Rethinking state-aid rules after Brexit

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Brexit commentary often focuses on the barriers to trade and labour exchange that the EU-UK Trade and Cooperation Agreement has created between the UK and its near neighbours.

But Brexit is not just about international trade. As Lord David Frost outlined in his speech last week, it is potentially a springboard from which to radically rethink the way the UK regulates and manages its economy.

One obvious area where leaving the EU brings benefits is in the area of subsidy control policy — what the EU calls state aid — where the UK is freed from a cumbersome regime that was designed to yoke together 27 economies into a single market.

Logically, this regime is necessary to create a level playing field and avoid EU member states out-subsidising each other in a “race to the bottom”. But that requires a centralised system to approve all grants that fall outside the so-called “block exemption” for smaller subsidies.

Getting decisions from the European Commission on complex subsidies that fell outside the block exemption “often took between six and 24 months”, according to Alexander Rose and Jonathan Branton, both lawyers at DWF, who gave evidence to MPs recently on how the UK regime might be different.

In theory, post-Brexit, the UK could dish out subsidies far more quickly and effectively, helping to attract investment and facilitate the government’s social and environmental policy goals in a faster and more targeted way. 

But will it? This is the question currently being debated by leading subsidy lawyers as the government’s Subsidy Control Bill works its way through the House of Commons in order to lay down the legal framework for how subsidies will work.

This might all sound a bit abstruse, but the new regime will be fundamental to how about 500 UK awarding bodies — from big government departments to quangos and local councils — hand out grants and subsidies.

And there is lots of money about — the £4.8bn Levelling Up Fund, the £1.5bn-a-year UK Shared Prosperity Fund, a planned £22bn-a-year in research funding, to mention just some — and how the money is spent will be important to the success of post-Brexit Britain.

As we wait for the new UK regime to be legally fleshed out, subsidies are still being granted. In the absence of a formal regime, these awards have to adhere to the broad principles on subsidy that were agreed by the EU and the UK as the price of a zero-tariff, zero-quota trade agreement.

The result is a transitional arrangement that George Peretz QC of Monckton Chambers calls “truly dysfunctional” because, without the equivalent of those EU “block exemptions” that made smaller subsidies legally safe, too many subsidies that are above the current limit of about £340,000 over three years are open to legal challenge.

This deters grantors from dishing out subsidies for fear of ending up in court, in some cases setting back the government’s own policy goals.

Peretz gives the (real-world) example of a residential lettings business that owns lots of flats that need re-cladding but isn’t being permitted to take more than £340,000 from the government’s Building Safety Fund for fear of transgressing the subsidy control principles in the Trade and Cooperation Agreement.

For smaller councils that don’t have large legal departments, the result is a lack of clarity that inhibits the granting of awards, according to Kieran McGaughey, of Lawyers in Local Government (LLG), a membership body for local government lawyers.

“There is a lot less clarity,” he says. “Under state aid rules you had the General Block Exemption and, overwhelmingly, subsidies were given out under that regime. It was like a preset menu of what was permitted, but now the onus has shifted on to public authorities to make decisions themselves.”

This is an area that will be addressed by the UK Subsidy Control Bill via what is called the “Streamlined Subsidy Schemes” that will enable central government to create robust “safe harbours” for aid grants — large or small — that meet certain criteria.

With primary legislation still at the report stage in the Commons, it is still not clear exactly how expansive these schemes will be, and whether they will create clarity and speed (which the government desire) or risk more confusion and delay.

James Webber, a partner at the law firm Shearman & Sterling, says the system should recreate the “preset menu” effect of the EU’s exemption system, but much more simply.

One area of concern is around plans to give companies just one month to bring a case to challenge the subsidy as unlawful. Rose argued in his evidence that this time limit is too short, recommending it be extended to three months, so it is consistent with other areas of judicial review. 

This would still be far, far faster than the EU system (where complaints can be made for up to 10 years) but would avoid companies arguing to courts they had had no meaningful chance to understand and challenge a subsidy. Again, clarity drives speed.

Monitoring the UK system will rely on a database of publicly posted subsidies run by the business department, which is already up and running, but which — as Rose says — “is currently not fit for purpose”. 

At present, the database contains just 1,600 entries of immensely variable quality and usefulness and is incredibly difficult to search chronologically. Without greater clarity, the lawyers warn, the new system risks being blighted with ongoing confusion.

McGaughey of LLG says the fact that so few councils have posted details of their awards “suggests confusion and nervousness” about the new regime.

The other area that is notably absent in the proposed new UK regime is an equivalent to the EU’s Regional Aid schemes, which allowed poorer areas greater latitude in subsidy control.

The EU’s map-based system, says Rose, could be clumsy and create anomalies, but the UK could still create a principles-based system that allowed poorer areas to benefit from greater subsidies based on accepted deprivation indices.

This would also chime with the government’s political agenda. Because, as things stand, Rose told MPs in his evidence, there is “nothing within the bill which currently contributes to Levelling Up, and some elements which might even be seen to be capable of thwarting it”.

Others, like Webber, argue that replicating this element of EU state aid would be a mistake, precisely because the aim is to try to avoid using the bill to force spending (or prevent spending) in particular areas or priorities.

It will be interesting to see if the government — which has so far rejected any amendments to the bill — will take on board some of these criticisms as it works its way through the House of Lords. 

As Peretz says, the bill is merely the “steel framework” of the regime and the material finish — setting out de minimis limits, identifying which kinds of subsidy need deeper scrutiny, how “schemes” will work — will only come via secondary legislation and regulations that are still to be handed down by ministers.

Webber is optimistic that when the details become clear, the UK regime will be an enabling force, helping to drive key agendas such as “net zero” and “levelling up”. 

“It’s a good bill that is analytically robust,” he says, arguing that it will take time for UK granting authorities to stop thinking along the old State Aid lines. He is confident that “we’ll all feel much better about this Bill when the meat is added to the bones”. We shall see.

The FT is trialing a new short-form audio digest of the day’s top headlines. Click here to listen to the latest news in less than three minutes.

Brexit in numbers

Bar chart of Experimental gross value added, % compared with Q4 2019 showing The economy of Northern Ireland has nearly recovered to pre-pandemic levels

Negotiations rumble on over the Northern Ireland Protocol, with Frost and his opposite number Maros Sefcovic due to meet again on Friday, this time in Brussels. 

No one is expecting any breakthroughs or breakdowns, although the European Commission is getting itchy feet over changing rules to ensure equal availability of medicines in Northern Ireland and Great Britain.

For its part, the UK continues to make the argument that fundamental changes are needed to the protocol in order to address what Frost contends are the “serious economic, societal or environmental difficulties”, or a “diversion of trade” caused by the protocol. 

The case that the protocol has damaged Northern Ireland economically got a bit harder to make this week after the Office for National Statistics found that the region performed better than any other in the UK in recovering from the pandemic. 

As my colleagues Valentina Romei and Chris Giles reported, economic output in Northern Ireland in the third quarter of this year was only 0.3 per cent below that of the final quarter of 2019 — a favourable comparison with the overall picture, which saw output falling by 2.1 per cent over the same period.

Stephen Kelly, chief executive of Manufacturing NI, a lobby group that has argued against using the Article 16 safeguards clause, said the data — coupled with inflation in the region running at half the UK average — appeared to show the protocol had helped to “insulate local firms and families from the inevitable costs of Brexit”.

He also noted that it was still not clear what impact exiting the protocol grace periods on food and parcels would have on the economy, or indeed the introduction of a UK customs border for goods from the EU over the course of 2022. 

“Only then will GB boardrooms and households find out what Brexit really means for their profits and purses,” Kelly concluded.

And, finally, three unmissable Brexit stories

An exclusive FT report suggests that the US government is delaying a deal to remove Trump-era tariffs on UK steel and aluminium because of concerns in Washington about London’s threats to change post-Brexit trading rules in Northern Ireland.

There are signs that at least some in Downing Street can see the advantages of a reset in relations with the EU, argues Robert Shrimsley in his latest column. But, he goes on to argue, the character of the prime minister and his government militate against the pragmatism required for this new approach.

London is becoming the Jurassic Park of stock exchanges, argues the chair of hedge fund Marshall Wace in a hard-hitting column. It is time the income fund sector was phased out and replaced with funds that are more focused on growth than dividends, he says.

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