Where Are We on Brexit? The Picture Looks Messy Six Months On

(Bloomberg) -- Six months on from the U.K.’s referendum, the broad outlines of Brexit are emerging through the winter gloom.

While much remains uncertain about Prime Minister Theresa May’s ambitions as she sets about leaving the European Union, one of the few certainties is her insistence that Article 50 -- the mechanism that will start exit negotiations -- will be triggered by the end of March.

With little more than three months before she pushes the button, Bloomberg has conducted interviews and analyzed public comments with two dozen officials on both sides of the negotiations to reveal the emerging thinking, key battle-lines and likely obstacles that lie ahead. A summit of EU leaders in Brussels on Thursday should offer a further glimpse of the challenges, and how May’s EU counterparts respond to them.

Process

The one thing London and Brussels agree on is that the time for negotiations will be short. Once May invokes Article 50, negotiators will have less than 18 months to reach a deal, allowing enough time for the European Parliament and British lawmakers to ratify it. With European elections due in 2019, negotiators on both sides worry the Parliament will prove the toughest hurdle.

Beyond this, there is little consensus. May needs to reach two main agreements: one on withdrawal from the bloc, covering borders, budgets, pensions for British EU staff, and an exit charge of up to 60 billion euros ($64 billion). The second part will cover the U.K.’s future trading relationship with the bloc.

Britain wants to work on both deals simultaneously. Michel Barnier, the chief EU negotiator, rejects this, favoring the traditional European approach of negotiating treaties one chapter at a time. He has told diplomats that a lack of resources mean parallel talks would be tough.

Transition

Both Barnier and U.K. ministers now believe some kind of transitional arrangement may be required to avoid a sudden, shock exit. On Monday, U.K. Chancellor of the Exchequer Philip Hammond warned publicly for the first time that the negotiations could fail to reach a final deal within the two-year timeframe, making a transition plan essential.

Brexit Secretary David Davis is reluctant to endorse the idea, but others in his department confirmed it’s under discussion. May, who will ultimately decide, has been Delphic so far, saying only that no-one wants a “cliff edge.”

EU diplomats think the transition will merely extend the U.K.’s current membership, with full single-market access in exchange for free movement of people and the rule of the European Court of Justice -- conditions that British Euro-skeptics will abhor.

May will also be asked to set out her preferred shape for the permanent relationship before Barnier offers a transition package. “There would be some point and usefulness to a transitional period if it is the path to this new partnership,” Barnier said last week. But neither side wants a bridging arrangement to become permanent.

Money

As the second largest economy in the bloc, Britain’s financial might is one of its strongest bargaining chips. Hammond and Davis are considering paying the EU for access to the single market. “The major criterion here is that we get the best possible access for goods and services to the European market,” Davis explained this month.

Hard-line Euro-skeptics in May’s governing Tory party, such as Foreign Secretary Boris Johnson, disagree. Johnson campaigned to leave the EU, promising to regain 350 million pounds ($440 million) a week of British contributions to the Brussels budget.

Money talks on the other side of the Channel, too. When Britain -- a net contributor to the EU -- withdraws, it will severely dent the funds available for the main net recipients in eastern Europe. These states are likely to push for the U.K. to keep paying, potentially until the current budget period ends in 2020, diplomats said. U.K. officials think this could persuade eastern European countries to accept British demands for some migration controls, or single-market access.

Banks

While vital for some of the biggest global businesses, maintaining the rights of British-based banks to provide services across the EU is a lesser priority for the rest of the bloc. France, Germany and Poland are among countries trying to lure financial services away from London.

Davis has privately warned there will be no special favors for financial services, but he sees the significance of the 70 billion pounds annually they contribute in U.K. taxes. His officials are working on fixes to allow banks and insurers to continue operating across the EU. At the minimum, banks want a pledge of a transitional arrangement.

One option -- access for banks on the basis that the EU judges U.K. financial regulations as equivalent to its own -- would be difficult. Trade minister Mark Garnier said maintaining equivalence could mean having to accept all Brussels regulations with no chance to shape them.

Migration

Ending the open border with the EU is the only immovable red line in the talks for many in May’s team. Unfortunately, “free movement” is also a red line for the rest of the EU. A succession of leaders warned May that if she wants no free movement of people, she will have no membership of the single market. Hammond, Davis and others have promised they won’t stop “highly skilled, highly paid” individuals moving to the U.K. to work.

Trade

British and EU diplomats accept that May’s stance on migration rules out the U.K. remaining inside the single market. If that were not enough, May also declared Britain must not be subject to the European Court of Justice, another requirement of single-market membership.

A murkier question is whether the U.K. will stay in the customs union, which sets common tariff arrangements with external countries and enables goods to move freely across borders within the EU. May wants Britain to lead a new era of global free trade but Britain cannot strike trade deals on its own until it leaves the customs union. 

May’s key ministers are split on the issue, while she seems to be eyeing a hybrid deal. One U.K. minister suggested a compromise could keep Britain in the customs union for some products and sectors of the economy while leaving it for others.

Davis is studying the trading relationships the EU has with Canada, as well as Norway -- which is in the single market and outside the customs union -- and Switzerland, which is outside both but has its own customs deal with Brussels.

Davis regards a bespoke free-trade deal as the most likely goal for the U.K. May has said she wants a “red, white and blue” Brexit, rather than replicating a model that already exists.

--With assistance from Svenja O'Donnell Jonathan Stearns Nikos Chrysoloras Peter Levring and Amanda Billner To contact the reporters on this story: Tim Ross in London at tross54@bloomberg.net, Ian Wishart in Brussels at iwishart@bloomberg.net. To contact the editors responsible for this story: Simon Kennedy at skennedy4@bloomberg.net, Alan Crawford at acrawford6@bloomberg.net.