Brexit - What happens next?

Despite a series of close opinion polls, many showing the Leave campaign ahead, the outcome of the referendum caused widespread shock. The United Kingdom voted to leave the European Union by a margin of 1.2 million votes, a lead of 3.9%. Although a narrow win, the 17,410,742 leave votes are the most for any cause in UK political history, on the highest turnout in a national vote since 1992. Of the 12 counting regions, only London, Scotland and Northern Ireland voted to remain.

The question for politicians, businesses and voters alike is simple: what happens next?

Leadership: now to September 2016

David Cameron has resigned as Conservative Party leader and will step down as Prime Minister once his successor is announced on 9 September 2016. Conservative MPs will reduce the field of candidates to a final two, who will be put forward to a ballot of Conservative Party members. The early favourites for the run-off are Boris Johnson and Theresa May, with Stephen Crabb also attracting some support.

Announcing his resignation on Friday, Cameron said:

“A negotiation with the European Union will need to begin under a new Prime Minister, and I think it is right that this new Prime Minister takes the decision about when to trigger article 50 and start the formal and legal process of leaving the EU.”

No medium-term decisions will be taken before a new Conservative leader is elected, with the intention of producing a period of calm and reflection, during which the markets can settle. The leadership contest will provide an opportunity for candidates to set out their approach to negotiating and propose a model for future relations with EU countries.

The European Commission President, Jean-Claude Juncker, has demanded that the United Kingdom should leave the EU, “as soon as possible, however painful this process will be”. However, his desire for speed is in contrast to the Vote Leave campaign’s desire to take as much time as required to get the best deal for the UK, and the Commission is not able to trigger an exit. The Prime Minister’s decision has ensured that proper negotiations cannot begin before the autumn.

European leaders are likely to be more cautious about taking definite positions before the UK’s leadership is settled, although some outlines will emerge from an informal meeting of the other 27 EU member states. Already, there are calls for MEPs to step down, while the UK may be prevented from taking up the rotating Presidency of the European Council in 2017. The UK’s Commissioner, Lord Hill, resigned in protest at the referendum result, which has transferred responsibility for the financial services portfolio to Valdis Dombrovskis, at least temporarily.

No changes to ministerial appointments are anticipated until the next Prime Minister is in place. A special Cabinet Office unit has been created to examine options for the negotiations, which will co-opt civil servants from the Foreign Office, HM Treasury and other departments. It will report to the full Cabinet until September.

Initial negotiations: October 2016 to early 2017

The next Prime Minister will attempt to seek pre-agreement on key issues with other EU governments, together with the Commission, before considering any use of article 50 (see below).

Whether article 50 is triggered or not, early provisional agreement could be reached on:

  • Opt-outs from specific EU directives, rules and schemes, e.g. on procurement (OJEU) and VAT zero-rating
  • Aspects of EU budget contributions and EU spending
  • The Presidency and participation in EU institutions, probably by adopting voluntary conventions
  • Restoration of the UK’s seats on the World Trade Organisation and other international standard-setting bodies
  • Potential temporary membership of the EEA (European Economic Area), with continued participation in the single market, but withdrawal from the EU itsel
  • Restrictions on freedom of movement and an approach to the rights of future EU migrants and future UK expats
  • Other transition measures

The UK has the domestic legal ability to unilaterally withdraw from the jurisdiction of the European Court of Justice, which was proposed as an initial step on security measures by the Vote Leave campaign. This kind of action would require enabling legislation in Parliament, which could be difficult to pass, particularly in the House of Lords.

Most EU rules affecting businesses have been implemented through UK statute. All of these laws will remain in place unless and until Parliament votes to change or scrap them. The rights of EU citizens currently living in the UK, and of British citizens living in EU countries, are protected through international law under the Vienna Convention of 1969.

It will take some time for the Government to establish its EU negotiation priorities, for both sectors and terms. It will also need to bolster the negotiation capacity of the civil service, bringing in more outside expertise to the Cabinet Office, the FCO and UKREP.

FTAs with the rest of the world: Autumn 2016 onwards

There will be two distinct approaches towards free-trade agreements (FTAs) with non-EU countries:

  1. For countries where the EU has an existing FTA: an agreement to match or amend the current terms, post-withdrawal. This could involve an initial agreement to match terms, with ongoing discussions about extensions or limitations.
  2. For other countries: discussions on creating new FTAs with an independent UK. This will involve prioritisation of resources, with the US, Australia, China, and India likely to be among early targets.

These discussions are likely to include visa arrangements.

Withdrawal mechanism: Article 50 or treaty change?

Both Jean-Claude Juncker and the German Chancellor, Angela Merkel, are insisting that article 50 must be invoked before negotiations of any kind can take place. This is a political stance, not a legal requirement.

Although article 50 is the presumed mechanism for withdrawal, it severely limits the UK’s freedom to negotiate. It creates a binding, 2-year time limit on withdrawal, while placing final agreement on terms out of the UK’s hands. For this reason, the Government will try to delay invoking article 50 until heads-of-terms are agreed on the post-withdrawal relationship. Alternatively, it could pursue an agreement outside the existing framework, although this would be resisted by other members. For example, withdrawal could be incorporated within the next EU treaty, allowing the UK’s existing veto over measures for the Eurozone to act as a counter to any aggressive EU negotiating stance.

It will be difficult for negotiations to proceed in any detail until the French Presidential election concludes on 7 May 2017, not least because any favourable terms for the UK could be exploited by Front National candidate, Marine Le Pen. The German Federal elections are set to follow, with convention suggesting a date in September 2017. Given the increasing prominence of the AfD party (Alternative für Deutschland), this may require further postponement of an outline agreement.

General Election: by May 2017?

The next Prime Minister will inherit a tiny majority in the House of Commons, while lacking a mandate beyond their party for their negotiating position. Should the Labour Party’s present difficulties continue, the temptation to circumvent the Fixed-term Parliaments Act and trigger a general election may be irresistible, particularly if a window emerges before the elections in France and Germany. A snap election could take place as early as October 2016, but the government would need a clear model for relations with the EU before going to the polls.

Agreed terms with EU: probably not before late 2017, possibly 2018

Unless a consensus on favourable terms for the UK swiftly emerges among the other 27 EU members, head-of-terms for withdrawal will not be agreed until 2017 or later. An extended period of transitional EEA membership is possible, but would be politically difficult without limits on freedom of movement. A permanent EEA “Norway” model was rejected by the Vote Leave campaign, because it retains freedom of movement and budget contributions, although there is now some traction for an “EEA minus” deal.

Once the terms of agreement are secured, phased implementation is then likely, over a period of years. This will include the adoption of a new UK immigration system and the parallel introduction of FTAs with the rest of the world. Skilled migration is likely to be prioritised through a points-based system, but some Vote Leave campaigners have advocated an alternative free-movement deal with Canada, Australia and New Zealand, while others have suggested more generous visa arrangements with Commonwealth members in the Caribbean, India and Pakistan.

The terms agreed are unlikely to involve import or export tariffs, which would have to fall within the WTO limits in any case, such as those applying to current UK trade with the US. Manufacturing is better placed to handle the range of possible outcomes, while financial services and service industries face more complicated issues around access to the single market, including “passporting” rights on Euro-denominated trading. Tariffs would also be less significant than the value of the pound. A low-value pound would create inflationary pressure, but would also assist exporters, with the potential to help sustain inward investment alongside changes to the UK tax regime. This includes foreign investment in the UK property market.

Legislative review: 2017 onwards

In practice, many current EU rules will apply for years to come, irrespective of post-withdrawal arrangements, because they are incorporated in domestic law. Nevertheless, the assumptions behind much EU-based regulation will cease to apply, allowing industry rules to be completely rewritten. Economic benefits from simplification and deregulation have the potential to offset costs involved with leaving the EU. A rolling legislative and fiscal review programme will begin to identify priority areas for change, within and across Government departments. Industry pressure will obviously help to shape this process.

A second referendum in Scotland?

The Scottish First Minister, Nicola Sturgeon, has begun preparations for a second independence referendum. Her view that an independent Scotland could remain in the EU while the rest of the UK withdrew has been rejected by the European Commission, however, which only recognises member states in their entirety. Assuming and independence referendum were held and won, Scotland would have to apply to join the EU from outside, subject to the vetoes of other states (e.g. Spain, which is resisting Catalonian independence) and the delays of the accession process.

In reality, the Government is almost certain to prevent a ballot before UK withdrawal. Ministers can argue that Scotland’s status through a newly independent Britain must be clarified first, before independence can be reconsidered. Although Scotland voted to remain in the EU, the collapse in oil prices limit the SNP’s desire for an actual ballot, because it would be forced to explain how it would fund current public services. Adoption of the Euro and immigration controls are now major issues. Sturgeon’s stance is an effort to buy time, nurture grievance with Westminster and keep nationalism alive: unless opinion in Scotland swings further towards independence during and after EU withdrawal, another referendum is not going to happen.

Post-withdrawal

Understandably, given expectations for a Remain vote that ignored the close opinion polls, there has been significant market volatility in early trading. Confidence will be hit for at least the short-term and the implications for listed companies are still being worked through by analysts. The long timeline to withdrawal should give the markets an extended period to adjust for the post-withdrawal political and economic landscape. Because the nature of UK withdrawal will be agreed well in advance of the date, exit itself should not give rise to further round of volatility.

Following withdrawal, a mix of risks and opportunities arise from the potential to diverge from the EU framework. This includes areas like:

  • Tax competition and structures
  • Employment and procurement rules
  • Industry regulation
  • Legal action and judicial review
  • State aid rules
  • Skilled immigration
  • Human rights and the ECHR
  • Retention of EU budget contributions
  • Trade agreements with non-EU countries

The EU framework itself will not remain static, because the other member states will continue to develop and add to the existing rules, which the UK may choose to retain in their existing form. For example, the harmonisation of company law and property rights is expected to be included in future EU treaty discussions.

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