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State aid question remains stumbling block in Brexit talks

How the UK will run its state-aid regime after the end of the Brexit transition period remains one of the hardest issues to settle in the continuing UK-EU negotiations.

With less than six months to go to the end of the transition, EU negotiators are growing increasingly impatient at Boris Johnson’s failure to set out his plans for a domestic subsidy regime and provide concrete reassurance that the UK does not intend to unfairly undercut EU economies.

Michel Barnier, the EU’s chief negotiator, signalled last week that the EU was prepared to shift some of its red lines, a change of tack noted by his British counterpart David Frost. With the latest round of intensified talks under way in Brussels this week, the question now is whether a compromise can be reached.

Why is state aid such a problem?

Because it threatens to most undermine the relationship of “sovereign equals” that Mr Johnson says must be the foundational principle of the UK-EU future relationship.

The EU’s opening position is that the deal should “ensure the application of Union state aid rules to and in the United Kingdom” on a continuing basis, with EU standards as the “reference point”. This would leave the European Court of Justice (ECJ), which is the sole arbiter of EU law, with a binding say over parts of UK economic policy

Mr Frost says this is “unrealistic” and must change if both sides are to move forward.

What is the UK’s opening position?

The UK says it will create its own regime of subsidy control, based on the concepts of the World Trade Organisation Agreement on Subsidies and Countervailing Measures, with both sides agreeing to notify each other “every two years” on subsidies.

EU officials say that — given the size and proximity of the UK’s economy — there is “no way” that this is acceptable if the UK wants a “zero tariff, zero-quota” free trade agreement with the EU.

The risks of the UK freeriding on the EU single market are too great. “This approach — ‘we’ll notify you every two years on what we’ve done and if you want to punish us, then punish us’ — that’s never going to fly,” said an EU official close to the talks.

What is the solution?

Legal experts suggest both sides will have to agree to parallel subsidy regimes, which respect each other’s judicial sovereignty but rely on a mutually agreed set of parameters and principles set out in the UK-EU agreement.

Under Britain’s former prime minister Theresa May, the Competition and Markets Authority (CMA) was set to be the UK state aid regulator and could still end up with that role, UK officials believe.

James Webber, an antitrust partner at the law firm Shearman & Sterling, said that in lieu of a common judicial framework, the EU and the UK could use independent regulators that protect the judicial sovereignty of both sides.

“The rules in an EU-UK FTA should only ‘bite’ on areas which can be shown to distort trade and competition,” he said. “This is not done in EU state aid currently but it is perfectly possible to create a structured way to assess which subsidies distort competition.”

Any dispute resolution mechanism would need to avoid cutting across either side’s top court. If both sides could not settle disagreements through political engagement, then enforcement would ultimately come by imposing retaliatory tariffs, but these would be proportionate and a matter of last resort, Mr Webber added. 

Will the EU compromise?

From the EU side, such a solution would require a big shift from its current position, allowing a much looser relationship than it would like. According to Mr Webber, the European Commission may resist the rigorous analysis of “competitive effects”.

Mr Barnier took exactly this line last week, warning that “the level playing field is not for sale,” and that “we refuse to compromise our values to help the British economy”. 

The issue is further complicated, says George Peretz QC, a lawyer at Monckton Chambers in London and expert in EU law, by the Northern Ireland Protocol, which in effect allows Brussels to rule on any UK subsidy decision that affects the goods sector in the region. In theory, this could anyway give the commission significant reach into UK affairs.

For the UK side, agreeing to what one EU official called a “joint philosophy” on economic subsidies, is a much deeper commitment than many Brexiters would like to make — even if ECJ jurisdiction is avoided. “The Vote Leave caucus in Number 10 wants a very minimalist approach,” said a UK official close to the talks. 

Will the EU and UK risk a ‘no deal’ on state aid?

The signs are that a compromise can be probably found. But it will not be easy and time is short.

Under questioning by peers, British ministers have conceded that — despite promises of full independence from Brussels — the new UK regime will only emerge “in tandem” with EU negotiations.

During the election Mr Johnson said he wanted it to be “faster and easier” to rescue businesses, but since then the government has refused to divulge details of its ambitions. A promised consultation with business has not materialised. No legislation has been proposed.

UK business leaders are, for example, keen to have a regime that allows the government to “pump-prime” a green new deal to encourage environmentally friendly businesses, said Stephen Phipson, head of Make UK, the manufacturing group. Officials also say freeports are a key part of the government’s future plans.

But it is not clear that either of those things would be precluded by an agreed regime as part of the UK-EU future partnership, legal experts said, given that historically the UK has been less prone to use state aid than other EU nations such as France and Germany.

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