The term Brexit has now become used as an encapsulation of the incredibly complex journey we have ahead of us in moving Britain out of the EU. The actual Brexit referendum was held on Thursday 23 June 2016 with a decision to leave carried by 51.9% to 48.1% with a turnout of 71.8% and more than 30 million people voting. England and Wales voted in favour of leaving but Scotland and Northern Ireland both backed staying in the EU by 62% and 55.8% respectively.
There were prophesies of huge market impacts and the pound did slump the day after the referendum and it remains around 15% lower against the dollar and 10% down against the euro, but the UK economy is still forecast to have grown 1.8% in 2016 which is in second place to Germany at 1.9% and among the world’s G7 leading industrialised nations.
Inflation has increased to 1.8% in January which is its highest rate for two and a half years but unemployment has reduced and is now at an 11-year low at 4.8%. House prices increases have also fallen from 9.4% in June to 7.4% in December according to ONS figures.
Brexit is a hugely complex topic and way beyond the constraints of an article here. Accordingly, this should only be seen as a broad overview of the key impacts of Brexit on the SME community in the Britain and an attempt to provide a useful base of preparatory information for SME boards that will be impacted by these changes.
The Brexit Mechanism
The route to Brexit
Article 50 of the Treaty on European Union defines the precise mechanism we have to follow to leave the EU. It states that any Member can “decide to withdraw from the Union in accordance with its own constitutional requirements.” The EU Referendum was only advisory to the UK Government and the referendum result in itself could not trigger the Article 50 process and the UK Government needed to formally trigger this process in accordance with UK constitutional law.
The original intention was to use the royal prerogative, a set of powers that gives the Prime Minister and the Government the authority to make decisions without consulting Parliament, to trigger Article 50. These ancient powers are officially held by the Queen and are also used by cabinet ministers. However, on 24 January 2017 the UK Supreme Court ruled that the UK Government have it authorised by an Act of Parliament.
Accordingly, on 13 March 2017 the UK Parliament passed the European Union (Notification of Withdrawal) Bill which required Royal Assent. This enables the British Prime Minister to give notice of the UK’s intention to leave the EU to the European Council. This must be either be a letter to the President of the European Council or an official statement at a meeting of the European Council duly noted in the official records of the meeting.
Once notice is given, negotiations between the UK and the rest of the EU to agree a withdrawal agreement will commence. According to the terms of Article 50, the agreement must also take account of the framework for the UK’s future relationship with the EU. According to Article 50(2), the withdrawal agreement must also be agreed by the European Parliament and the European Council.
The UK will cease to be an EU Member State on either a withdrawal agreement being concluded or two years from the date of notice, whichever is sooner. This two year period can also be extended by the unanimous consent of the UK and all the other EU Member States. The earliest date in theory that the UK could leave the EU is March 2019, albeit the expectation is for a longer withdrawal period.
It is important to note that while in negotiations the UK will still remain a full EU Member State and take part in all EU decision-making except in relation to the withdrawal agreement.
UK economy performance is key to any assessment of the effects of the Brexit on the UK and the GDP (Gross Domestic Product) data provides a good reference point. GDP in volume terms was estimated to have increased by 0.7% between Quarter 3 (July to Sept) 2016 and Quarter 4 (Oct to Dec) 2016, revised up 0.1 percentage points from the preliminary estimate of GDP published on 26 January 2017. UK GDP growth in Quarter 4 2016 saw a continuation of strong consumer spending which is in line with the Retail Sales Index for Quarter 4, which grew by 1.2% (published on 20 January 2017) and strong growth in the output of the services sector with a notable contribution in consumer-focused industries. In Quarter 4 2016, there has been a slowdown within business investment which fell by 1.0%, driven by subdued growth within the “ICT equipment and other machinery and equipment” assets.
GDP by Industry
During Quarter 4 2016, the UK experienced the strongest rate of growth among European groupings and G7 countries. In Quarter 4 2016, the UK experienced 0.2 percentage points higher growth than the USA, who experienced a slowdown in growth from 0.9% in Quarter 3 (July to Sept) 2016 to 0.5% in Quarter 4 2016.
France and Germany experienced growth of 0.4%, whilst Italy and Japan experienced growth of 0.2%. The European Union grew by 0.5%, marking 15 consecutive quarters of positive growth and in the same period, the group of Euro Area countries grew by 0.4%. Italy is the only G7 country with its GDP still 7.4% below its pre-downturn peak (Quarter 1 2008). All other G7 countries are currently above pre-economic downturn peaks, in Quarter 4 2016 the USA shows signs of the strongest recovery at 12.9%. The UK has the second strongest rate at 8.6%, whilst Germany and France have rates of 7.8% and 4.5% respectively. Japan has experienced a slower recovery and at present is 3.3% above its pre-downturn peak.
GDP by country
Based on these figures it would appear that the economy to date has not been affected by the decision taken for Brexit. However, at this stage we simply do not know what is going to happen as in general economies are highly complex, take time to react, and do not always behave in accordance with economic predictions. Confidence has been affected with many business surveys pointing to understandable concerns over the future. But many are just monitoring the headlines for further Brexit related news.
SME’s are typically are the most vulnerable of businesses to economic change, especially if they have a high reliance on imported goods and the Pound buys less than it did last year. They may also be more regional so local economic downturns will have a greater affect. This particularly extends to collateral impacts say when a factory closes it may also result in a ripple effect on businesses that rely in it for income.
The pound has dropped 15% against a range of currencies since the vote in the last quarter of 2016 Sterling became the world’s worst performing currency as it fell behind 150 others. This may be as a consequence of Theresa May’s language of a ‘hard’ Brexit whereby the UK favours complete control of sovereignty (borders and law making) over access to the single market.
As a net importer, the weak Pound is bad for the UK since we buy more from overseas than we sell. Whilst selling goods overseas has become cheaper, buying from overseas is becoming more expensive. The weakening Pound is also driving an increase in the level of Inflation which could result in an increase of the price of goods in the UK. This has a much larger impact on SME’s than much larger businesses and industries as, in many case, they are able to fix their currency on a ‘forward contract’ which allows for planning in the event of future weakness. Examples include the Motor Industry and the big supermarkets. As these contracts run out their cost base will be increasing and naturally this will have to be passed onto consumers who as we may see, will already be feeling the pinch.
The EU has the exclusive right to negotiate trade agreements on behalf of its Member States under its Common Commercial Policy. The UK has not negotiated a trade agreement for over 40 years. Trade deals with the EU are difficult to negotiate and can take many years to agree. All EU Member States would need to agree the terms of any new trade deal.
If no trade deal can be agreed then the UK and the EU will have to trade under the terms of the World Trade Organisation (“WTO”). The EU would be forced to impose its Common External Tariff on UK imports and the UK would be free to impose import tariffs on goods entering the UK (from the EU and elsewhere). Goods would also be subject to customs checks. The EU’s Common External Tariff varies from 0% on cotton, 11.5% on clothing, 26% on sugar and confectionery, to 45% on certain dairy products. Goods exported to the EU would still need to comply with EU standards.
The UK will also lose the benefit of EU’s free trade deals with non-EU countries and will have to negotiate new trade agreements with countries with which the EU does not have a relationship. Many countries have already expressed an interest in negotiating trade agreements including, Brazil, Canada, China, the Gulf States, Mexico, South Korea and the United States of America and we have also commenced scoping discussions on trade agreements with Australia, India and New Zealand.
In the cases where the UK does not negotiate a free trade agreement, WTO rules require the UK to charge each country the same tariffs (referred to as its “most favoured nation” tariffs). It is expected that the UK will seek to adopt the EU’s Common External Tariff as a starting point. Over time, however, it seems likely that the UK would seek to drop the EU’s protectionist tariffs on produce and goods that the UK does not grow or make, but the EU does, such as bananas and tobacco.
There are likely to be more limitations on British nationals’ ability to live and work in EU countries but it is highly unlikely that any barriers will be presented to impact tourism or business travel. There are already a number of countries outside the European Economic Area, including the 28 EU nations plus Iceland, Lichtenstein and Norway, that British citizens can visit for up to 90 days without needing a visa and it is probable that similar arrangements will be negotiated with our existing European neighbours.
EU Treaties provide the constitutional basis of the EU and the Single Market which is supported by the four freedoms of movement in goods, people, services and capital. The EU Treaties are implemented into UK law through the European Communities Act 1972 (“ECA”). The ECA provides for the supremacy of EU law in the event of a conflict with UK law and also provides the legislative basis for transposing EU law into UK law.
Once the UK leaves the EU it will repeal the ECA and EU law will no longer apply. All EU law in force immediately prior to that date including case law will, however, be converted into UK law through the “Great Repeal Act”. This will give the UK Parliament time to decide whether to amend, repeal or improve those laws.
Once the UK leaves the EU the CJEU will no longer have jurisdiction in the UK. Judgments of the CJEU which are already reflected in EU law immediately prior to Brexit will continue to apply until the UK Parliament and/or UK courts decide otherwise. It is expected that post-Brexit, CJEU judgments will remain persuasive if decided on equivalent law.
The review process will take many years might lead to a divergence between EU and UK law. UK businesses exporting to the EU may find that they need to comply with two sets of laws. It may make practical sense to separate businesses exporting to the EU and selling into the UK domestic market into different legal entities.
As UK company law has been influenced by European Directives rather than changed on a wholesale basis by EU law, an exit from the EU would in all likelihood not require material changes to the UK company law regime.
The law and regulation governing shares and shareholdings in the UK has been affected by EU directives on shareholder rights, anti-money laundering, data protection, client asset rules, and transaction reporting. It is unlikely that there will need to be major changes to how the system operates with the exception of regulations governing overseas ownership, cross-border share trading and settlement, and international share plans.
The Central Securities Depositaries Regulation (CSDR) is directly effective into UK law. The main impact has been the move to T+2 settlement for securities transactions. Industry bodies have been lobbying for implementation of dematerialisation to be brought forward to 2018 (from the regulation requirement of 2023/2025). This approach may need to be revised in the light of the referendum outcome however dematerialisation within the UK is still a goal that should be pursued, given the benefits for share trading and ownership.
Direct taxes, such as corporation and income tax, and the changes to it are predominately determined nationally and hence will face little impact from any changes to the relationship with Europe. The UK will also continue to be part of the international/OECD efforts at tax harmonisation including Base Erosion and Profit Shifting or BEPS.
Employment law in the UK is now largely founded EU legislation which can be seen in employment contracts and UK company policy. As part of Brexit we would have an opportunity to review workplace discrimination, working time and family related rights.
One key concern is if Brexit resulted in changes to the freedom of movement for labour and hence access for companies in the UK for both skilled and unskilled staff from Europe. With the enormous reliance that many of our businesses have on labour from Europe this is going to be a key topic for discussion and policy and is unlikely to be effected before a lengthy and comprehensive transitional period.
The EU Directive on Data Protection provides much of the basis of the current Data Protection Act in the UK. The new data privacy laws comprise the General Data Protection Regulation (GDPR) which governs the use and privacy of EU citizens’ data. The Data Protection Directive governs the use of EU citizens’ data by law enforcement. The GDPR was recently approved by the European Parliament and companies will have two years to implement the changes (estimated summer 2018). Post Brexit UK businesses will still need to adhere to all or parts of the new regulation to do business in the EU.
Scotland & Ireland
Scotland voted in favour of the UK staying in the EU by 62% to 38% with all 32 council areas in Scotland voting to Remain in the EU. Scottish First Minister Nicola Sturgeon has confirmed her intention to hold a second referendum on Scottish independence between fall 2018 and spring 2019. A vote in the Scottish parliament will authorize her to begin Section 30 discussions with the U.K. government which is the legal mechanism for triggering an independence referendum.
Northern Ireland primary impact is in farming as thousands of small farmers straddle the line that divides the six counties of Ulster from the Republic of Ireland. When Brexit is complete that land will be split between two different regulatory and trading regimes with same farm EU cows grazing in one field and British ones in another!
Dublin is likely to continue to attract at City firms that need to move operations into the EU for passport purposes. It’s English-speaking and well-connected to the US, and Ireland is far less taxed and regulated than France and Germany. Dublin is also quite a small city, with a much smaller talent pool than London, and very high property prices caused by tight planning laws (though less high than London’s). It would only take a portion of the City moving to Ireland to substantially boost the Irish economy, and if Ireland could make itself attractive to them as a base in the EU it could find that Brexit turns out to be a net positive. Over thirty large insurers are already in talks with the Irish Central Bank to relocate to Dublin!
The UK and Ireland have long been close allies within the EU and have shared a basic belief in (relatively) low regulation and low tax compared as the way to prosperity. Brexit might result in a renewed push by the European Commission for a “Common Consolidated Corporate Tax Base” (CCCTB) and the Apple case last year where the EC tried to force the Irish government to collect tax from Apple to stop it from acting as a sort of tax haven is an example of this. If a CCCTB is passed then harmonisation of the corporation tax rate may be next on the agenda However, this is unlikely as taxation change at EU level require unanimous consent and thus Ireland has a veto.