Preparing for Brexit

Hello and welcome to Brain Food For General Counsel, where we take a monthly look at the biggest issues your organisation faces, helping you to navigate them with thoughts from some expert voices. My name is Matthew Magee, and I am a journalist here at Pinsent Masons.

The UK is on the cusp of one of the most fundamental social, political and economic changes in decades – leaving the European Union. Technically Brexit has already happened but the transition period has kept everything more or less the same and it lapses at the end of 2020.

Change, when it comes, will be profound in the UK and material in Europe. The effect will be more minor in the rest of the world but many countries will find the UK suddenly at their door, looking to negotiate separate trade deals and create direct political and economic relationships. A deal with Japan was announced recently, though it was more or less a lift and shift of the existing EU deal.

Businesses have been preparing for years. The referendum vote was in 2016 after all, but they have been hamstrung by a frustrating lack of clarity about what a trade deal with the EU would look like, or whether there would be one at all. Recent months have brought that clarity, though not necessarily in the way that business wants it. Any deal is now likely to be so narrow in scope that the difference between it and no deal is smaller than ever.

What does it all mean? We will hear from former head of the UK Government Economic Service, Vicky Pryce. How did we get here? David Thorneloe of Pinsent Masons, who advised the UK government on some of its Brexit work this year, can help with that. And what should companies do to prepare, now that the eve of Brexit is upon us? Brexit specialist Clare Francis of Pinsent Masons will give some useful pointers. And trade negotiator will help us understand how trade agreements work and how companies can respond to that.

And there's some good news. Brexit was not what business wanted, and the version we are getting is different from that most often discussed in the referendum campaign, but Vicky and Clare have both found some grounds for optimism. Limited, speculative and conditional, but at the moment we will take all the optimism we can find.

We will turn to Vicky first for a quick primer on the economics. When you live in a country and are exposed to what feels like an increasing degree of myth-making about what state the country is in, it is easy to lose perspective. So I asked Vicky, is the UK genuinely an important economic power in the world, and what effect might Brexit have on that standing in the medium term.

Vicky Pryce:

The UK is a very significant player in the world in the world economy. We are the fifth largest economy in the world. We account for something like just over 3% of world GDP. We are members of all the major international bodies, we are members of the G7. We are members of OECD. We play a big role in the G20. And if you look at our share of GDP in Europe, we are about 16% of the overall GDP. In reality, we did have quite a lot of power as part of the big bloc, of course a big bloc like the EU which has quite a lot of power in relation to ensuring that trade agreements were done in a certain way in negotiating with other countries, having a voice in the WTO, the World Trade Organisation. The sort of things that we will have now to recreate ourselves, despite our economic power as an individual country, we will have a lot less of a say in what happens in the world arena as a result of being outside the EU. 

If we go for World Trade Organisation rules, in other words no deal, then we could see GDP fall by or being 9% lower than it is now, over the next 13 years. Most forecasters with agree with that. If we have something that is looking more like Norway, if we are ever able to move in that direction, then the hit is considerably less and in between is what we are discussing now, which is an FTA which is a free trade agreement, then that will mean that somewhere like, possibly 5% to 6% lower. The problem with that is of course you lose that output over a period of time you cannot really recover it and that is why so many people now, including the LSE, the London School of Economics, has some recent calculations and others, are saying that in fact the long term impact on Brexit is likely to be possibly at least twice as large on the UK economy as the impact of Covid 19.

Matthew Magee:

That is the big picture but what is the situation for businesses? All businesses asked for from the very start from this phenomenon has been certainty. The good news is they now have it, even if the practicalities of that certainty might not be wholly welcomed. But Brexit expert Clare Francis of Pinsent Masons says that whether there is a deal or not business now have answers to most of their questions about what happens next.

Clare Francis:

There is a real convergence between what on the one hand a deal might look like, and on the other hand what a no deal scenario would be. And that convergence has come about over time rather than being a really stark contrast we saw last year of that cliff edge scenario because we know the deal is becoming thinner and therefore there will be some change even if there is a deal on the various elements. That means for businesses that convergence does give them some areas of more certainty where they can plan and prioritise their resources and their activities accordingly. One thing we finding many clients look at and focus is actually the lessons they have learned from the impact of the Covid 19 pandemic, particularly in terms of their supply chains. Supply chains were massively impacted by Covid 19 and businesses have learned some very valuable lessons from that which they have been able to take into their Brexit planning now, in terms of whether they have dual source suppliers or where those really critical pinch points in the supply chain are, so they can really focus and prioritise on those and make sure they are the goods that they have either stockpiled or have alternative sources for, or mitigated their plans accordingly. 

And that has certainly meant many businesses feel much more robust going into this uncertainty now because they have dealt with those issues in the Corona Virus lens and therefore they can use that learning in their Brexit preparations and feel more confident about where the impact may be felt by their business. So the most affected companies remain those in a regulated sector, so financial services and life sciences being a real good example and those that transfer goods across the border. They have always been the most affected, the regulatory ones, because of the different way the regulatory regimes are going to work but that does mean that those business in the regulated sectors are generally more prepared, because they have been forced to prepare earlier and had a lot of guidance from their regulators in terms of what to do. Probably less so, and where people have been waiting for more certainty, is those businesses who trade goods across the border with the EU and the UK, vice versa. Where there has been a real wait for certainty in terms of what that all look like and that is where they could see some really bumpy disruption in terms of delays and additional costs at the border.

Matthew:

Trade law expert David Thorneloe of Pinsent Masons agrees with Clare that the deal and no deal pictures now look quite similar.

David Thorneloe:

We are seeing this year more certainty than ever as the deal and no deal scenarios comes closer together. It has become clear from all the briefings coming out form both sides that if there is a deal it will be a slim deal and that for many, if not most sectors in the UK, that that bill may have little impact. The impacts which we are likely to see from day one in January 2021 do look now pretty similar whether it is deal or no deal. It is most likely to have a major impact around that question of zero tariffs and quotas. The biggest change that will affect all sectors of the UK economy will be around the UK border because even if there is a deal on tariffs and quotas the border is being erected and there will be customs formalities to be complied with and that will lead to a slow down of movement and trade at the border. By the UK government's own calculations there will be an extra 200 million customs declarations a year, which really is an eye-watering number, to give you a flavour of that administrative burden that will come from next year. 

In the longer term the other sort of general thematic change is going to be around the UK services sector, with some services affected more than others. There is every chance, particularly with something like the financial services sector where the UK has such a strong portion of the market, that the EU will from its perspective will quite possibly be looking at more protective measures. So it is really about service providers in the UK thinking about how they can get that foothold in the EU market? They are no longer going to have that right to do so just by virtue of being based in the UK and they will need to think much more closely about how they really embed their operations in the EU in ways that comply with EU regulations if they really want to continue to benefit from accessing the EU market.

Matthew:

We've been living with the reality of Brexit for four years and yet it still has the capacity to surprise, even alarm. This autumn an almighty political row broke out between the devolved administrations in Scotland, Wales and Northern Ireland on one hand and the UK government in Westminster on the other. 

It was about the Internal Market Bill, a piece of legislation designed to make sure the trading bloc within the UK survived. It takes the place of EU internal market legislation once it no longer applies in the UK and ensures that there is a frictionless market within the UK, but could have some pretty hefty consequences for the whole country as it risks undermining the powers of devolved nations. Trade law expert David Thorneloe.

David:

It does that through two principles essentially. The first is mutual recognition, so if a good can be lawfully sold in one part of the UK then it can or should be sold in other parts of the UK. And the second is non-discrimination, so that goods moving from one part of the UK to another are not discriminated about in the regulatory systems that apply in different parts of the UK. We see a labour administration in Cardiff and an SNP administration in Edinburgh who are more inclined to pass legislative measures that might impose higher food standards, higher consumer protection, public health protection, environmental protection and they have a real suspicion of the Conservative government in Westminster that it will be seeking to deregulate and lower standards in its attempts to deregulate for business. 

If there are higher food standards, environmental protection standards, public health standards that are imposed in legislation in Wales or in Scotland, then they will be trumped if there are lower regulatory standards in England, because goods will comply with those standards in England can be traded in Wales or Scotland and those high standards cannot prevail. So there is some sense in those criticism we seeing from devolved administrations, but it is also dependent very much on the political context and what, at the moment, are merely suspicions that they have of the deregulatory intentions of this UK government. 

I think there is no doubt that this hardline approach being taken in the bill does risk long term constitutional implications. In our 20 year history of devolution in the UK over the last 20 years it has been characterised by devolving more powers out, so different parts of the UK and very much taking a much more consensual approach and I think if the UK government is going to stick to its hardline retreating from that kind of approach, it does not bode well for the future constitutional status of the UK.

Matthew:

Let us get to some of the practicalities. Brexit will change the way companies operate in some pretty major ways. How they construct goods and where they can sell them; where they can offer services or advice, and what other companies they can work with are all issues that suddenly become much more complicated on 1 January. A major focus is on supply chains where companies are trying to find more local suppliers, or using more than one supplier for components, or just holding lots of stock themselves, all in search of resilience, says Clare Francis.

Clare:

So, certainly people are looking at supply chains in a different light and a different context than they had before. The supply chain resilience piece we are finding in our discussions with clients and also a study we have done recently with Warwick Manufacturing Group that there is no one-size-fits-all solution. So dual sourcing is not the magic answer. Holding stock or buffer inventory is not the magic answer and actually it is a combination of those various different things that will bring you resilience in your supply chain. However, as with everything in life that does come at a cost and businesses are really challenging themselves to say, what is the acceptable cost to buy that supply chain resilience? Rather than it necessarily being a race to the bottom. I think that is one thing that businesses should certainly look at in great detail, and one of the opportunities as they go forward into 2021 and beyond is just how they adapt and manage their supply chain in different ways going forwards in order to rebuild that resilience and what is that acceptable cost.

Matthew:

So companies are trying to prepare and change how they do business, but customs and international trade consultant Anna Jerzewska says that companies have just not had adequate opportunity to prepare enough for what is about to happen.

Anna:

For the most part businesses are not prepared, they are not ready. Even the businesses that have been trying to get ready cannot be fully ready because of lack of information. So, we are still waiting for proof or guidance, not only in terms of Northern Ireland but also in terms of just our normal border with the EU. We are still waiting for information, still waiting for applications for certain certifications, for a number of other things. No one can tell you to be ready because the information is just not available. In the UK we are just generally not ready, in particular the government is not ready and there are couple of things here the government has not issued all the guidance. The border operating models, we do not have our IT systems in place. There will be issues with border procedures, issues with understanding for what it means to be an importer and exporter because whenever we import something into a different country, there is also a liability that comes with that, a legal liability and I do not think companies understand that and the communication from the government has not really helped in that respect.

Matthew:

Because trade was taken care of by the European Union the UK is going to be new to the process of negotiating its own trade deals. Anna gives us a bit of an insight into how the UK will fare when it attempts to negotiate bespoke deals with economic giants such as the US without the power of 27 other countries behind it.

Anna:

These will be the first agreements where the UK will negotiate from scratch and this will be interesting to see because it is a completely different story where you take an existing agreement and slightly amend it to make it more relevant for the UK and where you negotiate an agreement with a tough trading partner, a tough negotiator such as the US, on issues that are important for them and from scratch. I think that is going to make a massive difference in terms of what these agreements look like and we might find out that it is more complicated than we originally thought. The reason that EU did not manage to get a deal with the US, in the simplest terms possible, was because the EU did not want to compromise certain things and if we, the UK want to have a deal with the US chances are we will be forced to compromise on certain aspects and then we know that the UK general public, the people in the UK, do not want to see a compromise when it comes to food standards. They do not want to see a compromise when it comes to NHS and a number of other high profile topics is going to be challenge. The UK getting a deal will be dependent on how much the UK is willing and able to bend to American demands and requests.

Matthew:

The trade negotiations with the EU have been particularly fractious and politicised. A trade deal should take years to negotiate, but the UK and the EU were trying to hammer one out in months against an increasingly toxic political backdrop. David Thorneloe says they have been unique. 

David:

These been trade negotiations like no other. If we remember the context and think back to the beginning of this year, I do not think any informed observer believed then a complex negotiation like this could be completed in anything less than two years. But, the UK government insisted a deal had to be done in seven months and that is because the Johnson government's first priority is to ensure that the Brexit transition period does end at the end of this year, come what may. There has been progress, we have heard reports that both sides have agreed in principle on a number of issues that are around the edges of a trade deal, but it is looking like a slim deal from everything we hear. There have been three major sticking points in the negotiations, the first is the so called level playing field guarantees that the EU wants from the UK to ensure that the UK is not subsidising UK businesses in a way that distorts competition; access to the UK fishing waters for the EU fishing fleet, and thirdly effective enforcement which has become particularly important because I think it is fair to say that the levels of trust from the EU on the UK sticking to the terms of agreement are not particularly high right now. What we have seen really over the course of this year is the UK taking a really firm line in negotiations, no real compromises, particularly on those big issues, and it is fair to say that cannot realistically be a deal unless that does change in the final weeks. The process of a trade negotiation - of course each side starts with its red lines, with its opening position and it is then about trying to find that middle ground of where things lie. I think what has been really unusual about this negotiation between the UK and EU is the UK has been so hardline about it. The Johnson government is wise enough to know that if it wanted much more from the EU it would need to give up much more in particularly give up more control by the EU on how we would regulate elements of the UK economy.

Matthew:

Most observers harbour some optimism that some kind of deal can be done in the coming days but David says that observers may not be fully aware of just how unusual this negotiation has been, and of the actual state of talks.

David:

What I have heard from contacts in UK government since the summer is real pessimism on the prospects of a deal. In the negotiating room the UK is being just as unflinching in its position as it has been publicly. One of the reasons for that pessimism is just how far the negotiations have progressed. Typically in a negotiation like this we broadly expect there to see four stages. The first is the exploratory talks, where each is seeking to understand the positions of the other. That tends to be lots of very dry Powerpoint presentations and people dozing off in the corner of the meeting room while there are side talks at length about what they want and perhaps a few questions and answers just to try and understand what the other side is looking for. So that was those first couple of months back in the spring. 

The second stage is about getting broad agreement in principle on the main issues and where talks have progressed in the summer. The third is then moving on into the second half of the negotiations where you move onto negotiating the real detail of hundreds of pages that we see in a trade agreement. Typically a trade agreement is going to run to three four five hundred pages and that will all need to be negotiated in detail to make sure it is doing exactly what each side wants and it will be a lot of haggling over the details, a lot of horse trading. 

And then the fourth stage is that final haggling in a dark room over the last few issues that remain outstanding. Now the challenge with these negotiations, there is a lot of reporting in the press that assumes we are at that last stage we are getting into that haggling over the last few issues but that is not right. We have not actually moved past, as at mid October, when both sides took stock, they had not yet moved past the second stage, they got stuck. That really means both sides are leaving themselves a huge amount of remaining work to do in the final weeks. Certainly what I would say is, it would be a remarkable turnaround if both sides did manage to achieve a deal when they had left so much to be done so late in the process.

Matthew:

Trade is just not something most of us think about very much. It is a vital part of business activity and the expansion of global trade and removal of tariffs and barriers over the past century have changed the political, social and economic shape of the world. Globalisation has been the result. An increase in economic activity, an internationalisation of business and the lifting of billions of people out of poverty.

Yet those of us in developed EU economies just have no experience of the ins and outs of trade, how power defines its flows, how regulations open or close markets and how the day to day stuff of customs forms, queues and congested ports decides the economic fate of nations. Vicky Pryce and Anna Jerzewska explain the impact of new frictions in the UK's trade.

Vicky:

The way it works of course is that once you put frictions in your trade which was until now frictionless, even if you do not actually have any extra tariffs on trade either way, then obviously you make the life of businesses costlier and investment decisions will be affected by this. What it also does is it changes quite considerably your competitive position in relation to anyone else in Europe. What you find therefore is that markets become smaller. But I think the financial crisis is a very good comparison which gives us a reason to worry, if you like, in terms of Brexit. By looking at what happened during the financial crisis and beyond and then think that this is something similar that actually may have, according to forecasters, an even bigger long-term impact when you lose continuously because you of this enormous bloc. Then you just may never recover to the path that you had before.

Anna:

We have seen companies lose contracts, new contracts, so that is already happening, that might happen more. There is a number of issues that are different when you are a member of the EU versus when you are not a member of EU when you want to place a product on the EU market. You are no longer in the club, your rules are no longer accepted and treated as equivalent by the EU. You are outside and you need to comply with the EU's external regulation along the way that EU treats imports from third countries. UK companies are still hopeful that they will be able to maintain their market share in the EU. They are prepared to go an extra mile to be able to do that but if you are an EU client and you looking for parts that are not necessarily particularly unique, why would you from 1 January go to the UK knowing that you have to comply with customs procedures and import and export procedures. Why would you not just get it from someone else in the EU? I think that is going to be a problem and that is possibly … this is companies choosing the path of least resistance.

Matthew:

There is a steep learning curve ahead, then, for UK companies which want to continue to reach international markets, but much of what we've heard about is way beyond our influence or control. So what can we do in immediate, practical terms to make the best of the situation? Clare Francis.

Clare:

We know that in the short term there is still a bumpy road, obviously businesses are going to need to deal with Brexit on top of the ongoing Covid 19 pandemic. And the changes and disruptions that in itself brings, so really businesses need to look to 2021 and beyond in terms of their planning. From a Brexit perspective most businesses have already looked at their workforce planning so that is good and it is keeping on top that and making sure the processes are in place to attract and retain the talent required in order to operate the business. From a data perspective, if there is no adequacy decision and the end of the transition period then businesses will need to make sure they have put in place the relevant date to transfer agreements in order to deal with that. 

There is also an element around their contracts, just in terms of ensuring they remain legally compliant or doing what the business thought they did, so for example, is the territory referencing something as simple as EU or EEA and does that need to be updated to make sure that still includes the UK. And then I think we have touched on supply chain a lot and because that is an area so heavily affected by Brexit is an area of real focus for business. And in that supply chain and the contracts within it, we really moved and shifted in terms of the way our clients are responding to that from looking at a Brexit clause or something that gives a renegotiation right, to overlaying exactly how the contract deals with the way the business is responding from an operational perspective. 

Let me give you an example of what I mean there. So operationally some businesses would already do a lot of rest of world trade, for example, are thinking we are good at dealing with customs clearances, we understand how it works, we know what to do from our rest of world trade and we have the right resource in terms of capability and capacity to do that ourselves and we would you rather take control of that arrangement and make sure it works and be confident about it than push that risk onto our suppliers. In that respect they need to draft their contracts very differently to a business who is saying, I am not confident, I want my suppliers or my third party logistics provider to take on that risk and therefore the contracts really need to reflect very accurately the operational decisions that the businesses taken. 

That joined up approach between the operational teams and the in house legal teams is really critical going forward from a legal perspective. What you find a vast majority of businesses are doing is to prepare for a not deal scenario and then if there is the slim deal, obviously they can track back from that and that put them in the best possible position. It is being able to plan and prioritise accordingly. So, certainly we have helped clients map, what would I be doing if I was preparing for a no deal and where is that activity exactly the same based on what we now think the slim deal will look like and therefore that is something they can be doing now and would need to do in either scenario so it gives them that certainty that they are investing their time and energy in the right place that will have a good impact on their business going forward.

Matthew:

The economic picture is going to change quite dramatically, particularly for the UK, but also for parts of the EU as well. Nothing can alter that fact now. And the change will come at a time when the world still in the grip of a global pandemic with profound economic consequences. And this is where we get to one of the small glimmers of hope in what is otherwise an anxious time. Vicky Pryce says that some of the actions taken by governments to combat the impact of coronavirus could also help the UK survive Brexit. These are options that were always there she says, but have only just now been made palatable because with Covid-19 there has been no other option.

Vicky:

What we found with the coronavirus crisis is that quite a lot of those constraints in Europe and also here have now been thrown out of the window if you like, in the sense of there is a rethink of what support needs to come from particular countries when they are hit by a crisis. We have borrowed extensively already. Europe is borrowing very significantly. So what we have learned is that there can be government intervention to ease the pain. What it means that there could be some active policy to reverse some of the negative trends that we might see because of Brexit. A lot more innovative policies, a lot more investment perhaps, in areas that might lead to further growth in the future. But most importantly on the competitiveness side you do need to spend a lot of money on innovation, new technologies, everyone talks about green, of course so really much more involvement from the government in these areas and I think what we also learned from the corona virus crisis and we are probably going to be learning and also in relation to Brexit is that we are now in a situation where … most countries that we look at, the ones that have successfully survived the previous crisis and the ones that are now doing reasonably well in current crisis is that the state is getting considerably more involved.

Matthew:

And another little sliver of optimism comes from Clare, who has worked with companies for more than four years to help them prepare for the next few weeks. It has been a long, uncertain journey marked by frustration and confusion, but underneath all that has been real change, some of it very promising indeed.

Clare:

Often we hear that the business will say, we are doing this, but actually this has been a catalyst for us making a change we probably should have made before or we had already be considering in some way. So Brexit is part of that decision making process but rarely the only decision making factor there. We are in a world where there is no new normal in many ways. There is always change and the businesses that can deal with that change and be agile in the way they deal with it are the ones that are really going to survive and thrive. If we get through the next five years without some other significant disruption, then in my view that has probably been a lucky break. So for businesses it is really focussing on how you deal with adversity and be agile and resilient in the way that you address that so that you can survive anything that might be thrown at you.

Matthew:

Thanks for joining us for the latest Brain Food for General Counsel podcast. Remember you can keep up to date with hour by hour coverage of business law news by the Outlaw reporting team at pinsentmasons.com. Do not forget to subscribe to us wherever you get your podcast until next time, goodbye.

Brain Food for General Counsel was produced and presented by Matthew Magee for Pinsent Masons, the purpose-led international professional services firm with law at its core.