In this week’s Column, Mark Essex discusses why organisations cannot ignore the risks associated with a hard Brexit.
The prime minister’s Brexit speech on Tuesday offers a coherent opening gambit for talks, now just weeks away. Yes, the vision is ambitious and will need further definition. A good chunk of the business community, currency markets and political pundits seemed to agree with me. Even a majority of European leaders gave it a cautious welcome.
Was it the perfect speech for business? Not quite. Companies on both sides of the Channel continue to face a number of risks. I believe that we will need to see a lot more detail from Mrs May and her European colleagues to protect business from the calamity of a ‘cliff edge Brexit’. More of that later.
The most ambitious aspect of the speech was on trade. Mrs May seeks to become a “global Britain” (a phrase she used 11 times), signing comprehensive trade deals with the rest of the world. At the same time she wants a “comprehensive, bold and ambitious” free trade agreement with the EU. That’s been done before; Canada is a party to both the North America Free Trade Agreement and their new deal with the EU. But Canada is not in a customs union, with the common external tariff and trade policy that comes with it. There is no precedent for a country that is, even partially, inside a real customs union to strike comprehensive free trade agreements with others.
And for good reason. For example, if the UK signed a deal that allowed New Zealand lamb into the UK at zero tariff, then without checks the UK would become a back door for that duty-free lamb to flood into Europe. The UK would therefore have to agree that exporters pay the tariff on non-EU countries’ products if they were then re-exported to Europe. That means we would need some sort of customs border at the Channel. Of course, it isn’t quite as simple as that. If that lamb were cooked in gravy, placed in a foil tin and topped with pastry, is it now a British or a New Zealand pie? This issue is already addressed by international ‘rules of origin’. For those who want the detail, I recommend an analysis by our customs expert Bob Jones here.
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Can the new deal create an arrangement that works like a customs union for interconnected supply chains, but protects the EU from back doors? I believe the government can achieve that balance with some creative thinking. For a start, the UK should also clear one hurdle on which many trade deals have become stuck in the past: the fact that regulations in the UK and EU are identical right now means that the EU and UK at least start in the same place when agreeing future regulatory equivalence and common standards.
And the UK and EU don’t have to review the impact of setting tariffs on 15,000 commodities. The end point on the UK:EU deal would be close to the start point in many respects. For business, UK:EU tariffs would change only as and when we sign new deals with third parties and then, only on those products where we want to diverge from the EU’s external tariff.
What I think is just as important is smoothing out non-tariff barriers – the grit in the system – to achieve what Mrs May referred to as “frictionless” trade. Any friction can end up costing companies considerably more than the tariffs themselves and would pose a major threat to industries where supply chains are pan-European, and Just-In-Time such as aerospace or automotive. We are used to simplified procedures for large companies who self-certify customs declarations and calculate tariffs at the end of the month. Goods aren’t stuck in port waiting for inspections but zoom straight through. Norway is one example where relatively frictionless trade is already a reality. As the Financial Times quoted one lorry driver crossing the border with Sweden last October, “I’ve got time for one cigarette and just one question … it takes just five minutes here. It’s very easy.”
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Can this system still be applied to the new deal? Rolling it out across the economy might be hard. And away from the physical shipment of goods, the financial services sector in particular would need years to safely replumb the system to transfer parts of it to mainland Europe. In other words the “phased implementation” Mrs May described is incredibly important. But what happens if the two sides fail to do a deal? The prime minister herself said the UK needed to walk away before taking a bad deal. And even if the UK and the EU’s 27 member states agreed, the European or British Parliaments still have potential to throw a spanner in the works.
The fall-back position if talks failed would be a sudden reversion to WTO tariffs, two years from now. That would feel like a punishingly hard Brexit to many sectors of the British and European economies.
Whether company boards view this as likely or not, they cannot do their fiduciary duty to shareholders if they ignore the risk. They have to make provision by taking out a kind of insurance: preparing for a sudden, hard Brexit by preparing plans for setting up European subsidiaries and legal entities, separating IT systems and rejigging supply chains. For some that will be a significant (and, we hope, unnecessary) expense.
For that reason, business would benefit from both sides prioritising an agreement committing to a phased UK withdrawal, even if they fail to reach a deal. Such a pact would need to be agreed early, before companies started spending serious money on implementing their contingency plans.
The prime minister talked about giving us all as much certainty as possible. A reserve parachute to ensure a soft landing, even if plan A fails, will make the cliff edge seem less daunting.
This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG in the UK. You can register for the email subscription list of this column and expert views from our Brexit leaders.