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Brexit round-up - Issue two

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Latest views and news on Brexit and its impact on food and grocery businesses. For further help through strategic briefings, scenario planning workshops or research customised to your business, please email brexit@igd.com

Prime Minister Theresa May says she’s determined to invoke Article 50 by the end of March 2017 and every day brings fresh speculation about what will follow.

Since our first issue the main domestic economic indicators have stayed intriguingly stable but there have been big shifts in some international markets, following the unexpected result of the US election.

Now some pivotal elections in Europe lie ahead. It seems we all must adjust to a higher level of external risk.

In this issue:

 

Five ways for your business to capitalise on Brexit

The dialogue around Brexit and business has so far focused mainly on the negative. It has created uncertainties but as always with change, it also presents fresh opportunities. Positive thinkers will see it as a chance to gain an advantage.

Here are five ways you might be able to prosper from Brexit, wherever your business is based:

1. Act decisively

“Wait and see” is a natural reaction to a seismic event like Brexit. According to a survey by Hitachi Capital and the CEBR in November 2016, a third of British businesses have abandoned investments totalling £65.5 billion as a result of the referendum vote.

But if others put their business on pause this offers an opportunity for entrepreneurs to press ahead and establish a gap. The new wave of disruptive digital companies won’t be holding back. So although the risks do need to be assessed carefully, this is a time when fortune is likely to favour the brave.

2. Build your local credentials

If one thing linked the Brexit referendum and the US election, it was a public backlash against globalisation. Consumer support for local products has been growing in many countries for many years and when the Brexit negotiations get serious, it will be no surprise to see this surge again.

Companies with a strong story to tell about domestically sourced ingredients and local production are in prime position to make a virtue of this in their marketing.

3. Revamp your sourcing

There are benefits from long term, stable supply arrangements but now and again every relationship needs to come up for review. This is one of those moments.

In a global marketplace, there are usually many alternative sources and for British companies, domestic suppliers are likely to be more competitive with the depreciation of Sterling. Now is the time for procurement teams to come to the fore and for ingredient and materials suppliers to hunt down new customers.

4. Manage risk skilfully

Volatile, uncertain, complex and ambiguous, Brexit makes this an even more “VUCA world”. Fortunately, there’s a wide range of financial instruments available for companies to hedge against currency, liquidity, interest rate and creditor risks. Unfortunately, some of these can be very costly if you make the wrong calls.

In such unstable conditions, the performance of the Treasury department could outweigh the whole of the rest of the business in determining the bottom line. Risk management training, expert external advice and close oversight by the Board all represent wise investments.

5. Improve your agility

Traditional planning and project management tools were built in a slower moving age of greater predictability. The big disruptive digital companies have succeeded partly by tearing up the old rule books and developing new techniques, equally disciplined but far more agile. They’re used to support experimentation, rapid decision making and empowering people on the front line.

These techniques are steadily being transplanted into other companies but Brexit increases the urgency. Nobody really knows what the next few years will hold, so the ability to respond rapidly to any change in conditions will be the decisive factor.


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Will Brexit help the UK close its food and drink trade gap?

Food and drink is the UK’s biggest manufacturing sector by far and its products are sold around the world. In spite of many individual success stories, the overall UK trade deficit in food and drink remains stubbornly high.

The bulk of the world’s food trade is in basic commodities and the UK simply doesn’t produce enough to be in surplus. It’s currently only 61% self-sufficient in food.

Quoting from the latest trade statistics, at £21.1bn the deficit exceeds the entire £18.2bn value of food and drink exports. So, if UK food and drink exports were somehow to double overnight, there would still be a sizeable gap.

For Brexit to be deemed an economic success, it requires at least a narrowing of the overall UK trade deficit. With food and drink accounting for around 60% of this total deficit, it offers the biggest opportunity to rebalance trade.

Prospects pre-Brexit

  • Irrespective of Brexit, there are reasons to be optimistic about the UK’s long term export prospects for food and drink:
  • The rapid global growth in demand for food and drink means that if the UK can increase production, it’s likely to find a market
  • The UK’s strength is in high added-value products and this is a big growth opportunity as the world becomes more affluent
  • The demand for whisky, for example, is likely to accelerate, especially in Asia as this is the shining star of British food and drink exports

The early impact of Brexit

The two routes to reducing a trade gap are growing exports and displacing imports. The second of these could happen quickly.

If the UK leaves the European single market, it’s likely to mean new tariffs or other trade barriers. Globally, tariffs tend to be applied to food and so our sector is likely to be affected.

New barriers would curtail imports but also exports. However, if Sterling remains devalued versus the Euro, it should tilt the equation in favour of British producers.

There are some caveats though:

  • The new trade deal might not be fully reciprocal, i.e. the UK’s export barriers for food might be raised higher than the import barriers. This could happen, for instance, if the UK government prioritises other sectors over food in its negotiations
  • The rest of the world, rather than the UK, could be the main beneficiary of any new trade barriers in Europe. This is likely to apply, for instance, to warm weather fruit and vegetables
  • Capacity constraints will restrict the UK’s ability to capitalise on opportunities; for instance, the UK’s dairy herd has declined by about 25% over the last 20 years. This could be reversed over time but it won’t happen instantly
  • In currency terms, what goes down could go back up, and with critical elections ahead in France and Germany in 2017, the Euro may no longer be a safe bet
  • Severe trade barriers between the UK and the EU would damage the economies of both parties, triggering inflation, hitting real incomes and restricting consumer demand

Long term prognosis

Perhaps the UK is too small a land mass and too densely populated ever to reach 100% self-sufficiency in food and drink again. But there’s certainly scope to make a big dent in the trade gap.

Whether Brexit helps or hinders, the future of grocery sector will hinge on four main questions:

  1. Will food and drink be prioritised in the UK’s trade negotiations around the world or will it be used as a bargaining chip to secure deals for other sectors, such as finance and automotive?
  2. Will the tax and regulatory environment incentivise enterprise and investment?
  3. Will food businesses rise to the challenge and pursue exports with renewed vigour?
  4. How patriotic will tomorrow’s consumers be in their food choices?

The sheer scale of our sector and it’s near 4 million employees, from farm to fork, means that food and drink merits being centre stage in the UK’s post-Brexit economic strategy. Closing, or at least greatly reducing the trade gap in food, would be a fitting national objective.


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The UK’s Future Trade Policy Framework – straight to the WTO?

We now know there are different sets of negotiations that must happen in order for the UK to leave the European Union and also for it to trade with the remaining EU countries thereafter. If the UK and EU cannot agree a new set of trading rules, then the default would be for the UK to rely on its World Trade Organisation (WTO) membership. The UK would then be required to develop its own tariff schedule for imports and provide it to the WTO Secretariat in Geneva. The UK could also negotiate some interim trading arrangements with the EU bloc, but WTO rules require those to be timebound.

Clean break from the EU or status quo lite?

A simple solution would be to stick closely to the status quo. The very fact that Liam Fox and his new Department for International Trade have been tasked with striking new international trade deals suggests though that the Government expects to break from the EU Customs Union. As a member, having a separate trading relationship with non-EU countries would not be possible. There is another important consideration about leaving the EU customs union: the UK’s relationship with the WTO.

The UK’s terms of membership of the WTO are currently governed by its membership of the EU Customs Union. So, when the UK leaves the EU, simply transposing the EU’s existing tariff commitments into a standalone UK agreement may not be accepted by any number of the 163 other member countries. That’s because New Zealand, Argentina and Mexico, to name a few, have agriculture quotas and other arrangements with the EU and are likely to want to push for greater market access to the UK. So, even a simple mirroring of existing commitments could involve complicated negotiations between the EU, the UK and other countries.

Lots of talk, but no decisions

Liam Fox has already clocked up a fair number of air miles as he starts to rebuild direct relationships with Trade Ministers in key trading markets. However, there are big questions about the sequencing of any trade agreement negotiations, and how long they will take. Informal discussions can take place, but the UK cannot sign new bilateral agreements until it has left the EU. Countries beyond Europe will want to know whether or not the UK intends to stay within the EU Customs Union before they start engaging in meaningful negotiations.

This is one of the key indicators for companies to look out for and, if Parliament is allowed to have its say, the likely topic of much debate.


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Brexit Jargon Busting  

The EU Single Market

The EU Single Market is a framework that seeks to guarantee the free movement of goods, capital, services, and people – the "four freedoms" – between the EU's 28 member states.

The EU Single Market rests on four pillars:

  1. Free movement of goods, persons, services and capital between member states

  2. The harmonisation of relevant laws, regulations and administrative provisions between member states

  3. EU-wide competition policy, administered by the commission

  4. A system of common external tariffs (CET - also known as the Common Customs Tariff

Internal tariff and quota barriers within the EU were abolished in 1968 but it was not until 1992 that much of the EU Single Market was deemed to have been completed. However, it remains a project in 'continuous creation'.

Many of the regulations that govern the food and drink sector were introduced to support the development of the EU Single Market.

Article 50 

Article 50 of the Lisbon Treaty on European Union allows a member state to notify the EU of its withdrawal and obliges the EU to try to negotiate a ‘withdrawal agreement’ with that state – it involves five points laid out in legal text below.

The Legal Text

  1. Any Member State may decide to withdraw from the Union in accordance with its own constitutional requirements.
  2. A Member State which decides to withdraw shall notify the European Council of its intention. In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union. That agreement shall be negotiated in accordance with Article 218(3) of the Treaty on the Functioning of the European Union. It shall be concluded on behalf of the Union by the Council, acting by a qualified majority, after obtaining the consent of the European Parliament.
  3. The Treaties shall cease to apply to the State in question from the date of entry into force of the withdrawal agreement or, failing that, two years after the notification referred to in paragraph 2, unless the European Council, in agreement with the Member State concerned, unanimously decides to extend this period.
  4. For the purposes of paragraphs 2 and 3, the member of the European Council or of the Council representing the withdrawing Member State shall not participate in the discussions of the European Council or Council or in decisions concerning it. A qualified majority shall be defined in accordance with Article 238(3)(b) of the Treaty on the Functioning of the European Union.
  5. If a State which has withdrawn from the Union asks to re-join, its request shall be subject to the procedure referred to in Article 49.

What this actually means:

The starting gun

A Member State which decides to withdraw shall notify the European Council of its intention.

Theresa May said at the Conservative Party Conference that the government will “invoke Article 50 no later than the end of March next year” although that is not a legal commitment and further delays are feasible. Brussels and hard-line EU states want the process activated sooner. Only the UK can decide when to invoke Article 50.

How long?

In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union.

The Commission interprets “withdrawal” as unravelling the legacy of membership. One extreme way to do that is with a clean hard break. That would simply sever the UK and EU’s obligations to each other including budget payments, membership rights of EU agencies, liabilities to pensions for EU staff and payments to farmers; all ending on a set date.

Anything else requires a more complicated negotiation that very much depends on what sort of relationship the UK wants following the divorce. For instance, any serious transitional arrangement on EU agriculture subsidies will make assumptions about future UK-EU relations and bilateral market access. Without making such assumptions, the only possible answer is a clean hard break.

Some pacts will require a separate negotiating track. A comprehensive EU/UK trade deal, for example, would involve more voting and ratification rules, which take longer and would need unanimity between 27 countries and ratification through 38 national assemblies and the European Parliament, which will take time.

So, before an exit via Article 50 is complete, probably the best the UK can hope for is an agreement on a “framework” for future relations — such as agreed objectives for a trade deal. What is most likely to happen is that there will be two key sets of negotiations: the first being the withdrawal agreement – the ‘terms of the divorce’ from the EU; and the second - and likely much lengthier - a future UK–EU relationship.

A withdrawal agreement will cover short-term issues such as:

  • The rights of EU citizens living in the UK and of UK citizens living in the EU
  • The closure and re-location of EU agencies currently based in the UK
  • Access to EU agencies that play a role in UK domestic law, such as the European Medicines Agency
  • How to allocate unspent funds due to be received by UK regions and farmers
  • Cross-border security arrangements
  • Transfer of regulatory responsibilities
  • Arrangements for contracts drawn up in accordance with EU law

David Davis MP, the Secretary of State for Exiting the European Union, states that the Government’s priority should be to agree new trade deals with large markets like China and the US, while seeking continued access to the EU Single Market but control over free movement of people.

The power balance

The Treaties shall cease to apply to the State in question from the date of entry into force of the withdrawal agreement or, failing that, two years after the notification referred to in paragraph 2, unless the European Council, in agreement with the Member State concerned, unanimously decides to extend this period.

The first deadline for talks is two years and senior EU officials do not want talks to drag on. The way Article 50 is drafted implies that there will be no deal until everything is agreed because there are too many moving parts. That suggests a protracted period of uncertainty for businesses and all EU citizens.

Choices

For the purposes of paragraphs 2 and 3, the member of the European Council or of the Council representing the withdrawing Member State shall not participate in the discussions of the European Council or Council or in decisions concerning it.

This sentence sets the voting rules for the EU to decide on the UK’s exit deal — without the UK in the room. The UK remains a full member, with full membership rights, until the day it leaves. But the parting of the ways has already started as we saw in the hours after the referendum result was declared - EU leaders and diplomats quickly met without the UK to discuss the future. The Prime Minister and her colleagues have also been excluded from some European Council meetings.

Is re-entry really an option?

If a State which has withdrawn from the Union asks to re-join, its request shall be subject to the procedure referred to in Article 49.

Can the UK change its mind once Article 50 is invoked? Can the process be stopped once it has legally started? This part of the Article has yet to be tested, but it only makes clear that any country, once it has left, cannot re-join without repeating the demanding EU accession process, which would include adopting requirements like pledging to join the Euro.

Commission lawyers have indicated they will take a hard line: a decision to invoke Article 50 is a legal act that cannot be withdrawn. However, if the leaders of the 27 other Member States agree then the Brexit process could come to an end if the UK Government decided to stay in.

Customs Union

What is a customs union and why does it matter?

A customs union is a binding arrangement between two or more countries on how they will trade goods with each other and is designed to make importing and exporting easier. The countries agree not to impose tariffs (taxes on imports) on each other's goods, but agree to impose ‘common external tariffs’ on goods from countries outside their customs union. Customs unions also reduce administrative and financial trade barriers (such as customs checks and charges) and enhance economic cooperation.

Importantly, they also prevent the individual countries from creating separate trading arrangements with countries inside or outside the customs union – this is a key issue as the UK decides the trading frameworks that it seeks to put in place when it leaves the EU.

The European Union Customs Union is the world’s biggest customs union if calculated on gross economic output. Article 28 of the Treaty on the Functioning of the European Union states that all trade in goods between EU countries must be free of customs duties and that member states must apply a common customs tariff for goods imported from outside the EU. That means that all goods that have been imported into an EU country can then be moved freely within the EU without further customs checks.

Does the EU Customs Union = EU Single Market membership?

No, it is possible to be part of the EU Customs Union but outside the EU Single Market. The EU Customs Union includes the 28 EU member states as well as Monaco. In addition, the EU also has customs union agreements - which vary in scope, such as type of goods covered - with Turkey, Andorra and San Marino.

It is not possible to be within the EU Single Market but outside the EU Customs Union.

Is the EU Customs Union the same as the European Economic Area?

No, the European Economic Area (EEA) contains some but not all the provisions of the EU Customs Union. The EEA provides for the free movement of persons, goods, services and capital within the internal market of the EU between its 28 member states, as well as three of the four member states of the European Free Trade Association (EFTA): Iceland, Liechtenstein and Norway. The EEA Agreement does not establish binding provisions in all sectors of the internal market or in other policies under the EU Treaties.

Norway is not a member of the EU Customs Union – does that affect it?

To a certain degree. In practice, this means that while most goods that originate in Norway can still be traded tariff-free to the rest of the European single market, products coming through Norway into the single market are subject to further checks.

It is worth noting that there are some customs checks on the border between Norway and Sweden even though they are both part of the single market, to check for products originating outside Norway.

Setting common external tariffs is what distinguishes a customs union from a free trade area as a free trade area allows member countries to trade freely with each other while still being able to set their own separate tariffs on goods imported from the rest of the world.

What would be the impact on the UK leaving the EU Customs Union?

The impact could be significant for businesses that import or export goods as there is likely to be much more paperwork for UK businesses to complete, and it could make the border issues involving Northern Ireland and the Irish Republic more complicated.

Another implication is that the UK will no longer benefit from the EU’s 56 free trade agreements (FTAs), which provide better access for UK goods to markets outside of the EU, such as Korea, Mexico and Chile. This may mean that UK exporters face higher tariffs and other trade barriers in these markets unless new agreements can be swiftly negotiated.

The Great Repeal Bill

What is the Great Repeal Bill?

At the Conservative Party Conference, Theresa May announced that her Government would introduce a Great Repeal Bill to repeal the European Communities Act 1972 and convert the ‘acquis’ – the body of existing EU law – into British law.

What will it do?

The Bill will bring all EU laws onto the UK statute books. This means that when the Government invokes Article 50 of the Lisbon Treaty, laws and regulations made over the past 40 years when the UK was part of the EU will continue to apply. Specifically, the Bill will:

  1. Repeal the European Communities Act 1972, which provides legal authority for EU law to have effect as national law in the UK
  2. Transfer all EU laws currently in force onto the UK statute book

If the UK is leaving the EU, why is it keeping EU law?

EU law covers a wide range of regulation across many sectors, including the food and drinks sector. Without the Great Repeal Bill, when the UK leaves the EU all these rules and regulations would no longer have legal standing in the UK, creating a ‘black hole’ in the UK statute book and leading to uncertainty and confusion. After transferring EU laws over into UK law, the Government plans to review, amend or scrap these laws in future.

When will the Bill be published?

The Government has said that the Bill will be included in the next Queen’s Speech and introduced in the next parliamentary session. The session is due to begin in Spring 2017.

When will it come into force?

The Government wants the Bill in place before the point at which the UK leaves the EU.

Will this be simple to manage in practice?

There are legal complications most notable with laws that require an EU body for arbitration and enforcement. Provisions will be needed to manage these instances.

Will it be given such a grand title as the Great Repeal Bill?

Parliamentary rules make it very unlikely that the Bill will in fact be called the Great Repeal Bill. It is more likely to be called something like the European Communities (Repeal) Bill.

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