In a tightly-contested referendum on June 23, 2016, a narrow majority of the United Kingdom (“UK”) electorate voted for the UK to leave the European Union (“EU”). A Withdrawal Agreement1 was then agreed upon on October 17, 2019, which set out the terms of the UK's orderly withdrawal from the EU in accordance with Article 50 of the Treaty of the European Union, including a transition period that extended until December 31, 2020 (“Brexit”).
After a four-year period of intensive negotiations, and marginally ahead of the end of the transition period, an agreement in-principle was reached between the European Commission and the UK on December 24, 2020 at the negotiators' level, setting out the future trading relationship between the EU and UK post Brexit, in the form of a new EU-UK ‘Trade and Cooperation Agreement' (the “TCA”).2 Both the EU and the UK have begun the process of signing and ratifying the TCA, in line with their respective rules and procedures for democratic scrutiny, with its provisional application from January 1, 2021.
With Brexit, the UK has left the EU Single Market and Customs Union, as well as the EU's ecosystem of common rules, policies, supervision and enforcement mechanisms. Consequently, the primary concern for the UK (and foreign investors in the UK) is that it no longer enjoys full access to the EU, including with respect to the free movement of persons, goods, services and capital across the EU, as it enjoyed being a Member State. To this extent, the EU Commission has noted that the EU and the UK will now form two separate markets with two distinct regulatory and legal spaces, creating new barriers to trade in goods and services as well as in cross-border mobility and exchanges, in both directions.3 With these changes, Brexit poses significant implications for companies globally, including from India, with business interests in the cross-border trade of goods and services between the UK and EU markets.
India has been an important source of investment in the UK, with Indian companies contributing significantly to employment generation and tax over the past several years. Many Indian companies across different sectors ranging from financial services, information technology, pharmaceutical and automobile, have traditionally established their EU presence through headquarters or affiliates based in the UK. Some key reasons for this choice include the shared history, culture and language between India and the UK, the strong financial services market in London, similarity in laws in both jurisdictions, and the benefits of EU membership – i.e. frictionless access to the EU Single Market and Customs Union – that the UK jurisdiction offered prior to Brexit.
In this backdrop, we set out below an overview of the major issues arising out of Brexit and the TCA, which may impact the overall foreign investment landscape in the UK.
- KEY ASPECTS OF THE TCA
2.1 Tariff and quote free trade in all goods
The TCA preserves tariff- and quota-free trade on all goods between the EU and the UK, subject to compliance with appropriate rules of origin. This has been welcomed by manufacturers and consumers on both sides, given the substantial export interdependencies between the two regions in some sectors, and partly because it alleviates the continued uncertainty surrounding Brexit since 2016, including the growing apprehension of a ‘no-deal' scenario, which had distressed manufacturers, resulted in more expenditure towards contingency plans, and delayed investment decisions.
However, the UK's departure from the EU Single Market and Customs Unions introduces new non-tariff barriers, such as customs checks, controls and border procedures, as well as dual compliance requirements with separate EU and UK standards and certifications. This indicates that the cross-border trade of goods between the EU and the UK may be more difficult going forward. Even with the TCA in place, the new border procedures will require certain adjustments to be made to the existing EU-UK supply chains, adding a degree of operational complexity and costs for manufacturers catering to both markets, and which already operate on thin margins. To this extent, Indian manufacturing companies that have been set up in the UK as a stepping-stone to cater to the wider EU economy and which rely on scale and distribution available through the EU Single Market, may no longer benefit from frictionless movement of goods across the EU, and will have to weigh this cost against the other benefits of manufacturing in the UK.
It remains to be seen how, as part of their larger economic partnership, the two jurisdictions cooperate in the future to smoothen the customs and border mechanisms for different sectors, including through technology deployment for border clearances and checks, in order to offset the frictions in cross-border trade that may arise in the short term.
2.2 Level playing field
The EU and the UK have committed to ensure that any future regulatory divergence will respect the level playing field and high levels of protection maintained in areas such as environment, climate change, social and labour rights, tax transparency and state-aid. To this extent, certain safeguards have been built within the TCA to ensure that both jurisdictions have strong incentives to maintain a level playing field in the exercise of their regulatory autonomy. This is in the form of a rebalancing provision that allows for either side to initiate a formal review in case of significant divergences in the level playing field standards and to apply tariffs subject to the approval of an independent arbitration panel. In the future, each side is likely to monitor the other's regulatory policies in this regard to evaluate whether to impose sanctions in the form of tariffs, and this arrangement leaves the long-term trade relationship across the EU-UK border subject to policy uncertainty.
2.3 Free movement of services and people
From January 1, 2021, UK will no longer benefit from the principles of free movement of persons, free provision of services, and freedom of establishment, across the EU Single Market. UK citizens will now require visas for long-term stays in the EU and face addition cross-border mobility restrictions based on immigration policies. UK service providers will also no longer benefit from the country-of-origin principle and there will no more be a mutual recognition of professional qualifications between the two jurisdictions. Accordingly, UK service providers and professionals will now have to comply with the varying rules, procedures and authorisations applicable to their activities in each EU Member State they operate in, or relocate to the EU if they want to continue operating in the EU Single Market as they have done prior to Brexit.
It is likely that the two jurisdictions will agree on additional arrangements for the mutual recognition of certain professional qualifications, pursuant to the TCA. The interim uncertainty may prove to be problematic for services firms, as it may reduce the overall talent pool available to such companies, and further increase their operational costs with respect to employees' compliance with newly-applicable immigration policies between the EU and the UK.
Moreover, with Brexit, UK financial services firms lose their ‘passport' rights in the EU. To this extent, the TCA does not concretely cover the future relationship between the EU and the UK as regards financial services, and instead provides for a foundation for future deliberation and cooperation on the basis of an equivalence framework for market access in financial services. This equivalence assessment has not been concluded and will continue to take place between both sides. However, any equivalence rights granted to conduct certain financial activities would be withdrawable at short notice, and this aspect has raised a cause of concern in the financial services sector, given the piecemeal nature and lack of stability or permanence of the proposed system.
3.1 Loss of access to the EU Single Market and common laws
The immediate beneficiaries of the TCA include the vulnerable manufacturing and exports sectors, who can continue to trade across the EU-UK border free from any tariffs or quotas. However, it is evident that the trade and economic relationship of the UK with the EU will be different going forward and a primary concern for UK-based Indian companies would be the loss of full access to the EU Single Market, given that: (i) people will no longer be able to work freely in both economies by right; (ii) additional bureaucracy at the border will make it more difficult and expensive to trade and invest across the borders; (iii) there will be a reduced market access for cross-border trade in services; and (iv) the UK financial services firms will no longer have guaranteed and permanent EU market access. Businesses, in particular, are also concerned about the possibility of regulatory divergence between the two jurisdictions in the future, that may increase compliance and co-ordination costs for operating on both sides.
3.2 Regulatory uncertainty as regards UK-EU cross border trade
Post the Brexit referendum in 2016, it was clear that undoing nearly fifty years of integration of the UK as a key Member State within the EU Single Market and Customs Union will be difficult in the short term. The TCA represents a starting point to UK's disintegration process with the EU, providing a preliminary foundation for the EU and the UK to build their future trade relationship and cooperation, which will inevitably evolve over time. However, the long-term regulatory position for EU-UK cross-border trade is yet to be fully determined and stabilized, in particular with respect to some important economic issues for the UK, such as market access in the EU for the service economy and financial services, that continue to remain open and subject to further discussions.
In the long run, successive governments may want to renegotiate or alter aspects of the trade relationship between the EU and the UK agreed under the TCA, which may create ongoing regulatory uncertainty. In this regard, in the coming months, the UK may also need to tackle the internal side effects of Brexit as regards Scotland's push to become independent and potential instability in Northern Ireland. Any continuing regulatory ambiguity around the precise contours of the EU and UK trade relationship in the future would be disadvantageous to the UK's economic position, as it may make it difficult and reduce the incentive for companies currently invested in the UK with a substantial EU-focus, to commit to further long-term investments in the UK. The second order consequences of this could be a disbursement of Indian investment into other EU Member States, that traditionally would have come into the UK.
3.3 UK-based European headquarters
From the above discussion, it is clear that Brexit will impact individual companies in different ways depending on whether they are more UK or EU-focused. More impact will be felt by Indian companies that have chosen the UK jurisdiction purely as a gateway to access the wider EU markets and that deeply rely on cross-border trade in the Single Market. The potential regulatory divergence, new barriers to trade in goods and services as well as in cross-border mobility between the two regions, could result in significant challenges for these companies to now conduct pan-EU business and trade headquartered in the UK. These companies may be constrained to realign their investment strategies and set up a new or greater presence in the EU, along with their presence in the UK, in order to seamlessly access both the markets. Furthermore, UK-based Indian companies that have substantial business in the EU may find it commercially viable to altogether move operations out of the UK and set up a new presence in an EU Member State, in order to avoid the additional expenditure of having separate entities in the UK and the EU, and to continue availing the advantages of frictionless movement of persons, goods, services and capital in the Single Market.
In this regard, given the unique position of Ireland and Northern Ireland within the scheme of the TCA – i.e., a separate protocol on Ireland and Northern Ireland built in to allow Northern Ireland to remain in the UK customs territory and, at the same time, benefit from the EU Single Market4 – Ireland can become an attractive jurisdiction for many companies globally to set up and expand in post-Brexit, in order to have access to both the EU and the UK markets.
3.4 Brexit – an opportunity for the UK?
The UK has long been a preferred choice in Europe to harbour global companies, especially from Asian jurisdictions. Some key economic drivers that make the UK an attractive choice for foreign investment include its open economy, ease of doing business, stable business and political environment, strong digital and physical infrastructure, highly skilled workforce, cultural appeal, high quality professional support services, competitive tax environment, a developed intellectual property regime, membership with international forums, as well as an established common law system, compliance with the rule of law, and efficient dispute resolution framework. The UK is also prominent in key sectors such as life sciences and technology, as well as in research and development. In this context, while there are clear risks to UK's economic position after Brexit, particularly in relation to the EU Single Market as discussed above, however, given its economic policy which supports business competitiveness and investment, Brexit may not undermine UK's long-term position as a choice of jurisdiction, and it may continue to attract global foreign investment and talent, particularly in a world where English is the dominant language of commerce.
Moreover, Brexit provides a unique opportunity for the UK to reset the terms of its economic and trade relations outside the EU in order to maximise opportunities in the global market and offset any possible negative trade impact or vacuum within the EU. This may be particularly important for UK's export growth in services, which continues to expand more strongly globally, than trade in goods. In this regard, the UK and India have already been working towards different possibilities to boost cooperation, deepen and enhance the existing economic partnership between the two countries, from trade and investment, to information technology, financial services, defence, security, education, healthcare and climate change.5 A favourable trade agreement between the UK and India in the future, which recognizes the shared culture and history between the two countries as well India's significant contribution in the form of investment and support of jobs across the UK, could result in many Indian companies committing long-term investments in the UK, and allow the UK to salvage and strengthen its strategic economic relationship with India.
With greater political and economic independence from the bureaucracy and constraints at Brussels, Brexit also provides an opportunity to the UK to make different choices from the EU, in order to better suit UK's needs and reduce costs for businesses. This may allow the UK to achieve greater innovation and economic growth in the long term outside of the Single Market, compared to the growingly stagnant and shrinking EU economy. This would be an interesting aspect to watch out for in the post-Brexit scenario, particularly in the context of regulating technology and internet companies. While the UK can generally be seen as a proponent of flexible and light touch regulation in the case of technology companies, EU has been more aggressive in its stance towards large internet and technology companies. To this extent, the EU has also recently proposed two legislative initiatives in the form of the draft Digital Services Act and the Digital Markets Act, to govern the digital services space in the EU. In the long run, it will be interesting to evaluate how safe-harbour protection in digital markets is built in the EU regulatory framework for technology companies, and whether an ‘independent' UK would be able to be more hospitable to technology companies through a lighter regulatory touch in order to benefit from more investment by such companies in the UK vis-à-vis the EU.
Originally Published by IndusLaw, January 2021
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