After years of debate, negotiation and controversy, and an 11-month transition period, the United Kingdom formally completed its withdrawal from the European Union on December 31, 2020. Now that Brexit has become official, what will happen for businesses that operate in these markets, and what challenges and opportunities will they face going forward?
On December 24, 2020, after prolonged negotiations, the European Union and the United Kingdom agreed to a Brexit trade deal. Set out in a 1,246-page document, the UK-EU Trade and Cooperation Agreement (UK-EU TCA) details how the two markets will transact business going forward.
While the agreement aligns regulations in several key areas, the majority of businesses that trade between the EU and U.K. are likely to feel an impact—more paperwork and form-filling at a minimum, and likely more significant changes in industry sectors like agriculture, food and manufacturing. “For businesses exporting most kinds of goods into Europe, the deal isn’t great,” said Ian Borman, corporate finance partner at law firm Winston & Strawn. “But for those companies that are designing and manufacturing high-end sophisticated goods, such as microchips and software, or working in new industries such as fintech, the trade arrangements may be less prohibitive due to demand.”
New Trade Rules
One of the cornerstones of the Brexit agreement is the guarantee of tariff-free, quota-free access for most goods and products traded between the United Kingdom and European Union. However, there are also a number of new customs procedures and formalities aimed at U.K.-based exporters, including new “rules of origin” requirements that are likely to make it more costly and burdensome to do business in Europe.
Under these rules, U.K.-based firms (including foreign companies with operations based in the United Kingdom) will need to certify the origin of their exports to qualify for tariff-free access to the EU. While EU parts will count as “local content,” there will be limits on what proportion of goods can be assembled from parts made from other countries and still qualify for tariff-free access.
This will inevitably impact manufacturers that rely heavily on international supply chains, and may vary widely even among a single manufacturer’s products. Cars, for example, will fall under special restrictions. Gasoline or diesel vehicles will need to be made with at least 55% local parts to escape tariffs, while electric and hybrid vehicles will need to have 40% local content, which will rise to 45% by 2026.
Attorneys warn that importing and exporting goods and services will get significantly more complicated. According to Mark Blunden, partner and head of technology and commercial for technology law firm Boyes Turner, it is crucial for U.S. and other foreign firms operating in the U.K. to be aware of the country’s new regulatory arrangements to avoid being flagged for noncompliance. For example, there are now different accreditation systems in place in the U.K. and EU to which businesses trading in both jurisdictions will need to adhere so that goods meet both sets of regulatory standards.
Customs rules have also changed. “Many U.S. businesses ship goods into both the U.K. and EU, and these goods will now be subject to two separate customs regimes,” Blunden said. “U.S. businesses that are established in the U.K. and trade in the EU will also need to review their accounting arrangements. Now that there is no longer a common VAT regime, they may also need to register in relevant EU countries.”
Recruitment and talent management programs may also be impacted. Before Brexit, a U.S. business with a base in the United Kingdom was able to easily recruit talent from across the EU. Post-Brexit, it is more complicated. To bring EU nationals to work in the United Kingdom, U.S. firms will now need to register as a sponsor and abide by new U.K. immigration rules. On the other hand, U.S. companies will find it easier to hire and get immigration clearance for non-EU nationals (such as candidates from India and South Africa) to work in the U.K. than it was before Brexit.
One of the key issues during negotiations was whether the U.K. would try to attract foreign direct investment by undercutting EU rules, tilting the “level playing field” in its favor. As part of the Brexit deal, both sides have committed to upholding their environmental, social, employment and tax transparency standards so that neither market provides an unfair competitive advantage, while subsidies and state aid will come under tougher scrutiny.
Despite such commitments, however, the U.K. is not obligated to always align with the EU, and the agreement does not include any ratchet clauses that would require the UK to make its rules more onerous to keep in step with the EU. Instead, the deal includes a “re-balancing” mechanism allowing either side to retaliate with tariffs if they diverge too much, though “such measures shall be restricted with respect to their scope and duration to what is strictly necessary and proportionate in order to remedy the situation,” according to the agreement. As such, there is scope for the U.K. to unveil more business-friendly legislation and regulations.
“The U.K. government is acutely aware that it needs to make Brexit a success, so it is going to look at ways of making the country an attractive place for foreign direct investment,” Borman said.
Insurance Considerations
When it comes to insurance, companies with U.K. or pan-European operations will not experience any reduction in coverage or legal difficulty when purchasing a policy post-Brexit, said Peter Blanc, group CEO of insurance broker Aston Lark and deputy president of the U.K.’s Chartered Insurance Institute. Companies also will not need to buy separate policies to cover EU and U.K. operations and risks, and policies can still be bought in London or through a company’s usual insurers or brokers to cover both markets. “Some insurers may try to change policy wordings or introduce policy exemptions, but this has more to do with their own risk appetite than anything to do with the Brexit deal,” he said.
However, Blanc pointed out that “it is definitely a seller’s market” and premiums are rising as the market hardens further. “Whereas, previously, a company aiming to get €150 million [about $180 million] worth of cover for factory premises could find a single insurer to take on the full policy, now brokers are having to use three or four insurers to provide the same level of cover, which may add to the cost slightly,” he said.
Some areas of coverage are also becoming increasingly tight due to a lack of capacity. “The pandemic—rather than Brexit—has hit the market and dented insurers’ appetite to provide cover for some lines of insurance where future claims are likely,” Blanc said. “Directors and officers (D&O) insurance, for example, is becoming increasingly difficult to secure, especially for high levels of cover. This is because there is an expectation that a lot of companies are going to reveal how bad their financials are, which could lead to investor lawsuits and regulatory investigations into company accounts over potential incidences of fraud and negligence.”
Forging a Different Path
Many experts view the Brexit agreement as a largely positive step compared to the potentially damaging “no deal” scenario, in which the U.K. and EU would revert to trading on basic (and widely considered “unfavorable”) World Trade Organization rules.
Brexit may afford some new opportunities for U.S. firms, according to Andrew Northage, head of international trade at law firm Walker Morris. The fact that the U.K. no longer has to follow or stay aligned with EU legislation means that “the U.K. can forge a regulatory path that is much more in sync with the rules that U.S. companies already follow,” he said.
Following President Joe Biden’s inauguration, the U.K. is looking to press ahead with a bilateral trade deal with the United States. Just what any deal would include—or omit—is still unclear, as is the timeline for finalizing it. Even if an agreement is not forthcoming in the next couple of years, many believe that there is likely to be some “cozying up” on both sides to boost trans-Atlantic investment opportunities.
“Both countries are highly attractive markets in which to sell goods and services,” Northage said. “The United States wants to export more of its agricultural produce overseas. Efforts by the U.K. to create greater alignment on food standards would boost bilateral trade. Similarly, as European business returns to Eurozone-based banks, U.K. financial services firms should be exploring possibilities to sell services into the U.S. market and the U.K. government should be pushing for that.”
While companies may hope that the U.K. government acts fast to improve its level of business-friendliness through a mix of tax and regulatory cuts, even without them, the U.K. is likely to remain a destination from which U.S. companies want to operate. Over 8,500 U.S. businesses already call London their European home. Low corporate tax rates and double taxation agreements with destinations such as Ireland, France and India make the U.K. an attractive option for companies looking to expand into Europe. The country has the second-largest workforce in the EU (after Germany) and is forecast to be one of the few countries in Europe that will have a growing labor market in the next couple of years.
According to Paul Sleath, CEO at employee management firm PEO Worldwide, the U.K. is generally regarded as having very business-friendly, flexible labor laws that enable employers to have greater scope to customize employee compensation. “Collective bargaining agreements are rare and tend to only occur in public organizations,” he said. “This means you are free, subject to statutory minimums such as holiday and employee pension provisions, to offer the salary, working hours and benefits you want.”
To encourage greater investment by U.S. businesses, however, the United Kingdom will have to do more than simply rely on these historic advantages. “Long-sighted strategic government support will be critical and will be the key point of competitive advantage between locations,” said Ben Collett, managing director for transaction advisory services at governance and risk consultancy firm Duff & Phelps. “Financial incentives will need to be creative—not just in the setup of new plants, but also in the investment in capital expenditure and automation to transform existing facilities. Tax rates will also need to remain low. It will require government intervention to implement these changes to link all these sectors together in a coherent manner. The free market on its own will not do so.”
New regulatory initiatives may take time, however—especially as the pandemic continues to be a priority. But as the U.K. assesses its trade and business regulations to determine what needs to be improved, simplified or scrapped, businesses may be able to influence policy. “Companies should use the current situation as an opportunity to raise their voice to help shape the kind of market they would like to be active in in the future,” said Sally Jones, trade strategy leader for the U.K. and Ireland at professional services firm EY.
More immediately, U.S. companies should keep an eye on their competitors to see what immediate impact Brexit might be having on them, and how that might pan out in the short- to medium-term. “Look at your rivals and see if they are benefitting from Brexit or not,” Jones said. “Have costs risen for them? Are exports more difficult? Is production turnaround longer? To what extent are they modifying their supply chains or the way they do business? Are they pulling out of the U.K. or getting in deeper? Looking at how your competitors are doing will give you a better idea of the potential risks and opportunities, as well as provide an assessment of whether your organization is capable of adapting quickly enough to turn the situation to your advantage.”