Brexit deal's state aid rules might have long reach

31 October 2019 10:01am

30 October 2019, by Matthew Holehouse

Boris Johnson’s big win in his revised Brexit deal was shifting the UK-wide “level playing field” commitments — covering labor, environmental, tax and competition law — from the binding withdrawal treaty into the aspirational political declaration. 

This followed the prime minister's rejection of an all-UK solution to the Irish border. It sets the stage for a wrestling match in the phase-two trade negotiations, where the UK will seek to claw market access in exchange for complying with EU rules. The shallower the UK-EU relationship, the greater freedom it will have to change its economic model.

Or so the story in Westminster goes — to the admiration of Johnson's free-marketeer backbenchers, and to the deep concern of lawmakers who fear the UK is embarking on a race to the bottom.

But the state aid provisions in the Northern Irish protocol merit a closer look. The protocol places the whole province within the EU’s customs union, in goods elements of the single market and in the all-Ireland single electricity market. It was hammered together in less than a week, as the prime minister dashed to meet his European Council summit deadline.

Far from applying only to Northern Ireland, the past application of EU state aid rules suggests they are likely to have a significant reach into Great Britain. The UK's room to adjust its economic model might be narrower than thought.

All-UK scope

It’s clear the state aid regime bites across the UK. Under the protocol, the full body of EU state aid law, listed in Annex 5, will “apply to the United Kingdom . . . in respect of measures which affect that trade between Northern Ireland and the Union which is subject to this protocol.”

The existing procedural rules will continue to apply to the UK, as will the oversight of the European Commission and the European Court of Justice.

This is a significantly different formulation to the much narrower concept of the “the United Kingdom in respect of Northern Ireland” — used to describe the geographic scope of a long list of EU rules on aerosols, food colorings and medical implants that will apply only in the province under the protocol, and that are listed in Annex 2.

Indirect and potential effects

What about the “measures which affect that trade”?

It’s a mirror of the EU’s existing state aid test of trade between member states, which the EU institutions have established a famously low bar for meeting. An impact may be “direct or indirect, actual or potential.” An aid recipient need not be selling outside its national borders to be in scope, if state support makes it harder for rivals to penetrate that market. In competitive markets, the sums of aid involved need only be small.

Clearly, direct subsidies or tax breaks to manufacturers or electricity companies in Northern Ireland and trading under the protocol would be in scope. Already, trade bodies are asking for compensation from the UK government for the new barriers to trade erected between Northern Ireland and Great Britain.

But it would also entitle the commission to investigate pan-UK tax schemes, where they present a direct or indirect benefit to Northern Irish firms. That would likely include cases such as the UK’s Controlled Foreign Companies regime, which was struck down by the commission this summer — a decision that is currently under appeal.

And while the financial services industry is not covered by the protocol, state aid to UK banks might also be in the frame, if it allowed Northern Irish manufacturers or electricity companies to access cheaper credit.

So too could aid to a struggling car manufacturer in northeast England, if its vehicles were available for sale in Northern Ireland. Raw materials processed in Great Britain as steel or fuel, and used downstream in Northern Ireland, would also be in scope.

The EU courts have previously found that companies that trade only outside Europe are also in scope, if aid bolsters their position relative to their EU rivals. Therefore, support to Northern Irish companies to compete as the UK embarks on a new project of global trade agreements could also be in the frame.

There’s no precedent for the EU seeking to apply the state aid code to only part of a member state’s marketplace. Establishing where activity on the British mainland has repercussions over the Irish Sea won’t be straightforward, and will be fertile terrain for disputes.

Who cares?

The UK might feel this doesn’t particularly matter. The country has, famously, always championed state aid controls and is one of the lowest users of aid in the bloc. There have been few high-profile bust-ups with the commission, and both sides might want to keep things that way.

Yet the politics may shift. The ability to diverge, Johnson declared earlier this summer, is the "point of our exit." An exit with a thin, or no, trade agreement in December 2020 might compel the UK to dispense emergency support to ailing businesses, and to adjust its economic model in the long term.

UK opposition leader Jeremy Corbyn is a long-time critic of rules that he argues limit state ownership. The constraints in the protocol will limit the UK’s freedom to maneuver, and will limit its bargaining power in the phase-two trade negotiations.

Even if the UK doesn’t alter its approach, the commission’s role in vetting aid may prove an irritation. Standstill provisions prohibit aid being released until the EU executive has granted approval. The UK thinks this process could be accelerated under a domestic post-Brexit regime. It’s hard to see the incentive for the commission to hasten decisions that will unlock investment in the UK when it’s no longer a member state.

Nor is it necessarily in the UK’s interests to be providing the commission with a stream of reports of all its public grants, and the underpinning economic rationales, when the two parties are competitive rivals.

The consequences of the protocol may be significant for the long-term UK-EU relationship, and appear to have been overlooked in the UK’s race for a deal.