How to ensure your supply chain is Brexit ready

Brexit will have an impact on most supply chains.

This article is intended to help you identify where your key risks are and what you should do. We focus on UK businesses which trade with the rest of the EU, but we also comment on trading with the rest of the world.

Currently it is unclear what Brexit means and when it will impact. Current credible options include a hard Brexit, a soft Brexit or even no Brexit. Brexit could impact businesses:

• as shortly as 31 October 2019 (only some two weeks away now) when the UK will leave the EU in a no-deal Brexit scenario; or
• it could take place on 31 January 2020, under the extension proposed by the Benn Act; or
• it could take place on 31 December 2020, which is the end of the transition period previously agreed with the EU in the draft withdrawal agreement; or
• if the UK and EU agree it could be some other time.

This means businesses need to plan for both a hard Brexit and a soft Brexit - with a hard Brexit presenting the most risk of change to supply chains.

Businesses also need to bear in mind that although Brexit has its biggest impact on trade between the UK and the rest of the EU, it will also impact non EU international trade and UK domestic trade.

This note is broken into five parts:

• What you should do? This is the key part. It explains how to map your supply chain and the key issues you need to address.
• This explains the difference between a hard Brexit and a soft Brexit. It is important to understand the difference as a hard Brexit will introduce more change.
• Brexit opportunities. Brexit may bring new opportunities, this part explains those opportunities.
• Key risks of Brexit for the supply chain. This sets out the key Brexit risks.
• A Brexit supply chain checklist.

Part A - What should you do?

Map your supply chain to identify high risk supply chain contracts

You need to identify where your key risks lie:

• Identify your important customers and suppliers - which ones could cause the biggest impact on you. Financial value will be a key part of working out which are the important supply chain contracts but look out for the smaller but strategic supply chain relationships which could have a big impact.
• Put the supply chain relationships into one of three categories: those which relate to trade across the border between the UK and the EU; those which relate to trade between the UK and non EU countries; and those which are UK domestic. For each of these three types of trade the risks will be different.
• Also look at which contracts include commitments that extend beyond 31 October 2019 and those which extend beyond 31 December 2020. This is important as on long term contracts you might be trapped with limited choices. Short term contracts are more volatile but at least allow for choices.

With this information you can identify the highest risk relationships. The highest risk relationships will be important relationships, which require trade between the UK and the EU, and commit you beyond 31 December 2020. Lowest risk relationships will be lower value non strategic relationships, which are domestic UK trading and include no commitment beyond 31 October 2019.

For your higher risk contracts for trade between UK and the rest of the EU work through the immediate key risks

The immediate key risks arising in Brexit on supply chain contracts are:

• Delay in crossing the UK/EU border. If there is a hard Brexit delays in the short term and long term are likely.
• Costs in crossing the UK/EU border. This will be the risk of tariffs but also the increased logistic costs. Logistic costs are likely to increase in part because crossing the UK/EU border will be more complex but also due to the risk of delay.
• Export/import controls. Currently UK export/import controls are set by the EU. Post-Brexit (especially a hard Brexit) the UK may be able to set its own and different export/import controls. Therefore there is a risk of UK and EU export/import controls being different. In the short term the UK is unlikely to pursue a different approach to the EU but a foreign policy issue could have an impact. For example, the UK might take a different approach to Russian sanctions to the approach of the EU.
  
  There are currently (pre-Brexit) very few export/import controls between the UK and the EU. For example dual use products (products with both civil and military uses) can usually be moved freely within the UK and EU. Post-Brexit (especially a hard Brexit) that may change. This means that businesses are more likely to be having to deal with export/import licence requirements.
• Exchange rate risk. Since the referendum result the sterling exchange rate has been volatile. That volatility will continue for some time.
• Providing services (e.g. installation, servicing), especially at the other party's site, may become more difficult as there may be restrictions on movement of people (e.g. visas).
• All of the above creating upward pressure on prices and costs.

Consider how your higher risk contracts handle these risks:

• The allocation of the risk and cost of crossing the border will depend on the delivery term and detail of the contract. For example if you are in the UK and you are obliged to deliver into Germany then its probable you are responsible for all the costs and delays up to delivery in Germany and that will mean you take the delay/cost risk of crossing the border.
• Your contracts may already make specific provisions for border costs and delays. For example, if you use an Incoterm (e.g. Ex works, FCA, CIF, FOB, DAP, DDP) then these will specifically allocate those risks between the parties. For example if you are a UK buyer buying FCA (ICC Incoterms® 2020) from a Spanish supplier then the Spanish supplier will bear the risk of EU export tariffs, and the buyer will bear the risk of UK import tariffs.
• Restrictions on immigration may make on-site services more difficult. To what extent are you committed to provide on-site services? How reliant are you on UK nationals going to non UK EU based sites to provide services, or non UK EU nationals coming to the UK?
• If there is a change in exchange rate or upward pressure on prices what impact does that have on the contracted price? Are prices fixed or can they be reviewed?

If you are at risk under your contracts then consider what you can do to anticipate and manage the risks:

• Can stocks be built up pre-Brexit? What are the costs of doing so? Bear in mind that warehousing is in short supply as other people also build up stocks (including now for Black Friday and Christmas). You may need to secure warehousing space even if you are unsure you will need it.
• Consider the potential for increased logistic costs from crossing the UK/EU border - talk to your logistics provider.
• Consider how you will comply with export/import requirements. You may need to invest in IT systems and expertise/consultants to prepare. You should also consider if there are customs processes you need to take advantage of (e.g. customs warehousing).
• Consider what a change in tariffs could do for the price of the goods - identify now the custom classifications for the goods, check what the World Trade Organization (WTO) tariff would be for UK import/exports, and potential EU import/export tariffs.
• If you are subject to strict delivery time scales how will you reduce the risk of late delivery - e.g. build in contingency time for deliveries.
• If there are immigration restrictions between UK and EU consider impact on services. Can you adjust your workforce to manage this risk?
• Consider hedging for currency fluctuations.
• Consider how the contract price could be increased - for example is there a price review clause?

In the longer term the potential for the UK to take a different approach to regulations from the rest of the EU will also have an impact. Goods that can be sold in the UK may not be able to be sold in the EU and vice versa. Identify the regulatory requirements and relevant standards for the products and consider how it will work post-Brexit.

Consider the potential impact on contracts between UK and non EU countries

Brexit's main impact is on the relationship between the UK and EU. However it will also have an impact on trading with the rest of the world.

Key risks:

• Changes in duty. Currently UK duties with the rest of the world are the same as the EU. Post-Brexit they may change. The UK has indicated it does not plan to change tariffs in the short term. However other countries may have different views. For example the UK and EU proposal for post-Brexit WTO tariffs has been challenged by several trading partners.
• Border delay. Ports and borders will be more congested dealing with UK/EU trade. This may impact other exports/imports.
• Increased logistics costs. Freight forwarding services will be in demand and that is likely to increase costs.
• Exchange rate volatility.
• Export/import controls. Currently UK export/import controls are set by the EU. Post-Brexit the UK can introduce its own controls. For example the UK could take a different approach on Russian trade sanctions from the EU.

Therefore you should identify your key supply chain relationships and work through the risks applying the same approach as for UK/EU.

Bear in mind potential impact on UK domestic contracts

UK domestic contracts will not be directly impacted by Brexit. However it is likely that UK domestic supplies will be indirectly impacted. Any products with non UK content will be at risk of the issues set out above. That means potential product, logistics and warehousing shortages, price rises and delivery delays.

What about new contracts with EU trading partners?

With a new contract you have the opportunity to plan for the risks set out above:

• Given the uncertainty around long term contracts it is going to be difficult to manage unknown risks in a contract. Consider seeking a short term contract or a break clause.
• Make sure the delivery point and delivery term is clear. Use an Incoterm - it will allocate the responsibility for export and import duties and responsibilities.
• Allocating the risk of border delay, costs and tariffs between the parties will be difficult. No party will want to take an unknown risk. You may need a clause allowing for negotiation and termination if the parties are unable to agree.
• The pricing arrangements and how prices can be reviewed will be crucial.
• Review goods specifications. A UK importer will want goods that comply with UK laws, regulations and standards. But an EU importer will want goods that comply with EU laws, regulations and standards. EU requirements might be different to UK requirements.
• Do not seek to rely on a "force majeure" clause. The courts have indicated that the issues that Brexit raises are unlikely to be a force majeure event (or a frustrating one, as a matter of common law).
• The position on enforcement of court judgments in the UK/EU post-Brexit is currently unclear. Therefore consider using arbitration.
• Be conscious that change and uncertainty will heighten the insolvency risk. Check your trading partner before contracting with them and regularly review the credit risk. Consider requiring security for payment.

Part B - Look for the silver lining - identifying Brexit opportunities

Brexit does present substantial change, and with that change will come risk.

But businesses need to also look out for potential opportunities:

• A weak pound should mean that UK based suppliers will be more competitive. That should present UK opportunities (UK customers switching from imports to UK sourcing) and export opportunities.
• New international markets. A hard Brexit (but probably not a soft Brexit) will allow the UK to enter into trade agreements with countries. This could open up new markets for UK exporters. Businesses should assess the new opportunities. A note of caution:
  • The UK will potentially lose the benefit of the trade treaties the EU has entered into (most recently Japan and Canada). There are more than 50 of these arrangements. The UK has been seeking to put in place roll over arrangements but these are not complete.
  • Trade agreements often take time to develop and can create difficult political issues. For example a deal with the US might require the UK to open-up its agricultural products market and reduce subsidies for UK farmers.
  • The UK may be able to be more fleet of foot in doing trade deals than the EU. However although the UK is a large economy, the EU is a bigger economy and therefore can bring more muscle to those negotiations.
• Potential to reduce or change regulations. A substantial part of UK's regulations are EU wide regulations. A hard Brexit (but probably not a soft Brexit) would allow the UK to move away from EU regulations. The UK could reduce the amount of regulations or regulate differently. However it is currently very unclear what changes to UK regulations are likely. That in part is because it is unclear if the UK has the appetite for significantly reduced regulations (e.g. environmental regulations). Also diverging from EU regulations will make trading with the EU harder. Finally bear in mind some key UK regulations (e.g. health and safety) are not the product of the EU and therefore less likely to change.

Part C - What kind of Brexit?

There is lots of jargon flung around on the various different potential Brexits.

In this article "Hard Brexit" means that the UK leaves the EU and ceases to be a member of the "single market" and any form of "customs union" with the EU. A very hard Brexit would be where the UK does not enter into any form of free trade agreement with the EU. Hard Brexit would mean that exporting/importing goods from or to the UK would be subject to some form of border controls and duties (which will mean cost and risk of delay). The extent of border controls and tariffs depend on how hard a Brexit. A hard Brexit will mean that the UK will have more freedom to do trade deals with non EU countries.

"Soft Brexit" means that the UK leaves the EU but remains in the EU customs union or equivalent to it. There are various ways that could be achieved - for example joining the EEA (sometimes referred to the as the Norway model), or by entering into a customs agreement (such as Turkey). A customs union might apply to all goods or just some goods (for example agricultural products are often excluded). Movement of relevant goods within the customs union would attract no duty or tariffs and limited border checks. If the UK was to leave the EU but remain in the EU customs union it is very likely to be required to ensure that it ensures that the relevant goods comply with EU regulations - this is what is meant by being a "rule taker" - the UK would not have any direct control on the EU regulations but would have to apply them. A soft Brexit is likely to mean it is difficult or impossible for the UK to do its own trade deals with non EU countries.

A soft Brexit will be much less disruptive to EU supply chains than a hard Brexit.

Part D - Key risks of Brexit for the supply chain

• Delay
  • Any form of Brexit is likely to bring the risk of border delays. This is not just in relation to collecting duties but also ensuring various documents are in place. A hard Brexit will certainly result in border delays. The impact of a soft Brexit will depend on the detail - a very soft Brexit might result in no real change to existing border arrangements. It is unlikely a technology solution will be developed and implemented in time.
  • Businesses need to factor in the risk of delivery delay in their supply chains:
    • Increased lead times.
    • Does the risk of delay make it impractical to import/export - perishable goods are most at risk.
    • Ensure that the supply chain contract is clear on delivery date and time obligations, and allocation of risk of delay between parties. If goods are delayed at the border and incur costs or damage or failure to deliver on time who takes that risk?
    • Consider qualifying with UK customs (HMRC) as an Authorised Economic Operator - this establishes you as a "trusted trader" and should result in less border inspections and delays. However, it takes significant time and expense to implement.
• Cost
  • The most obvious costs are duties or tariffs.
    • Currently goods moved between the UK and the rest of the EU attract no duty. With a hard Brexit that will change.
    • Businesses need to consider how the cost of import and export duties is allocated between the parties. Many current contracts for trading goods between UK and the rest of the EU may be silent on the issue. You will need to make it clear. Incoterms are an excellent way of making it clear who is responsible.
    • We are seeing this already causing difficulties between UK and non UK EU parties. For example a UK company buying equipment from a German manufacturer. If tariffs are introduced (either export duties by the EU or import duties by the UK) should the UK equipment buyer or German equipment seller bear that risk? If the seller bears the risk they will almost certainly increase their price. If the buyer takes the risk then it is taking an unknown risk.
  • Cross border logistic costs will increase. Time is money - if it takes longer to move goods then it will cost more. Transport and warehouse costs are likely to increase as is insurance. In addition dealing with duties, documentation requirements, unravelling VAT issues will increase costs - internal costs in managing logistics, external costs in freight forwarders, customs brokers, accountants, tariffs experts, lawyers.
  • VAT is going to become more difficult. VAT is an EU tax. It is both a sales tax and an import tax. It is unclear how VAT will work in a soft or hard Brexit. The government has indicated VAT will remain in place but the detail is unclear.
• Trade restrictions. Currently most goods once they are in the EU can be moved freely round the EU. An automative accessory which is legal to import and use in the UK can currently be moved within the EU and sold in Germany. Following Brexit, and especially a hard Brexit that might not be the case:
  • Regulatory compliance. Currently all goods in the EU need to comply with EU regulations. Post-Brexit and especially a hard Brexit then UK regulations and EU regulations may diverge. This may mean that an automotive accessory which is legal in the UK might not be legal in Germany. Some EU regulations require manufacturers to have an authorised representative based in the EU. UK exporters will need to ensure arrangements are in place.
  • Sanctions and export/import controls. Following Brexit and especially a hard Brexit then UK could have different trade sanctions and export/import rules. For example the UK, if it wanted to, could introduce sanctions banning imports from Iran but the EU might not. This could mean that if that happens if you are importing goods with Iranian content you may not be able to import into the UK.
• Exchange rate risk. There has been substantial volatility in sterling exchange rate with the Euro, dollar and other currencies. That exchange rate volatility is likely to continue regardless of what happens. The recent growing risk of a hard Brexit has weakened sterling. A decision to abandon Brexit is likely to lead to a sudden immediate strengthening in sterling's value.
• Services. This article focuses on Brexit and the goods supply chain. In any form of Brexit (hard or soft) services will become harder to provide across the UK/EU border.
  • To date in the UK/EU negotiations there has been little priority given to cross border provision of services. It is likely that a UK company will find it harder to provide services in the EU post-Brexit. That might be because there are EU licensing or regulatory obligations which are difficult/impossible for a UK domiciled company to comply with, or visa/immigration requirements make it difficult to provide onsite services, or taxation arrangements which impact provision of services.
  • Services is relevant even to goods supplies - warranty and maintenance services are going to be potentially impacted.
  • Consider how to manage this risk. This will depend on the extent of services you provide. You may need to establish a non UK EU subsidiary or service network.
• Insolvency risk. Volatility, change, disruption in costs means that there is a higher risk that your suppliers and customers could become insolvent. Consider your exposure. Carry out credit checks.
• Enforcement risk. Currently UK court judgements are reasonably easily enforced in the non UK EU and vice versa. This has allowed companies to trade with more confidence in the EU then they can with non EU countries. For example an EU business trading with a Chinese business may use a letter of credit or some form of security (which adds cost and complexity) but would not bother if the other party is in the EU. The UK and EU have both identified this as an issue. Hopefully in a negotiated Brexit the UK and EU will agree to continue these arrangements. But there is no certainty on this issue. A hard Brexit brings a higher risk that the current UK/EU court enforcement arrangements will cease. Therefore consider using arbitration rather than courts and consider obtaining security (e.g. letter of credit, bank guarantee) to secure an exposure.

Part E - Brexit Supply Chain Checklist

1. Map the supply chain and prioritise.
   • Identify high value/strategic suppliers/customers.
   • Split supply chain contracts into three groups:
     • UK/EU.
     • UK/rest of the world.
     • UK domestic.
   • Identify binding commitments which:
     • go beyond 29 March 2019;
     • go beyond 31 December 2020.
2. For each relationship identify:
   • the delivery point;
   • who is responsible for border requirements/cost/delay.
3. Identify term and exit options for existing contracts.
4. Avoid long term contracts until position clearer.
5. Assess likely change in tariff/duty.
6. Prepare for cross border logistics getting harder:
   • Manage risk of border delays.
   • Prepare for increased logistic costs.
7. Assess if any export/import are likely to need export/import licences.
8. Consider impact of change in exchange rate.
9. How can prices in contract be reviewed/changed?
10. Identify if any services are provided. Consider impact.
11. For new contracts consider using arbitration.
12. Identify opportunities post-Brexit.