The anatomy of a Brexit transition deal

According to his colleagues, Britain’s departing EU ambassador had “his hair on fire” since the summer about one particular issue: the importance of a transitional deal for Brexit — and the risks of leaving the EU without one.

Sir Ivan Rogers’ warning to Downing Street, leaked in December, that the EU expects a full UK trade deal to take until the early to mid-2020s seemed stark. By Brussels standards, however, it was one of the more uncontroversial aspects of his advice.

More significant was his assessment that British political imperatives to control borders and leave the jurisdiction of European courts required the UK to go for a “hard Brexit” deal, leaving the UK outside the customs union and the single market. Given this reality, the most valuable outcome of Article 50 talks would be co-ordinated, orderly transition terms that would allow Britain to adjust.

Such a transition would also, in his view, quite well be impossible to agree.

His parting shot at “muddled thinking” was aimed at ministers or Whitehall officials who say a full UK-EU trade deal can be rushed through in the two years between the invoking of Article 50 and Brexit proper, or that a “bespoke” deal can somehow sidestep the most difficult choices.

Here the FT examines the anatomy of a transition and how it may become the crunch issue in Brexit talks.

The list of tricky decisions is lengthening: Secretary of state for international trade Liam Fox, foreign secretary Boris Johnson and DExEU secretary David Davis © EPA

There will be a transition . . . 

It is hard to imagine a Brexit scenario that does not include some period of adjustment. Britain entered the European Community in 1973 with a transition stretching seven years. The main question over its exit is whether the separation is gradual and managed under an UK-EU agreement, or whether it will be a more disruptive, abrupt process with only national measures to cushion change.

The need for bridging arrangements arises because Brexit involves many legal “moments” that are unlikely to coincide. An inexhaustive list includes agreement on a withdrawal treaty, a trade deal, the implementation and ratification of both of those, and the phasing in and out of rights and rules within each. This is why Philip Hammond, the UK chancellor, said “thoughtful politicians” were convinced of the need for a long transition.

. . . but not all transitions are equal

One form of transition could be to phase out old EU rights accrued while Britain was a member, such as the right of its citizens to reside in an EU country, to operate a business there, and potentially to seek redress in EU courts. This effectively deals with the legacy of 40 years of integration and shared law.

Another would comprise the phasing in of new trade terms once those had been agreed. Most free-trade deals need several years before and after they come into force to adjust tariffs or legal rights. Even recent big regulatory reforms of bank capital have included phase-in periods of six years or more.

A transition will probably set out certain cut-off points. These may vary sector by sector or right by right. Hard choices abound: should a transition apply only to “legacy” rights or should it encompass activity (new EU rules and laws) that takes place during the transition? What happens to a cross-border contract signed under EU law but disputed in court post-Brexit? The list of tricky decisions is lengthening. “Every day we seem to add one more thing,” said one senior EU negotiator.

There are key points of tension within Whitehall and between ministers © EPA

There are ways to cut things short . . . 

This is a key point of tension within Whitehall and between ministers.

One ambitious option is to agree both the terms of Britain’s withdrawal and a new UK-EU trade deal so they come into force on the same day. David Davis, Brexit minister, reckons this is possible within the two-year deadline once Article 50 has been triggered.

But it would require unprecedented speed from the EU, and on a matter of unprecedented complexity. EU negotiators reckon it would be impossible — and said as much to Sir Ivan. The EU is a tanker that turns slowly on trade, even when its leaders want to turn fast. After seven years of talks, for instance, the Canada-EU trade deal is still to be fully ratified and will only be “provisionally applied”, and only in part, from the spring.

A second “no-transition” option is to have no Brexit agreement at all. Withdrawal and trade talks would collapse and UK-EU business would revert to World Trade Organisation rules. There would be no treaty to cover the phasing-out of rights for cross-border businesses or expats. In this scenario, transition measures would be more unilateral, adopted by UK and EU authorities and regulators without formal co-ordination under a withdrawal treaty. The exit path would be more piecemeal, improvised and potentially chaotic.

. . . but when a transition is agreed is crucial

Typically in trade negotiations, transition terms are one of the last points addressed. Brexit differs because it is a matter of regulatory divergence, not convergence.

The uncertainty over losing rights has made UK-based businesses call for early transition guarantees. Without those, big banks in London say they will take decisions assuming there will be no transition.

If there is no agreement by March 2018 — basically one year before Britain’s formal exit in 2019 — the value of the interim deal diminishes dramatically for the UK. Companies would already have taken action to protect their own interests. The Treasury is alive to the risk of a City exodus if transition terms are not clear at an early stage.

Both sides see transition as a leverage point over issues such as access to the City of London © Bloomberg

So transition terms constitute leverage . . . 

The top priority for EU negotiators is the actual divorce — managing legacy rights (if and how various existing rights will carry over post-Brexit) and budget liabilities. They see a transition as an optional extra that can be discussed if and when Britain meets certain conditions: honouring an exit bill of up to €60bn and agreeing on the outline of future relations. The point at which the EU agrees to discuss a transition is, in other words, a bargaining chip it has to use against the UK.

That leverage is strengthened by another cold calculation in Paris, Brussels and Berlin: the longer Britain waits for a transition deal to be discussed and agreed, the more likely businesses will decide to move or shift investment away from the UK. For the EU-27, late agreement on transition would maximise relocation while still avoiding a “cliff edge” — sudden and disruptive change for businesses stemming from a sudden exit.

But Mr Davis also sees the transition as leverage. A hard exit would cut off corporate Europe from its main financial centre, the City of London. Highly integrated cross-border supply chains for carmaking or aeronautics would be badly disrupted. That would carry costs for all sides — if Britain was willing to walk away from the table.

. . . and tailoring terms to Westminster’s needs will be hard

For the EU-27, any transition must be simpler than a final EU-UK trade deal. That means fashioning a transition from existing EU systems: the European Court of Justice, EU laws, EU budget contributions and core EU rights such as the free movement of people. But any bespoke transition cannot be allowed to look better than actual membership.

By contrast, Theresa May, the UK prime minister, is preparing for an election in 2020. That would probably be after Britain leaves — likely to be in 2019 — so potentially in the middle of any transitional period. Yet she will have reconcile the terms of any deal with two promises she has made to British voters: to leave the jurisdiction of EU courts and to repatriate controls over immigration.

A transition deal would need to be sellable during a British election campaign, yet it will involve rights and obligations on which the EU side will be least willing to compromise. Here is the rub for both parties.

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