a particular sector through its specific obligations, or through an FTA, WTO members remain free to discriminate against foreign services and service providers and place limits on their abilities to access their domestic market. The only limitation is to this is that a WTO member must abide by the MFN principle and treat all other members on an equal footing.
The GATS outlines four main ways or “modes” that services are traded:
- Mode 1 (cross-border supply): where the service itself crosses the border to another WTO member e.g. a lawyer working in an office in the UK and sending advice to a client based outside the UK.
- Mode 2 (consumption abroad): where the consumer travels to the country of the service supplier and consumes the service there e.g. a tourist visiting a museum whilst abroad.
- Mode 3 (commercial presence): where a service supplier sets up a presence in another country to provide its services e.g. a German bank might establish a branch in the UK.
- Mode 4 (presence of natural persons): where a person crosses a border to supply a service and the service is produced in the country where it is consumed e.g. an engineer may travel abroad to oversee aspects of a building project.
Significantly, the GATS only provides limited rights for the entry and the temporary presence of business travellers under the “Mode 4" rights. Although these rights cover all service sectors, and define eligible categories of persons, specify limited duration of stay and prohibit numerical restrictions, they have no direct legal effect. Moreover, ‘free movement of workers’ is outside the scope of WTO law and not covered in the GATS, which means WTO members can significantly limit Mode 4 rights for business travellers.
Currently, by virtue of the UK’s membership to the EU, the UK and EU member states enjoy free movement of people with respect to services and market access. However, this will revert to WTO terms from the beginning of next year if the UK leaves the EU without a deal and will have the follow effects:
UK citizens travelling to an EU member state
EU Member States can treat UK citizens in the same way that they currently treat other third (i.e. non-EU) country citizens. The tangible impacts this would have for businesses will likely vary depending on the member state and their specific WTO commitments. However importantly, under the MFN principle (and assuming the UK does not negotiate a trade agreement with the EU) the EU is not allowed to show preferential treatment or discriminate against UK citizens over any other third country.
EU citizens traveling to the UK
EU citizens, when travelling to the UK, will be subject to the same rules that third country (i.e. non-EU) citizens are currently subject to when entering the UK. These rules strictly prohibit the visitor from working in the UK or receiving payment from a UK company source, unless permitted in specific circumstances. EU citizens who wish to work in the UK would need to apply for some sort of work permit / visa that permits work and such payments. Similar restrictions in respect of the MFN principle will apply to the UK in relation to traveling EU citizens.
What should you be doing?
Whilst trading on WTO terms provides a basic framework for world trade, there are a number of inadequacies that UK and EU businesses need to both identify and mitigate against. We suggest that you:
- Step up your Brexit preparations and ready your business to trade on WTO terms at the beginning of next year.
- Start conducting focused supply chain risk assessments to analyse the tariff and non-tariff barriers, including regulatory approvals, customs procedures and rules of origin, in your current and future key markets.
- Begin to engage with the UK and EU governments to inform and influence the outcome of negotiations in your interest.
How we can help you
DLA Piper’s team of lawyers and government affairs professionals in London and Brussels are here to assist you in your future preparations.
Our market-leading Brexit practice has a strong track record of helping clients prepare. We can carry out audits of your contractual agreements to assess their exposure to Brexit and undertake legal, commercial and human resources impact assessments, to identify areas requiring action.
With our full service, global capabilities, we can help you implement flexible Brexit-contingency plans, so that necessary adjustments can be made easily if a deal is reached before the end of the year.
Coming up next in the DLA Piper Trade Truths series
Whilst businesses are rightly focused on the current status of negotiations between the UK and EU, it is easy to lose sight of the impact of Brexit on the UK's trading relationship with the rest of the world. With the UK securing a free trade agreement with Japan, and active negotiations on-going with the United States and Australia, we take an in-depth look at what these FTAs will mean for clients.