How would a No Deal Brexit impact tech?

  • techUK techUK
    Monday14Jan 2019
    News

    While the default position is for the UK to leave the EU with No Deal unless something else is agreed, this is a scenario that doesn’t work for the tech sector.

There have been repeated assurances from the UK Government that it is not its intention to leave the European Union with No Deal. However, the reality is that until an agreement has been ratified by both the UK and EU, the consequence of triggering Article 50 is that the legal default in the absence of a ‘Deal’ is ‘No Deal’. While it is expected that the British Parliament would attempt to block a No Deal outcome, doing so is not simply a case of voting against No Deal, but for an alternative.  What that alternative remains the biggest question facing MPs and the country.

Given No Deal remains a very real potential outcome, and as the Government increases preparations for such a situation, it is important to fully assess the impact on the UK tech industry, tested against the key priorities of the tech industry of any future relationship with the EU.

It is worth remembering that technology increasingly underpins a significant part of the wider economy, with tech companies heavily integrated into the supply chains of sectors ranging from healthcare to financial services. This means that the impact of No Deal on these sectors will also be felt by the tech companies serving those sectors. In many ways the biggest unknown for many in the sector will be what happens to their clients in the event of No Deal, something ultimately outside their control. That is one of the reasons why talk of a ‘managed’ No Deal risks the unhelpful suggestion that companies, Government or even the EU is fully in charge of the consequences of a No Deal Brexit.

 

Data

techUK has been clear about the importance of data protection and international data transfers since June 2016. The entire digital economy relies on the ability to transfer data across borders. In a connected world trade involves increasing quantities of data to be transferred alongside the good or service being traded itself.

As a member of the EU, the UK has been part of the EU’s data protection framework. The framework establishes rules on how data should be protected and places restrictions on the transfer of data outside of the bloc in order to maintain those protections, while ensuring data can flow freely within the bloc. Personal data can only be transferred from the EU to third countries if the country has received an adequacy decision from the European Commission following an assessment of their domestic data protection law. In the absence of an adequacy decision individual companies will have to ensure appropriate safeguards exist before transferring data outside the EU.

The UK has fully implemented EU data protection laws, namely the recent General Data Protection Regulation (GDPR), via the UK’s own Data Protection Act 2018. The Government has also published plans for technical amendments to this legislation to ensure it continues to apply in the UK if there is no deal with the EU. That means that a no deal situation would not change the way in which companies have to handle personal data.

However, under a no deal arrangement, the UK would become a full ‘third country’ and therefore no longer automatically deemed a suitable place for EU data to be sent. Given this will take place in just over three months’ time, there is not time to complete full adequacy assessments between the UK and the EU. The fastest adequacy agreement took 18 months with Argentina. This means businesses would not be able to transfer personal data from EEA countries to the UK without additional suitable legal mechanisms in place, most likely Standard Contractual Clauses.

Additionally, because the UK has the same data protection framework, it places its own restrictions on the transfer of personal data FROM the UK to other countries. The UK would also no longer benefit from existing adequacy decisions.

Finally, the UK’s Information Commissioner’s Office (ICO) would lose its seat and involvement on the European Data Protection Board (EDPB) and UK businesses would no longer benefit from the consistency mechanisms than exist within the EU’s data protection framework which makes cross-border compliance with data protection regulations more efficient. Instead UK businesses will have to deal with individual data protection authorities in each EU member state or establish a representative for their business in the EU.

As part of its No Deal contingency planning, the UK Government has stated it would not restrict data transfers to EEA member states; that it would continue to recognise Standard Contractual Clauses approved by the European Commission; and that it will preserve the effect of existing EU adequacy decisions. These steps cover transfers from the UK to other countries, apart from the United States, which will require a separate agreement. However, transfers of personal data to the UK would be considerably impacted by leaving the EU without a deal. The ICO has recently published more detailed information on the impacts which you can see here.

While through the work of the ICO, and good business preparation, the policy consequences on data flows of a No Deal Brexit can be reduced, the administrative burden on firms could be significant.  Many tech firms have already begun the shifting of existing contracts to identify where they might need to insert Standard Contractual Clauses, but this will take time and significant legal costs. The impact on UK business competitiveness when dealing with EU businesses could well be that the offer of contracting with a UK entity becomes less competitive compared to doing so with another EU member who will be able to rely on a strong legal basis for the free flow of data. This is why techUK believes a No Deal would have a negative impact on the UK’s role as a global hub for data flows.

 

People

In No Deal, there would be a high level of uncertainty about individual citizens’ rights and future immigration systems, with freedom of movement coming to an immediate end.

The UK Government has stated that in the event of No Deal it would protect the rights of EU citizens already living in the UK and offer a clear route to UK citizenship through a settled status scheme. Details of how this will work have been published in the Government’s no deal technical notice on citizens’ rights.

However, no such guarantee has been provided to UK citizens living in EU member states. This would be up to individual member states and so far, none of the EU27 have confirmed they would provide this guarantee in the event of No Deal.

With regards to future immigration, as a third country the UK would have no specific relationship with the EU on migration. Immigration is a member state competence and so each individual member state would have to make decisions on the migration rules for UK citizens, for both personal and business reasons. The UK will also need to design a new immigration system to recognise the end of freedom of movement. The Government’s Immigration White Paper, suggests moving the system for EU nationals to one largely identical to that for Non-EU nationals. The paper suggests the impact of doing so will be to reduce EU migration by between to 200,000 and 400,000 over the first five years, at a cost to GDP of between £2 billion and £4 billion over the same period. While the proposals do contain measures to better support companies in recruiting highly skilled workers, such as engineers, techUK views the net impact of the proposals as making the recruitment and retention of the staff needed to build and grow a tech business in the UK more challenging.

This situation does not work for the UK tech industry, which is heavily reliant on the movement of people. The tech industry is already facing a major skills shortage which threatens to limit the growth of the sector. Putting more hurdles in the way of companies attracting skills and talent into the UK does nothing to make the UK an attractive place for tech.

Alongside migration, a No Deal would also impact the ability of UK digital businesses to service contracts in the EU through the movement of staff, for example by a UK member of staff travelling to help set up a data centre operation. If we leave the EU with No Deal we will be dealt with under different countries commitments in the World Trade Organisation (WTO)’s General Agreement on Trade in Services (GATS). The EU schedule states that, where Mode 4 delivery (travelling to another country but not establishing a business entity there) is concerned, such travel will only be permitted for three months in any 12 or for the duration of the contract, whichever is the lower. That means offering a contract longer than three months from the UK to an EU client would be increasingly difficult to service without establishing a business branch.  Even under a traditional Free Trade Deal (such as the EU’s Canadian Free Trade Agreement), this period is limited to 12 months, making it hard to compete with businesses in other Member States who could offer much longer contract terms.

This issue also works the other way because the UK’s GATS Schedule, recently submitted to the WTO, mirrors that of the EU, so EU businesses will have a tougher time offering contracts in the UK, which may have knock on impacts for competitiveness.

 

Customs

The impact of no deal on the UK’s customs arrangement are likely to be the most visibly stark, with immediate direct impacts on consumers as well as businesses. With no customs agreement there would be significant disruption for businesses trying to bring goods into the UK from EU27 countries. Moving goods into the country would become incredibly difficult due to the introduction of checks at the border and failure to agree the mutual recognition of goods.

In anticipation of this scenario some organisations are stock piling goods where possible. This includes technology companies who are ensuring they have supplies of, for example, spare parts. However, it is difficult for companies to know what they might need to bring into the country quickly, and therefore difficult to plan for sudden checks at the border.  

No Deal would require a new UK Customs system to be in place by 29 March 2019. There has been little evidence of progress on this to date and it is difficult to imagine a fully-fledged new customs system will be up and running in less than 100 days’ time. However, we do know that businesses would have to register for a UK Economic Operator Registration and ID (EORI) Number in order to export to the EU.

Part of the reason for increased friction in trade rising from No Deal would be tariff differentials between the UK and EU. In the event of No Deal the UK would have a full tariff regime, however the Government has said it would aim to meet the same WTO tariff schedule as the EU. The UK would also seek to continue preferential tariffs for developing countries, including the General Scheme of Preferences as well as the tariff rates found in the Information Technology Agreement which reduces most tariffs on digital goods to zero, with some notable exceptions such as fibre optic cabling required for digital infrastructure. It was also recently confirmed that the UK and EU have agreed that the Common Transition Convention will still apply even in the event of No Deal. This means tariffs can be collected at the final destination of the good, rather than at the border. This is helpful, however potential future differences in tariffs will further increase friction on trade between the UK and EU.

Additionally, relating to Customs, in the event of No Deal the UK would no longer participate in the EU’s VAT area, which will require businesses to register with HMRC in order to comply with VAT requirements, as well as registering for the EU VAT Refunds Scheme via individual EU27 tax authorities. This could have a significant impact on those selling goods via e-commerce platforms, who will now have to ensure they are properly VAT registered in multiple jurisdictions.

Finally, and crucially for tech companies, the UK will no longer be part of mutual recognition schemes, such as CE marking which is a recognised symbol that a product meets relevant regulations. In the event of No Deal, the UK Government has indicated it would unilaterally accept goods from the EU with relevant mark, including goods already on the market. However, the same will not be true for exports from the UK to the EU. Businesses would therefore have to re-register goods that were approved in the UK somewhere else in the EU in order to continue to have their mark recognised in the EU.

All of this means significant increased friction in both ongoing and future trade between the UK and EU, with delays and difficulty trying to bring goods from the EU to the UK and vice-versa. Various new systems are required in an incredibly short amount of time, and significant additional burdens placed on businesses. This will cause problems for businesses across the board, particularly those, such as tech firms, that operate on a ‘just-in-time’ model.

 

Access to the Single Market

Given the EU is the most important trading partner for the UK, continued access to that market is critical for UK businesses. The EU’s Single Market is governed by a whole host of rules and regulations which members of the EU agree to abide by, and help design through the EU institutions. Access to the single market by non-EU countries is possible and there are various models which exist for relationships between the EU and non-EU countries. Those models include the much debated ‘Norway’ and ‘Canada’ models which vary in their level of access to the EU’s single market. Different levels of access provide different pros and cons. However, it is clear that No Deal would provide almost no guaranteed market access for UK businesses.

The single market is based on the harmonisation of rules and regulations for businesses operating within it. Access therefore largely depends on the level of harmonisation between the EU and the third country in question. It is therefore a clear choice on whether you want to access the EU Single Market, and therefore align closely on rules, or if you want flexibility to have different rules and limit access to the Single Market.

In No Deal there would be no UK-EU trade agreement guaranteeing access to the EU Single Market. The level of access to the EU Single Market would therefore depend largely on the extent to which the UK Government diverges from existing rules and regulations. If there is significant divergence, for example of key digital policy areas such as limitations to liability or data protection, it will be difficult for UK firms to do business in the EU, unless they are able to comply with both sets of rules for different markets. This may be possible for large companies, but small and medium UK businesses will likely face a choice as to whether they focus on the UK or EU market in those circumstances.

Such regulatory divergence is unlikely to happen overnight, but the uncertainty about future alignment will have shorter term impacts on businesses as it would introduce significant additional uncertainty that is likely to be unhelpful for business planning cycles and seeking to develop new business deals with partners within the EU.

No Deal would also have some specific impacts on the harmonisation that currently exists between UK and EU activities which would increase friction between the two. This includes UK participation on EU regulatory bodies, which often shape the way rules apply and develop after they have been implemented. Of particular importance to the tech industry would be the participation of the UK Information Commissioner’s Office on the European Data Protection Board (EDPB), and Ofcom on the Body of European Regulators for Electronic Communications (BEREC). Taking the EDPB as an example, with the EU having recently passed GDPR, the EDPB will play an important role in shaping the practical application of GDPR in its early years. This could lead to an accidental divergence between the UK and EU if regulatory guidance is different in each jurisdiction, even if the laws themselves do not change.

Similarly, in No Deal the UK will immediately lose access to all shared EU databases and processes. A key one for the tech sector is the REACH chemicals database, whereby chemicals used in products are registered on an EEA database as complying with the REACH regulation. The UK has indicated it would maintain the REACH regulation and set up a UK registration system however yet again this will require a new IT system by 29 March 2019, as well as the burden on businesses to re-register in the UK and transfer existing registrations to elsewhere in the EEA.

The ability to continue accessing the EU Single Market, which has formed a key part of the British economy over the last 40 years, is key for UK businesses, and has made the UK an attractive place for non-EU countries to expand their businesses in Europe. Losing this access through No Deal would be damaging to both UK businesses looking to export to a large market on its doorstep, and for the UK’s reputation as an international business hub.

 

Investment

When it comes to investment levels in the UK tech industry there are three key impacts to consider in No Deal.

First, the UK businesses will no longer be the beneficiaries of various EU funding opportunities. This includes programmes such as Horizon 2020. In the event of No Deal, the Government has said it will guarantee funding for Horizon 2020 bids, although it is not clear how funds allocated to consortiums partly based in the UK will operate. In the short term this will fill the funding gap, but the longer term impact on the UK as an attractive destination for R&D investment is likely to be impacted by hindering the ability to collaborate.

Secondly, for a sector which has continuously been at the forefront of Venture Capital investment, a No Deal would have a very significant impact on the UK’s access to the funding which supports many tech businesses.  In a No Deal the UK will no longer be part of the European Investment Fund (EIF), which has been a vital source of investment for UK start ups in recent years. Between 30 and 40 per cent of all VC funds operating in the UK contain EIF money. While funds operating with EIF money are able to invest in non-EU firms, they are required to ensure that a majority of funding goes to EU businesses. No Deal is therefore likely to have a severe tightening effect on access to EIF funding for VC funds, which will in turn have an impact on funding within the sector.  Evidence suggests that the level EIF has already decreased following the triggering of Article 50, one of a number of ways in which the UK tech sector has already felt the impacts of Brexit.

Thirdly, there have been numerous reports of multinational companies already holding back investment into the UK market due to the uncertainty created by the unknown form of the UK’s departure from the EU. This will likely only be intensified in a No Deal exit given the additional friction in trade, reduced access to the Single Market, difficulty in attracting the relevant talent and additional barriers to using the UK has an international hub for data. Compounded, these factors would likely lead investors away from the UK market and to countries offering more stability and access to consumers.

Additionally, it is important to remember that business’ preparations for No Deal, which they must do while it remains a potential outcome, costs money. This is money they may previously have been ear-marked for investment into other projects. It is very difficult to measure this impact as it is essentially an alternative reality, but the opportunity cost of investing into no deal preparations should not be forgotten.

 

The wider picture

Concerns about business spending feed into a wider picture about the impact of No Deal on the tech industry. That is the impact No Deal would have on the wider economy. The technology industry supplies many other sectors, so impacts of No Deal on those sectors will have a knock-on effect on the tech industry. For example, the automotive industry is heavily reliant on customs arrangements, which will be significantly impacted by No Deal. Tech companies involved in serving the automotive industry, whether that is in autonomous vehicle research, the manufacturing of cars, navigation systems or fuel switching products, will feel the strain of impacts on the automotive sector. Similarly, the financial services industry relies heavily on regulatory equivalence with the EU. Without access to the EU’s financial services market the UK’s FinTech industry and providers of ancillary services to this large sector of the economy, everything from cloud services to mobile banking solutions, will be directly impacted.

In planning for No Deal there are certain issues which are simply beyond the control of individual businesses. It is very hard, if not impossible, for individual businesses to anticipate changes in the valuation of sterling or the impact of No Deal on sectors that business services, or indeed what the overall confidence in the economy will be in No Deal.

The tech sector is a fast-growing, innovative and dynamic industry, and has been pinpointed as the future of the economy. However, this sector will only be able to thrive if the ecosystem in the UK is the right one. Based on the key priorities for the tech sector, a No Deal Brexit is unpalatable for the UK tech industry. The consequences of No Deal on data transfers, access to talent, ability to move goods in and out of the UK, accessing a market of over 446 million consumers and likely investment levels, in the context of the wider economic impact, are incredibly concerning. Put simply, No Deal doesn’t work for tech.  

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