Potential trading implications for the UK post Brexit

WTOs, FTAs, Customs Unions and EUs? Let us simplify a few things on potential trading implications for the UK post Brexit

As the Brexit negotiations are intensifying, we thought it would be helpful to look in more detail at the legal framework by which the UK and EU are constrained and what is meant by free trade agreements, customs unions and the WTO rules.

Once the UK leaves the EU, it will lose the automatic right to form part of the single market and, if it leaves without a deal in place, this would mean that the relationship between the EU and the UK would be regulated solely by the World Trade Organisation (WTO).

The WTO

Most of the world’s nations are members of the WTO, which is run by its members’ governments. The WTO governs the trade of goods and services of its members under two agreements, (1) the General Agreement on Tariffs and Trade; and (2) the General Agreement on Trade in Services (Agreements).

All WTO members are bound by the rules in the Agreements, which include: 

• treating all trading partners equally. A WTO member may not grant any trade advantages to one country without immediately and unconditionally giving the same advantage to all other WTO members. This is known as the Most Favoured Nation principle.

   

• preventing members from applying internal measures to imported or domestic products in a way that protects domestic production. It also prevents members from treating imported products less favourably than domestic products. This is known as the National Treatment Obligation and aims to provide equal conditions of competition for all WTO members.

   

• preventing members from imposing quantitative restrictions, referring expressly to quotas, import or export licences. Quantitative restrictions are boarder measures that impose limits on the volume or value of goods that can be imported.

The WTO has set out exceptions to the Most Favoured Nation principle, which include where WTO members enter into a free trade agreement (FTA) or a customs union between. Provided that the FTA or customs union complies with the WTO’s requirements, the countries which are party to them are allowed to trade on more favourable terms without extending the same treatment to all WTO members.

Free Trade Agreement

An FTA is an agreement made between countries to ease barriers to cross-border trade by reducing or eliminating (1) tariffs, which are custom duties on goods crossing from one custom territory to another; or (2) non-tariffs, which are government-imposed and sponsored measures that prohibit or restrict the flow of imports and exports.

If one or more countries enter into an FTA, each of the parties are generally free to conduct independent external trade policies and set their own tariffs on trade with other countries which are not party to that FTA.

FTAs will usually include provisions requiring the goods subject to the FTA to have a specified minimum percentage of domestic content in order to qualify for preferential rates (‘rules of origin’). This is to prevent a country from importing products from a third country and then exporting them to its FTA trading partner at a preferential rate.  Exporting traders are therefore required to provide evidence that the goods are wholly or partly produced in the relevant party’s territory.  If an exporting trader cannot satisfy the rules of origin, then the tariff on the exported goods would be subject to the standard WTO rates.

Customs Agreements

Another alternative to the WTO rules is to enter into a customs agreement, which involves countries agreeing to form a customs union (Union). A Union is a type of preferential trade agreement, where members may agree to (1) remove or reduce tariffs on trade between them; and (2) charge a common tariff on imports from countries outside the Union. If countries are part of a Union, no proof of origin is required where the goods are passed between the borders of the Union members.

The EU is an example of a Union, where all 28 members have agreed (1) not to impose trade tariffs between the members, and (2) that all Union members must set the same tariffs on any goods imported from outside the Union.

The UK

Currently the UK is part of the EU and is, therefore, bound by the rules of that customs agreement. The EU has entered into FTAs with Canada and Switzerland, which means that the UK is able to take advantage of the preferential trading terms under those FTAs.

Before the UK leaves the EU, it is widely agreed that it would be preferable to have an agreement between the EU and the UK that governs trade. One of the options is to enter into a FTA with the EU, which would mean that the UK must comply with the relevant FTA which is likely to include most of the EU rules applicable to the goods or services subject of the FTA, but this arrangement will mean that the UK has more freedom to set up preferential free trade agreements with countries outside the EU. This will also mean that UK suppliers will be bound by any applicable rules of origin when trading with the EU.

A second option is to enter into a Customs Union with the EU, just as Turkey has. This would mean that the UK would be able to continue to trade with the EU on a tariff-free basis, without having to show proof of origin in respect of goods it is exporting to the EU. However, the UK would be bound by the EU rules, and would have to apply the external tariffs to imports from non-EU countries, as well as comply with any free trade agreements between the EU and any non EU countries.

The UK leaving the EU is unprecedented and the likely outcome of the negotiations remains unclear. If any compromise is reached, which falls short of a customs agreement, then the practical and financial implications for those businesses trading with the EU are likely to take some time to be fully understood.