This is the first of a three-part series examining what could happen to British and Japanese companies affected by Brexit.

As prospects of a no-deal Brexit persist, British companies are coming under more pressure than ever to develop a footprint in markets outside of the European Union.

In many ways, Japan is an obvious destination, considering the sheer size of its economy and the depth of historical ties — British industrialists played a key role in the overhaul of Japan’s economic base during the Meiji Era (1868-1912). Specifically, the country boasts mature, affluent consumers who demand high-quality goods, and manufacturers in need of the kinds of advanced components and machinery that British manufacturers specialize in.

In spite of all this, Japan has lagged behind as a destination for U.K. exports.

While the U.S. and China are Britain’s largest and sixth-largest export markets for goods and services, Japan ranked a distant 11th in 2017, according to the U.K.’s Office for National Statistics (ONS).

As such, there is a sense in the British business community that there are still many more deal-making opportunities to be clinched in Japan.

“It’s a big market, but the U.K. could certainly be doing better,” said Guy Dru Drury, the chief representative to Northeast Asia for the Confederation of British Industry, the U.K.’s largest business lobby group.

Companies with a presence in the market include titans of British business such as drugmaker GlaxoSmithKline PLC and professional services firm EY, as well as smaller companies that have inked deals selling everything from luxury soap to solar panels. And Jonathon Jones, managing director at Tregothnan, the operator of a tea estate and Department for International Trade (DIT) “export champion” that has signed deals with Japanese department stores, describes the market, even one as far flung as Japan, as a “huge opportunity” for small firms.

British manufacturers, meanwhile, supply everything from computer chips to high-definition speakers and cooling systems to Japanese buyers, and in the automotive sector components such as batteries and exhaust pipes represent key exports — machinery and transport equipment trade totaled just under £3 billion in 2017.

In recent years — especially since the 2016 Brexit referendum — London has sought to boost U.K.-Japan trade. The DIT has assigned officials to work with exporters, and the British Embassy in Tokyo regularly hosts trade delegations and offers support for emerging areas such as fintech, renewable energy, life sciences and cybersecurity by providing advice on the Japanese market and hosting events to help put British companies in touch with potential customers and investors.

“There’s quite an obvious role for us to always be at the cutting edge of new businesses coming through, so we do tend to focus on smaller companies,” said Chris Heffer, director of trade and investment at the British Embassy. “What (big businesses) tend to need from us is not market entry advice, but more general support with new sections of their businesses.”

Efforts to showcase Britain have been given a further boost by the U.K. in Japan 2019-20 initiative, a yearlong program run by the embassy and the British Council educational and cultural organization, based around the theme of “partnership” incorporating cultural events and “Great Weeks” — effectively trade missions — with topics such as “healthy aging,” “clean growth” and “future mobility.”

These form part of the U.K.’s high-profile “Great” campaign to raise awareness of British business globally. Last month, finance minister Sajid Javid announced that the campaign will be extended with another £60 million.

Other work has been geared toward lifting more specific barriers to trade, with the U.K. actively lobbying for the lifting of Japan’s ban on British beef and lamb, in place since 1996 following an outbreak of mad cow disease. The ban was lifted in January this year.

Overshadowing this work by government and business, however, is the prospect of a no-deal Brexit.

If the worst-case scenario materializes, the U.K. would trade under World Trade Organization tariffs and see a loss of regulatory alignment with the EU.

That remains the U.K.’s current trajectory in spite of parliamentary efforts to reduce the chance of this outcome, as the fate of an extension beyond the current leave date of Oct. 31 is in the hands of other EU member countries, and a potential Brexit deal remains up in the air. British Prime Minister Boris Johnson is also reportedly looking at ways to bypass recently passed legislation that requires him to ask for such an extension at this week’s EU Council meeting.

Global markets have been petrified by such an outcome, as it would be highly disruptive to manufacturers, farmers and others. Businesses would see higher tariffs when selling to the EU and markets the bloc has trade deals with, while goods entering the EU would see increased checks and regulated services face losing access to the single market. Moreover, impacts at home could have a knock-on effect on trade with countries such as Japan.

British trade minister Liz Truss and Foreign Minister Toshimitsu Motegi last month exchanged letters ensuring the mutual recognition of regulatory checks in the event of a no-deal Brexit. Areas covered would be electrical goods, chemicals, telecoms equipment and medicines— the last category being particularly important as medicinal and pharmaceutical products were the U.K.’s third-largest goods exports to Japan last year.

“That was quite a big one for pharmaceutical companies, that was quite an important component of what they were asking us to do,” Heffer said.

Some British companies exporting to Japan said they expect to see no or little impact from a no-deal Brexit. Some even say they are more focused on the perceived opportunities it brings, in particular the U.K.’s ability to strike new trade deals, something Brexit supporters say can be done faster and in a manner better suited to Britain’s interests than it currently is through the EU.

“I’ve been through a whole range of emotions on this … I used to be really nervous,” said Jones, the managing director at Tregothnan. “I respect there are risks, but I’ve come to the conclusion that dithering is the most dangerous thing. And I am now of the mind that we should just get out and really celebrate the fact that we’re an independent, free trading nation.”

In a Japan context, other areas less likely to be directly impacted from a no-deal Brexit include nonregulated services, such as creative industries, and businesses that have non-EU supply chains, meaning these sectors can continue to trade with Japan more or less as they have been.

While much of the debate has focused around the impact of Brexit on goods, with predictions of trucks backed up at ports and potential shortages of food and medicine dominating the news, the ability of services firms, which generate about 80 percent of the U.K.’s GDP, to trade with non-EU nations will be crucial to the country’s economic fortunes post-Brexit.

In 2017, the U.K. exported about £7 billion worth of services to Japan, a 3 percent increase from the year before and constituting a little over half of total exports, according to the ONS.

“One of the myths you’ll hear around international trade agreements is the importance of services in (free trade agreements),” said Tim Sarson, a partner at KPMG and the tax and location lead in the firm’s Brexit team.

“Generally speaking, the only area where free trade agreements are relevant for services is where you’re talking about access to the European and single market or regulatory alignment, so that’s only really relevant to regulated services.

“I wouldn’t see a huge amount of disruption to a lot of the service industry.”

But for all the impetus that Brexit provides in seeking out a greater presence in the Japanese market, the act of leaving the EU throws up some trade barriers to that very endeavor — something made all the more acute by the prospect of a no deal.

As British businesses are in the middle of global supply chains, a no-deal Brexit would severely impact manufacturers, particularly those reliant on “just in time” processes, with a knock-on effect on warehousing and related costs.

Other goods needed by firms could also become more expensive due to the introduction of tariffs, thereby affecting competitiveness in the Japanese market — casks for Scotch whisky, for example, are typically sourced from outside the U.K. — although the government has set out temporary tariffs in the event of a no deal that would slash them for many products.

All of this would entail potentially heavy restructuring of operations by British businesses.

“That implies a very significant cost and potentially job losses for people in those firms in the U.K.,” said Seamus Nevin, chief economist at Make UK, which represents engineering and manufacturing firms. “And it means less trade being done, which means overall our economy will be smaller and poorer as a result.”

In addition, the loss of EU-Japan EPA — a major trade deal that came into effect on Feb. 1 that, among others things, slashed tariffs and opened up sectors such as telecommunications, financial services and transport — could see British farmers, manufacturers and other businesses be gradually displaced by European competitors, with Japanese buyers preferring to take advantage of the benefits the trade deal offers.

Preparations for a potential no deal are also acting as a drag for many firms that are now having to ready themselves for a regulatory environment that would be completely different from the one they’ve been used to. That, in turn, affects their capacity to secure the new business that will be essential post-Brexit — “It’s paperwork behind the scenes rather than going out making deals with new partners to sell and buy goods,” as Nevin puts it.

In addition, continued uncertainty over the nature of Brexit dims both orders and investment. In the six weeks before the U.K.’s original leave date of March 29 — the time it takes to ship goods to Japan — Japanese companies stopped doing business with U.K. producers, according to Nevin.

“There’s a tendency … not to make big decisions at the moment, and I think that can then have a knock-on impact for foreign direct investment in other parts of the world, because everyone’s feeling quite risk averse,” said Sarson.

Brexit’s impact on the pound’s exchange rate also weighs on the prospects of firms looking to Japan, with the currency diving as the referendum result became clear, a fall it has not recovered from. It slumped again earlier this year after Johnson outlined his plans to suspend Parliament.

While that has been a boon for the likes of SoftBank Group Corp., which snapped up chip designer ARM in the aftermath of the 2016 referendum for £24.3 billion, it makes expansion tougher in the other direction.

“If you’re a U.K. group that’s investing outside the U.K., particularly in countries with strong currencies like Japan, then everything is rather expensive, which is great once you have assets because it means that the quality of your earnings is higher in sterling terms, but actually getting hold of those assets in the first place, you’re at a disadvantage compared to say a U.S. competitor,” said Sarson.

Given the dislocations to business that many companies face as a result of Brexit, the question arises as to what extent trade with Japan could offset a reduction of business with the EU, particularly in a no-deal scenario. Although Japan is by no means expected to completely shoulder that burden, the scale of the task is indicated by the fact that goods trade with EU members totaled £164 billion in 2017, dwarfing the figure of £6.36 billion for Japan.

Also illustrating the challenge is a report issued in November last year by the British government that showed the U.K. would be poorer in the long run under all Brexit scenarios modeled.

For companies already conducting most of their business with non-EU markets, that is not so much of a concern. But for those that don’t, such as Britain’s sheep farmers, Japan offers very little in terms of compensation — the country exports about £389 million worth of sheep meat to the EU each year, according to the NFU, while only about £10 million per year is projected to be exported to Japan.

Securing high-quality trade deals, then, is imperative for the U.K. That is particularly true for British businesses in Japan given their loss of coverage by the EU-Japan EPA, and experts consistently cited losing that coverage as one of the main downsides of a no-deal Brexit in a Japan context.

“That is going to absolutely be a hit across the bows,” said the CBI’s Dru Drury.

In a time of both misinformation and too much information, quality journalism is more crucial than ever.
By subscribing, you can help us get the story right.