A curious and unsettling silence has descended on the topic of what Brexit actually means for UK infrastructure investment – in part because surviving pandemic fallout is the main focus for now. But the UK’s trade deal with the EU has left developers to navigate a maze of non-tariff barriers and there is still very little clarity about what additional cost, if any, that means for future UK infrastructure projects
Agreed at the eleventh hour on 24 December 2020, the EU-UK Trade and Co-operation Agreement (EU-UK TCA) now defines the UK’s trading relationship with the EU as a non-EU country. As is well known, the trade deal largely ensures that trade between the two blocs is free from tariffs. Nevertheless, where the single market and customs union allowed for an unrestricted flow of goods, services, and people between the UK and the EU, the trade agreement now requires businesses, including infrastructure developers, to scale a number of new regulatory hills.
Some UK infrastructure projects inevitably rely on components that are imported from the EU, the UK’s closest trading partner. Bureaucracy surrounding imports could slow down project supply chains and could ultimately increase the capex of individual projects, although the extent to which non-tariff barriers will cause such issues is still being assessed. As Matthew Hardwick, a partner at Norton Rose Fulbright, says: “It might be that given the additional paperwork required and the additional complexity of getting materials for projects into the UK, suppliers may increase their prices. I think at this stage it is more people just being concerned about this problem, rather than it being something that has materialised.”
A new border for infrastructure materials
The most obvious example of a non-tariff barrier resulting from the EU-UK TCA is the presence of a border for goods. Now that the UK has left the EU and the transition period has ended, goods entering the UK from the EU must move across the same hard border that exists for trade between the UK and non-EU countries. This hard border does not exist between Northern Ireland and the Republic of Ireland, which have a different trading partnership set out by the Northern Ireland Protocol – currently the subject of a legal dispute between the UK and the EU.
Customs formalities now apply to goods moving from the EU to the UK. In order to import materials for UK projects in this way, developers and/or their suppliers will need to complete customs declarations, value and classify their goods, indicate the country of origin of goods, and ensure they understand the applicable IT systems. Imported goods can be subjected to physical checks at the border, although these checks are expected mainly to apply to agricultural products and food. Import VAT will be applied to goods imported from the EU, which will mean a marginal increase in the cost of any EU materials used in UK projects.
Pre-registration at departure ports can be required for some logistical operations in order to prevent bottlenecks. The UK and the EU also have the freedom to implement licences for imports or exports, although, according to a White & Case report, there is already ‘a general licence system for exports of “dual-use items” to the other Party’. Should regulatory divergence between the UK and the EU happen in the future, however, more onerous licensing requirements could be imposed.
For developers and their suppliers, one of the most complicated parts of these freshly minted customs regulations could be complying with the rules of origin mandated by the Brexit deal. Sidestepping tariffs means demonstrating that any infrastructure materials or components are made entirely from UK or EU materials. Bilateral cumulation applies, meaning that EU components imported to the UK can contain UK materials, but cannot contain materials from a third country without incurring tariffs.
There are some exceptions to this rule for individual products. Specific processes that are part of particular industries can be designated as conferring UK/EU origin on some goods, even if those goods are produced from materials from a third country. Other options include allowing a prescribed proportion of third-country materials to be used in manufacturing some products, as well as classifying products that undergo a change of tariff heading after processing in the UK/EU as having originated in the UK/EU. Most customs regulations are scheduled to be in force by 1 January 2022.
Increased costs as a result of these new rules seem fairly inevitable for project developers active in the UK, although there will be quite a lot of variation on this point. If developers are directly involved in the process of moving project components into the UK from the EU, they may need to employ advisers to interpret the new regulations or customs intermediaries to handle imports for them. Developers that do not import directly will have these costs passed along the food chain to them by suppliers.
If customs formalities are managed internally, more time and more staff will need to be devoted to completing paperwork and co-ordinating logistics. Logistics in particular might become rather more gruelling, with timelines for project supply chains more difficult to predict. Depending on the structure of project contracts or concessions, there can be penalties charged to developers for late delivery. This issue might be resolved as new border systems become more efficient, but if imports are permanently slower, timescales on projects will have to adjust accordingly in the long-term.
The rules of origin provisions are another potential booby trap. There is the weight of extra paperwork and its resultant costs to consider, but perhaps more significantly, the value of third-country goods sometimes has to be indicated as part of meeting requirements to escape tariffs. Suppliers will understandably be wary of disclosing the value of third-country goods that make up their products, as such disclosure can expose suppliers’ markups to their clients.
Referring to the complications of these origin rules, Iain MacVay, a partner at White & Case, says: “There is a conflict in international trade in various free trade agreements about whether companies actually utilise the trade preferences and often you find they don’t and the reason they don’t is they find it is too much trouble.” If trade preferences under the rules of origin provisions are too arduous to utilise, developers and suppliers might opt to pay tariffs, raising the capex of projects.
State aid and immigration roadblocks
A notable section of the trade agreement for UK infrastructure development concerns state aid regulations. Explaining how these would function in the energy sector, MacVay notes: “The energy and environment provision anticipates and acknowledges that the parties want to maintain affordable and sustainable energy systems and therefore says that subsidies should be aimed at incentivising the beneficiary delivering a secure, affordable energy source. It is giving some acknowledgement that there are subsidies in the sector, but it is without prejudice to the principles of the anti-subsidy principles that are set out and those principles are broadly that you cannot give a subsidy that requires either export performance, or that requires the use of domestic products over imported products, or that has an impact on the trade and investment pattern between the two jurisdictions.”
The three principles that MacVay sets out apply beyond the energy sector. This means that if Brexit does make importing from the EU more costly, the UK government will struggle to implement subsidies that encourage the use of local materials, because doing so breaches the EU-UK TCA and would allow the EU to retaliate with measures such as tariffs on UK exports. While market forces could seek out cheaper local content naturally, the UK has its hands tied when it comes to direct action.
A final area of concern for UK infrastructure in relation to Brexit is immigration, although this is not governed by the EU-UK TCA. When the UK was an EU member, EU personnel needed for UK projects had an automatic right to work in the UK. Under the new immigration system, hiring a skilled EU worker requires a Skilled Worker visa, which has an application fee of £610 for a visa of up to three years (reduced to £555 for some EU countries) and a healthcare surcharge of £624 per year.
In addition, to hire EU workers sponsors must have a sponsorship licence costing £536-£1,476 and pay an immigration skills charge for each worker of £364-£1,000 for the first 12 months and £182-£500 for each additional six months. Certificates of sponsorship are largely free for EU workers, but there may be further charges if immigration lawyers are hired to handle visas. While these costs may be fairly marginal in the context of a large infrastructure project, they are an illustration of the fact that employing EU staff on UK projects is now more expensive and complex.
The TXF perspective
The web of new rules now spread across the UK’s relationship with the EU will not derail UK infrastructure investment, but it will likely make it a little more pricey and cumbersome. Developers with an international presence will have experience with managing border controls and regulations in markets far more remote and difficult to access than the UK, experience that they can apply to the UK market as shaped by the EU-UK TCA. Some of the disruption will also be short-lived as project sponsors find ways to manoeuvre themselves through the world of post-Brexit infrastructure development. It is any long-term scarring of the UK’s capacity to deliver projects – however slight – that is a cause for concern.
It is worth remembering that, as Mark Dennison, a partner at Eversheds Sutherland, notes: “Everyone is mindful that Brexit has potentially significant effects, but as things currently stand, it is a case of wait and see. That may be partially a reflection of the fact that the UK infrastructure projects pipeline outside of offshore wind is in a bit of a lull. As that pipeline in conjunction with the National Infrastructure Bank gets going, we are likely to see the real effects of the Brexit trade deal on new UK infrastructure projects.” With the economic fallout of Covid-19 constricting the flow of projects and the UK economy artificially buoyed up by mass government spending, the depth of any crater for infrastructure investment caused by Brexit is difficult to measure at present.
It may be that the UK market adjusts to its extensively remodelled relationship with the EU with minimal fuss, but it is hard to believe that there will be no repercussions for any industries. According to the Department for Business, Energy & Industrial Strategy, the UK imported £10.8 billion of building materials and components from the EU in 2019, compared to £7.4 billion of imports from non-EU countries in the same period. While this data is not limited to infrastructure development, it does show that the UK has an established supply chain with the EU for materials that can be used in infrastructure. All such imports now have to clear the hurdles described earlier.
Should project materials from the EU become more expensive to source, a variety of projects could see cost increases. This could be anything from Engie and Equitix’s student accommodation project at the University of Birmingham, to the £400 million A465 road in Wales, to the 40 hospitals worth £3.7 billion that the government intends to build or upgrade by 2030, to the £100 billion (approx.) HS2 rail project. There may, of course, be an unexpected boost for UK manufacturing if it is easier and cheaper to source materials in the UK, but, depending on the materials, this could take time and would almost certainly not be a solution for all components that projects might use.
As one of the most prominent sectors in the UK’s current infrastructure pipeline, offshore wind also stands to be affected. Many of the largest offshore wind developers or suppliers are EU companies, such as Orsted, Equinor, Vestas, or Siemens Gamesa. Some of their personnel are certain to need work permits and parts of their supply chains will have to adapt to the EU-UK TCA. Referring to immigration, Peter Boeskov, chief commercial officer in global wind and structured finance at EKF, says: “In the long-term, we will have to see in terms of attracting labour. There are still a lot of Danish people involved in some of these UK offshore wind installations, as well as people from other European countries. It might be trickier in the future to get the work permits in place.”
Of the three dominant offshore wind suppliers – Siemens Gamesa, Vestas, and GE – Siemens Gamesa and Vestas already have manufacturing hubs in the UK, located in Hull and the Isle of Wight, respectively. GE is currently reported to be considering setting up a UK factory. Siemens Gamesa and Vestas are able to produce both turbine blades and towers in the UK, evading any impact from Brexit.
Other components will, however, be imported from the EU and subjected to customs processes. Shashi Barla, a principal analyst at Wood Mackenzie, notes that “Vestas uses gearboxes in its V164 and V174 turbines. These gearboxes are manufactured at suppliers factories in Belgium or Germany, as suppliers already have an established footprint with sizeable industrial capacity and testing benches. The volume that we see in the UK in terms of gearboxes would not warrant additional investments in setting up a gearbox manufacturing facility in the UK. I would assume that they would continue to import gearboxes from the EU for their next-generation V236 turbines in the future as well.”
GE and Siemens Gamesa use direct drive turbines, which do not have gearboxes. But parts such as the nacelle, generators, rotors, and turbine controls are common to all turbines, are largely imported from the EU, and will face customs formalities. If the raw materials for these parts, most notably steel, are acquired from third countries, then suppliers will have to work to satisfy rules of origin provisions, unless a specific exemption for offshore wind is carved out by the EU and the UK. Where projects are located beyond a 7-mile radius of the UK, immigration and trade laws do not apply. In some cases, supply ships could deliver EU workers and components directly to the project without entering the UK, but this is unlikely to be a workable option for all projects.
Reflecting on the impact of Brexit, Jonathan Turton, a director at Arup, says: “I think in many senses Covid overtook Brexit as the thing anyone really cared about and it made Brexit much less important to an extent. We are not seeing the kind of disruption that might have been anticipated. That may come later down the line, but it is not something our clients seem to be particularly concerned about at the moment. They are much more worried about the fallout of Covid on the economy and the ability of the government and public sector bodies to fund infrastructure going forward.”
At this point in time, strip away UK government PR about ‘building back better’ and the outlook does not seem overly positive. Public sector net debt sits at around 97.5% of GDP according to the Office for National Statistics (ONS), the UK’s National Infrastructure Strategy has no comprehensive mechanism for private sector infrastructure investment such as PFI, and it remains to be seen if the recently founded £22 billion UK Infrastructure Bank (UKIB) can match the EIB’s contribution to UK infrastructure funding (around £5 billion per year in the five years leading up to the Brexit vote in 2016). Adding an incremental, insidious rise in project costs as a result of Brexit to the UK government’s constrained balance sheet and its lack of a credible conduit for private sector capital does not make for a good recipe. In this context, Brexit should almost certainly raise some red flags about the future of UK infrastructure.