UK subsidy policy: first steps

Update: A chapter on subsidies is part of the new UK-EU Trade and Cooperation Agreement (TCA). Both the UK and EU must have independent regimes of subsidy control. The agreement includes broad common principles to prevent authorities from giving businesses subsidies, which could be detrimental to trade and investment. See our briefing The UK-EU Trade and Cooperation Agreement: Level playing field (section 3).

On 31 December 2020, the UK government published guidance, Complying with the UK’s international obligations on subsidy control, which sets out key steps for public authorities to take when awarding subsidies under the new UK regime. From 3 February 2021 to 31 March 2021, the government ran a consultation about the design of a bespoke approach to UK subsidy control. Its response to the consultation was published on 30 June. On the same day new legislation - the Subsidy Control Bill - was introduced in Parliament.

As an EU Member State, the UK was part of the EU state aid regime that limits trade-distorting government support to businesses. Having left the EU, the government is setting up for an independent UK state aid or ‘subsidy control’ regime, based on WTO rules. The EU state aid framework will cease to apply after the end of transition on 31 December 2020, but the discussion is ongoing about what will replace it.

This briefing describes how the UK government’s approach has shifted from remaining in step with EU state aid rules under Theresa May’s Government towards regulatory sovereignty and a focus on WTO rules under Boris Johnson’s leadership.

While some countries like the US do not have a domestic anti-subsidy regime, there are good arguments in favour: strong controls on government subsidies at all levels are thought to promote accountability and transparency of public spending. They can also prevent potentially harmful subsidy competition between the nations of the UK or between local authorities. On the other side of the argument, rules restricting subsidies would curtail the government’s freedom to invest in priority areas or industries.

A two-pronged approach

The UK government’s position in the negotiations with the EU has been that developing domestic subsidy controls is separate from a free trade agreement with the EU. UK’s international commitments, based on the WTO rules, should only catch subsidies that can distort trade. It’s up to the government to tailor the domestic rules, to choose which policy priorities to support and to decide how much funding will be available.

But the government has recognised that its domestic choices are influenced by the ongoing negotiations on the UK future relationship with the EU.

Domestic regime

As confirmed in the Government statement of 9 September 2020, the UK will follow the WTO subsidy rules. On 29 September the government has laid a statutory instrument which disapplies EU state aid law that would otherwise be retained in the UK by the EU Withdrawal Act 2018. The details of the new regime will be decided after a consultation, which the government has planned for the end of 2020 or 2021. It is not yet known whether the government will legislate to go further with domestic regulation than required under its international commitments on subsidies.

How much subsidies and to whom?

Successive UK governments have favoured rigorous state aid controls and on average have spent less on state aid as a percentage of GDP than most EU Member States. In September this Government said that it will not revert to the 1970s bailing out of unsustainable companies and will uphold competition.

Government statements indicate that it may seek freedom to intervene faster to protect jobs, invest in freeports and emerging industries or be free to manoeuvre when designing its support to business which suffer from the pandemic. There are also indications that the government may seek to channel state support towards innovation in the technology sector. The House of Lords EU Committee which has led parliamentary scrutiny of Brexit and state aid policies has pointed out that leaving the EU presents an opportunity to reshape UK subsidy policies in a way that supports its economic and industrial policies, such as the government’s net-zero targets or regional development through the shared prosperity fund.

Enforcement

It is not clear how any new subsidy rules would be enforced. While Theresa May’s Government had designated the CMA to become the state aid enforcement authority, this Government has not excluded the possibility of a minimal, light-touch regime without a regulator.

Devolved governments

The UK government considers state aid or subsidies to be a reserved matter, which means that the issue is the responsibility of the UK Parliament alone and the devolved legislatures are not able to legislate in this area. The UK Internal Market Bill, which is currently under consideration in Parliament, would set the reservation in law. In view of the government, this would allow to put in place a single, unified UK subsidy control regime.

Scottish and Welsh Governments have disputed the division of competences with the UK Government in this matter. They have emphasized from the outset that any new state aid regime should be designed “in close partnership” with devolved administrations and have dismissed the new bill.

Northern Ireland Protocol

The Protocol on Ireland/Northern Ireland of the Withdrawal Agreement sets out the arrangements to maintain an open border on the island of Ireland after the end of the transition period. Under Article 10 of the Protocol, in order to prevent undue distortion of competition and trade between Northern Ireland and the EU, EU state aid law will continue to apply to the UK with regard to Northern Ireland - EU trade. State aid controls will apply to business support measures which can potentially affect trade between Northern Ireland and the EU.

The Protocol is limited in scope to the movement of goods and wholesale electricity markets. But the traditionally broad interpretation of EU state aid rules implies that Article 10 could impact UK public support to businesses beyond Northern Ireland - the so-called “reach-back”. For example, UK-wide subsidy schemes, which benefit Northern Ireland businesses could be seen to affect NI-EU trade. Thus, government plans for a new UK-wide subsidy regime may be limited by the state aid obligations under the Northern Ireland Protocol.

State aid experts as well as the House of Lords EU committee have argued that if an agreement on state aid is reached with the EU, the government and the EU can seek to replace Article 10 of the Northern Ireland Protocol with new arrangements.

The government has proposed in the UK Internal Market Bill that it is given powers to unilaterally re-interpret and disapply parts of the Protocol. These powers would be a safety net to protect from reach-back. The EU has said that the Bill is in “clear breach” of the Withdrawal Agreement and the Northern Ireland Protocol and has called on the UK to withdraw the particular clauses. On 1 October 2020, the Commission initiated legal proceedings against the UK for breaching its international obligations.

Future relationship

The settlement of state aid has turned out to be one of the most contentious stumbling blocks in the UK-EU negotiations. Throughout the five rounds of talks from March to July 2020, the negotiations on state aid remained deadlocked.

The EU’s position is that enforceable commitments on state aid are a core part of the so-called level playing field – commonly agreed rules and principles that guarantee open and fair competition between both markets and prevent one partner’s less stringent regulation or subsidies from undercutting the other. Commitments on state aid would prevent the UK, a geographically close and intertwined economy, from undercutting the EU market with government support to businesses.

The EU’s initial proposal was for the UK to follow EU state aid law including its future amendments and put independent enforcement in place. The Court of Justice of the EU would remain the ultimate interpreter of the EU law. There would be a dispute settlement mechanism in the agreement.

The UK Government has rejected any alignment with EU state aid rules and a role of the CJEU. It proposes to base mutual commitments on the WTO Agreement on Subsidies and Countervailing measures, extending them to cover both goods and services. Both sides would further agree to transparency provisions. Both sides would use their “best endeavours” to resolve disagreements on subsidies through consultation.

However, the latest negotiation rounds have signalled moves towards a compromise, but, according to the negotiators, the gap between the UK and EU remains wide.

The EU has dropped the requirement that UK follows EU state aid rules. In exchange it is asking to sign up to high-level principles on subsidy policy. The UK would be required to have an independent institution to enforce them: the EU wants a sight of the UK’s domestic regime. The EU is also emphasizing the importance of dispute settlement mechanism and “autonomous retaliatory measures” (for example, tariffs on affected goods or suspension of parts of the agreement) which both sides could trigger if urgent action was required.

The UK chief negotiator David Frost has said that the UK is willing to commit to high-level principles such as allowing subsidies that can be justified on grounds of public policy or market failure. Subsidies which have negative effects on trade and investment, should not be allowed.

Such principles would be part of a good domestic subsidy system, but the government says that it cannot give the detail on domestic policy, that the EU has been asking for. That is to be decided after a consultation with UK businesses at a later stage.

Various UK state aid experts agree that in order to reach an agreement on state aid, the UK government would have to demonstrate that its independent subsidy regime offers equivalent protection to the EU state aid regime, possibly with both sides being able to invoke trade sanctions if the agreement is breached. They argue that setting out the details of a strong subsidy regime would create a win-win situation for the UK government: it would give the government a new domestic tool to strengthen fair competition and prevent subsidy races within the UK, and would make an agreement with the EU more likely.

Other EU trade agreements

The EU has insisted on including some sort of controls on state assistance in every more recent free trade agreement with other countries. Ensuring a level playing field in relations with its international partners and reforming the global subsidy rules, are among the focal points of to the EU’s overall trade policy.