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Analysis of the Economic Impact of Brexit on Japanese Companies in Germany

PricewaterhouseCoopers with the support of DJW

Summary of a study concerning the effect of UK leaving the EU (“Brexit”) on Japanese companies in Germany. Commissioned by the Ministry of Foreign Affairs of Japan (MoFA) via the Embassy of Japan in Germany (February 2017).

2017-06-30, 16:58

The following text summarizes the results of a study concerning the effect of UK leaving the EU (“Brexit”) on Japanese companies in Germany. The study was commissioned by the Ministry of Foreign Affairs of Japan (MoFA) via the Embassy of Japan in Germany in February 2017 and conducted by PricewaterhouseCoopers with the support of DJW (Japanese-German Business Association). The results have been presented during several seminars in Germany. A short Japanese summary of these presentations was published on the homepage of the Embassy of Japan in Germany in April 2017.

Background of the research

It is expected that many analyses on the economic impact of Brexit will be performed by international (financial) institutions and governmental institutions and that these analyses will present many opinions in occasionally very long reports. Furthermore, it is expected that information gained through opinion exchanges with companies from various industries will present a rather fragmented view that is unique to the respective industry or company. Therefore, the purpose of this study is to analyze this information comprehensively and from various angles and to evaluate potential effects of Brexit based on multiple scenarios in order to provide reference material for the development of governmental measures under each scenario and in order to deepen further the understanding of legal, economic and systemic implications of Brexit. The research and analysis should be conducted based on the following potential scenarios for Brexit and the post-Brexit relationship between the UK and the EU: EEA model, EU-Switzerland model (multiple agreements for various topics), EU-Turkey model (Custom Union), EU-Canada FTA model (CETA), WTO model, or a new model. 

Research result

The following items were identified as common influence on each industry.

Procurement/Supply Chain: There are concerns that customs may be imposed on trade between the UK and EU and that import and export procedures may become complicated. There is also concern that the lead time may be prolonged, which may lead to further cost increases.

Legal/Compliance: The Cross-border Merger Directive (2005/56/ EC) enables cross-border mergers of companies located in the EU. This may be, however, more difficult after Brexit. In the case of intellectual property rights (patents), it is possible for the UK to remain as a member of EPC even after the Brexit, because they are a party to the European Patent Convention (EPC) which is not derived from the EU. In that case, there is no change in the effectiveness of a patent right granted by the European Patent Office.

There is concern that the planned introduction of the European Unitary Patent and the establishment of the European Uniform Patent Court (UPC) in 2017 will be delayed. This is because both European Unitary Patent, which has been prepared under EU regulations, as well as an establishment of the European UPC require ratification of the UPC agreement by the UK to come into effect. With regard to the protection of Soft IP, the European Union Trademark will not be automatically applied any more after the Brexit, because the integration has been developed at Page 2 of 5 EU level. It is also possible that contracts and contract terms could be affected in various ways. For contracts that refer to “the EU”, it should be verified how the UK will be treated after Brexit.

IT · Information security: Preparations have to be made for the EU General Data Protection Rule (GDPR), which will be applied from 2018. Applicability to the UK after Brexit depends on the relationship between the UK and the EU as well as the newly concluded treaties.

Accounting and Tax: The UK will no longer be bound to accounting standards based on EU directives and regulations after the Brexit. In the medium and long term, therefore, the UK may adopt standards which are different from those in the EU. It is also possible for the UK to change the tax rate and legal responsibility without EU restrictions. However, when the UK becomes a third country to the EU as defined by the VAT directive, transactions between the UK and EU countries are treated as import and export transactions which lead to an increased work load for the VAT return. On the other hand, if the UK does not join the EEA or EFTA, it will be free from the various constraints of the EU, though tax treaties between the two countries will still be respected. In case the EU Parent Subsidiary Directive and the EU Interest and Royalties Directive are no longer applied, the attractiveness of setting up a holding company in the UK might decrease.

Human Resources: The employment of EU citizens in the UK who do not have permanent residency in the UK, as well as the employment of UK citizens in EU countries may be affected. This would influence talent management and the cost of human resources.

Asset management: There are concerns about the impacts on foreign exchange rates, stock prices, credit risk of UK companies and the increase of cost for financial arrangements due to the decline of the pound.

Particular influences for each industry are summarized below.

Transportation equipment (automobiles): The recent rise in domestic demand and full access to the EU single market are beneficial to manufacturers which own manufacturing bases in the UK. The recent decline in the pound value has brought both positive and negative influences. While the UK remains as an EU member country for the moment, the short-term positive effect from the weak pound increases the price competitiveness for exports and supports production in the UK. However, there is an adverse effect of cost increase for imported goods. This might influence the divided labour structure in the whole EU, because UK car manufacturing heavily depends on the import of parts and assembled vehicles.

Pharmaceuticals / Chemistry: In any Brexit scenario, UK pharmaceutical companies lose automatic access to the EU's research and innovation programs. The disruption and reduction of research funds from the EU will lead to a slowdown of innovation especially among small and medium-sized enterprises in the UK. Depending on the Brexit scenario, pharmaceutical and medical science and equipment industry may be affected in a wide range of fields such as product development, market approval and shipment of pharmaceuticals and medical equipment. Tariffs and non-tariff barriers cause costs (e.g. for transferring research teams) as well as delays in the market approval processes. If the European Medicines Agency (EMA), which conducts evaluation and marketing authorization of medicines, is moved from London to another EU member state, there is a possibility that pharmaceutical companies consider transferring their R&D team.

Logistics: It is expected that the trade between the EU and the UK will decrease due to the delay in complex supply chains, cost increase, increased operational burden and new trade barriers. Restoring customs between the UK and EU may lead to a longer lead time. In case customs on raw materials, parts and finished goods between the EU and the UK are restored, shipping companies (the owners of the goods) will be required to reconsider their supply chains. Further, energy cost rises due to the depreciation of pound. 

Finance: A loss of the passporting could lead to lost opportunities for free financial transactions between the UK and the EU. In addition, a relocation of organizations, departments and employees who are responsible for euro denomination settlement might become necessary, if the settlement function of the euro is transferred from London to another EU country.

Currently, export of financial services from the UK to the EU accounts for about 40% of the total trade. However, a change of the business model might be necessary to sell financial products freely, if it becomes difficult for highly skilled employees to work in the UK and the EU without restrictions. Furthermore, other questions might arise depending on future negotiations between the UK and the EU, such as location of the headquarters, necessity of establishment of a management company, and review of the current organization from the perspective of compliance with EU directives and regulations concerned with the financial industry.

It is difficult to prepare all the UK laws to take the place of EU laws which will not be applied anymore, because EU laws (treaties, regulations, directives, etc.) are incorporated into the UK laws very deeply. It cannot be denied that there could be a legally blank area immediately after the Brexit. There is also a possibility that requirements for regulatory authorizations and the required time for approvals may be affected.

There are uncertainties about the implementation of scheduled regulatory changes in Europe. For example, it is unclear if asset management companies and banks in the UK will be required to comply with MiFID II after the Brexit.

In the bank and capital markets, there is concern that the economic downturn will further lower interest rates. This has a significant impact not only on major banks, but also on challenger banks (new entrant banks). A decrease in income may lead to pressure on reducing costs.

Electrical machinery, machinery, precision equipment: The UK market was the target of foreign direct investment with an expectation of a "window" function to access the European market. Until the direction of the Brexit becomes clearer, it is expected that these investment decisions may be postponed. With this background, it might be advantageous to companies that have a production base for the European market in the UK to move some of the production bases into the EU. 

Analysis of the economic impact on trade and investment between Japan and EU as well as Japan and the UK 

The UK's economy and trade in the world: The UK is the world's fifth largest economy and has a GDP of $ 290 billion. Looking at UK trade, seven of the top ten trading partners in 2015 were EU member countries. In terms of economic relations between Japan and the UK, both imports and exports are less than 2% of the total.

Impacts on the financial markets and the economy due to Brexit: The value of the pound has continued to decrease against both the US dollar and the euro following the referendum on Brexit and it has impacted the financial market. A weaker pound helps UK exporters, but it also increases the prices of imported goods. According to an OECD analysis regarding the influence of Brexit on the real economy, the influence on the financial market will lead to a decline in demand and trade in the UK and in the EU, and the world economy will go downward. Japan's real GDP growth rate will also decrease by 0.46 percentage points by 2018. Many uncertainties surrounding the Brexit make it difficult to quantify the impact on the economy, but multiple studies show a negative impact for economic activities and households. 

Impacts on UK-EU, Japan-UK and Japan-EU trade: Brexit will affect UK trade through exchange rates. Taking the transportation equipment industry (the automobile industry) as an example, it is highly possible that the Brexit will have a significant impact on exports of automobiles from the UK. The industry has established a divided labour structure within the EU, in which Japanese automobile related companies also take part. Therefore, Brexit will also effect Page 4 of 5 the Japanese automobile industry. Manufacturers based in the UK benefit from the recent rise in domestic demand and full access to the EU single market. As long as the UK is still an EU member country and it helps production in the UK, decline of the pound will have a positive effect in terms of price competitiveness for exports for a short period. On the other hand, the cost increase of imported goods is a negative influence, because the UK auto industry relies heavily on the import of vehicles, parts, components and assembled vehicles.

Many economic benefits (especially in the automotive sector) are expected to be lost by the Brexit for Germany which is the biggest trading country in the EU. German exports are expected to be affected more than imports. Trade dependence on the UK is, however, relatively low in the country that is the EU's largest economy. 

Interview results and suggestions for the Japanese Government 

Based on research of existing studies and desktop research, interviews with 10 Japanese companies were conducted by telephone and email to identify the influence of Brexit on their business and specific company's function as well as planned counter measures. The results are summarized below. 

  • There is still a great uncertainty about the impact of the Brexit. Therefore, there is no company which has implemented concrete measures at this stage.
  • The primary impact recognized from the Brexit is the volatility in the exchange rate.
  • Multiple companies responded that there is a possibility of transferring functions currently located in the UK (manufacturing, consigned manufacturing, R&D etc.) to other EU member countries depending on the results of negotiations between the UK and the EU.
  • The logistics industry is concerned about increased cost and lead time due to tariffs and cabotage rights.
  • There are companies which are concerned about cost increases and a loss of human resources due to the changes in employment conditions of EU citizens in the UK.
  • Expected cost increase other than the ones already mentioned above are additional product testing and approval as well as individual negotiations with the UK authorities in case that rules of product specifications and standards diverge between the UK and the EU.
  • Some companies have started concentrating their business activities to continental Europe before Brexit, but it is accelerated by the Brexit.
  • Some companies listed early conclusion of EPA between Japan and the EU as a request for the Japanese Government.
  • Some companies requested lobbying by the Japanese Government to promote free trade between the UK and the EU. 

Implications for the German states 

Support for increased burden on companies from the Brexit: Each German state (Bundesland) has an economic development agency which offers one-stop support to domestic and foreign companies to enter the state for its business and to invest there. It is not their primary purpose to alleviate increased burdens on companies from the Brexit, but it serves as an entrance point to attract companies.

Subsidies are the center of economic incentives for Japanese companies, and the majority of programs are used by combing programs from the EU, the German Federal Government and each state. These programs consists of subsidies for direct investment, grants for the labor market, and support programs for R&D projects. As a general rule, no state offers special incentives to foreign capital, but its programs are offered equally to domestic and foreign companies. In addition, the public economic development agencies in states such as Nordrhein-Westfalen, Hessen and Bavaria, where many Japanese companies are located, provide services such as advice on business plans, market and industry trends, grants and financing. They also provide information in Japanese on their websites or issue newsletters in Japanese. 

It is also confirmed from interviews with the political parties that there is no tax deduction or subsidies specifically related to Brexit. This type of support must be agreed with the EU and no German state is allowed to implement such support measures independently. Currently, economic development agency such as NRW.INVEST provide “one-stop support” for companies, but they are also expected to provide equal services for all companies regardless the impacts from Brexit. 

Trends in German companies and local foreign companies (China, Korea) 

Based on research of existing studies and desktop research, interviews with 2 German, 1 Chinese and 2 Korean companies were conducted by telephone and email to identify the influence of Brexit on their business as well as planned counter measures. The results are summarized below. 

  • There is still a great uncertainty about the impact of the Brexit. Therefore, there is no company which has implemented concrete measures at this stage.
  • The primary impact recognized from the Brexit is the volatility in the exchange rate.
  • Some companies listed customs clearance procedures as an expected risk for the future.
  • There are companies which take the Brexit as a business opportunity.
  • When the UK leaves the EU, it is necessary to adjust the company’s processes according to the UK’s local conditions. However, there is a company which expressed that flexible response to the Brexit is possible, because this is business as usual in other countries, where such processes to adopt local business environment have already been implemented. 

A short Japanese summary of the presentation of this study can be found on the Homepage of the Embassy of Japan in Germany at http://www.de.emb-japan.go.jp/nihongo/info/bunka-osirase/Brexit%20Seminar_BLN12.pdf.

© Thomas Picard, freeimages © Thomas Picard, freeimages

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