Report: A transition to Brexit – deal or no deal?
November 2017 • Brexit • by William Wright & Panagiotis Asimakopoulos
The main benefit of a transition period is that it would reduce the risk of a ‘cliff-edge’ Brexit and buy more time for the UK and EU to negotiate a better long-term deal, but we think it is unlikely that any agreement can be reached early enough to prevent firms relocating significant numbers of staff. The good news is that an agreement on a transition period would be possible later next year – but only if the UK government changes direction in its negotiation strategy, and soon.
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Over the past few months, banks, trade bodies and senior figures from banking and other sectors of the economy have been queuing up to call for a Brexit ‘transition period’ to be agreed by the end of this year (or at the latest the end of March 2018) to reduce the risk of a cliff-edge Brexit. TheCityUK, the CBI, and others have warned that without such an agreement soon, firms will have to start moving staff and operations to the EU. But not for the first time, the City of London, the UK government and the EU are talking at crossed purposes.
This report analyses what a transition period might look like, why many people in the City want one, how it could work, and the political and legal obstacles to reaching an agreement. It also outlines some of the potential consequences if a transition deal is not agreed, and suggests the best way to reach a workable agreement.
One of the main issues we highlight is widespread confusion over the phrase ‘transition’. The UK government’s preferred language is an ‘implementation period’, which is often used interchangeably with ‘transition period’. This difference may seem semantic, but they mean different things, are based on different assumptions, and have profoundly different consequences.
The key difference is timing: an ‘implementation period’ would first require reaching a wider agreement with the EU to implement and assumes that the UK can negotiate a trade deal by March 2019, whereas a ‘transition period’ would be agreed before a wider deal is reached. By linking an implementation period to a trade deal, we believe the UK government reduces the chances of achieving either.
We don’t think a transition period can be agreed in time to prevent many firms from pressing ahead with their plans to relocate staff and operations to the EU27 next year (in part, we think this has been a distraction in the debate on transition). But a transition period can be agreed later next year if the government changes its negotiating strategy in the next few weeks and months, which would reduce the risk of a ‘no deal’ Brexit’.
Here is a short 10- point summary of our conclusions and recommendations:
1. Avoiding a cliff-edge: A transition period agreed in the next few months in advance of any wider deal would reduce the risk of a cliff edge Brexit, buy more time for financial services firms and their customers to prepare for Brexit, and prevent firms from moving substantial numbers of staff and operations before knowing the detail of the regulatory framework. But reaching such a deal in this time is unlikely.
2. Adapting to Brexit: If a future trade deal between the UK and the EU is agreed before March 2019, some form of post-Brexit implementation period would be essential to enable everyone to adapt to whatever terms have been agreed and to reduce the risk of significant disruption to financial markets and the wider economy after the UK leaves the EU.
3. Mind the gap: The gap between the political and business imperatives of Brexit will probably prove too wide for a legally-robust transition period to be agreed in the next few months, and efforts to reach such a deal in this timeframe would consume limited time and political capital. As a result, firms will have to push ahead with their plans to relocate staff and operations to the EU27 from early next year.
4. The risk of no deal: It is unlikely that the UK and EU27 will have time to reach a trade deal by the deadline of March 2019, although they may be able to reach a ‘heads of terms’ agreement. By focusing on trying to agree a deal by March 2019 and linking any transition to reaching one, the UK government is significantly reducing the chances of achieving either. This increases the risk of a ‘no deal’ Brexit.
5. Show me the money: To have any hope of negotiating any form of transition period and to improve the chances of reaching a trade deal before Brexit, the UK will have to offer significantly more money to the EU as part of its divorce bill in December at the next European Council meeting to unblock talks and move on to the next phase of negotiations.
6. A slow process: Even if the UK and EU agree to move on to the second phase of talks soon, it’s hard to see any agreement on transitional arrangements being reached before summer next year (the EU’s current timeline suggests October 2018). This would probably be too late to prevent firms from relocating staff, but it may limit the numbers and would address the more important risk of a ‘cliff edge’ Brexit.
7. If you don’t ask…The UK should present as soon as possible a more detailed outline of what it wants from a transition period and what sort of relationship it wants with the EU post-Brexit – and outline a realistic route to achieving both. The best option would be for the UK to ask to extend Article 50, but we don’t think this is politically tenable. The next best option would be to ask at the earliest opportunity for a two-year ‘status quo transition period’ starting in March 2019 that is not linked to a wider deal, during which it would a) leave the EU b) remain in the single market and customs union and c) not have a say in EU decisions.
8. A reality check: We think this is the only realistic way to a) ensure any form of transition period is agreed before Brexit b) remove the risk of a cliff-edge Brexit and c) set a more realistic timeframe for reaching a longer-term trade deal (it would effectively extend trade negotiations to March 2021).
9. Relocation, relocation, relocation: If the UK continues with its current approach, firms will have to push ahead with relocating staff. As the March 2019 deadline approaches, the EU would probably offer the UK a ‘take it or leave it’ transition on worse terms than the UK could get now (or the UK would have to ask for an extension late in the day) to avoid a ‘no deal’ Brexit.
10. Planning for the worst: The industry should continue to plan for a worst-case scenario, while continuing to warn of the huge risks of a ‘no deal’ Brexit and making a constructive case for potential longer-term solutions that would not need to be finalised until after Brexit if a transition period is agreed next year.
While the report focuses on financial services, many of the issues apply equally to other sectors of the economy. The report is in two parts: the first half includes our conclusions, a summary of the main issues, and an outline of the scale of the problem; the second part analyses the issues in more detail.
To request a copy of the full report click here
About New Financial:
New Financial is capital markets think tank launched in 2014. We’re having a growing impact among senior industry leaders and policymakers across Europe on making the case the case for bigger and better capital markets. In the wake of the financial crisis there is a huge opportunity for the industry to embrace change and to work with its customers and policymakers to rethink capital markets.
For more information, contact William Wright on 44 20 3743 8269 or firstname.lastname@example.org