UK's post-Brexit plan puts trade deal with the EU — and the U.S. — at risk

Key Points

• The U.K. government outlined on Wednesday how it plans to manage trade following its full breakup from the EU at the end of the year.
• The announcements have raised tensions within the U.K. and risk ending trade talks with the EU.
• Nancy Pelosi, the speaker of the House, said that if the U.K. violates its international agreements, "there will be absolutely no chance of a U.S.-U.K. trade agreement passing the Congress."

It looks increasingly unlikely that the U.K. will reach a trade agreement with the European Union — and that could also harm the chances of a future deal with the United States.

The U.K. government outlined on Wednesday how it plans to manage trade following its full breakup from the EU at the end of the year with two significant announcements.

Firstly, it proposed legislation, called the Internal Market Bill, which gives the U.K. government stronger powers over trade rules in Scotland, Wales and Northern Ireland -  something lawmakers in these countries have issue with.

Secondly, the government said the U.K. would not follow EU rules for state aid — a key stumbling block in the negotiations with Europe to date. Instead, it will apply state aid rules agreed at the World Trade Organization level, which are less strict.  

"It's a recipe for disaster," Paolo Palmigiano, head of the U.K. competition, EU and trade practice at the law firm Taylor Wessing, told CNBC.

The proposed legislation has to be approved by the U.K. Parliament before becoming law.

However, it raises questions about the U.K.'s ability to apply a WTO framework — which is meant to solve trade issues between two different nations — to its unique four-nation formation. In addition, the publication of the Internal Market Bill puts ongoing trade talks with the European Union at risk.

Ursula von der Leyen, European Commission president, said on Wednesday that she was "very concerned about the announcement from the British government."

Why does the EU care? 

To leave the European Union, the U.K. government put into law the Withdrawal Agreement in January. Its implementation is a precondition for the EU to sign any trade deal with the U.K. government.

In the Withdrawal Agreement, the U.K. agreed that state aid given by the U.K. government above a certain threshold that would impact trade between Northern Ireland and the rest of the EU would have to be approved by the European Commission.

Under the latest government bill, the U.K. government is overriding that part of the Withdrawal Agreement by giving its ministers the power to "disapply" that specific law concerning state aid.

"The Bill is in breach of this obligation," Palmigiano said.

As a result, law experts, politicians and even a member of the U.K. government have said that the Internal Market Bill, if approved by U.K. lawmakers, would break international law.

This is where the United States would have an issue too.

Why does the U.S. care?

Nancy Pelosi, the speaker of the House and a vocal Democrat lawmaker, said Wednesday that if the U.K. violates its international agreements, "there will be absolutely no chance of a U.S.-U.K. trade agreement passing the Congress."

The U.K. government could put its international credibility at risk if it indeed overrides parts of its already-legislated exit agreement with the EU.

Negotiating tactic?

European and U.K. officials are having emergency talks Thursday, however, some analysts have updated their forecasts in the last 48 hours and are now expecting a total rupture in trade negotiations between the EU and the U.K.

"We now think no deal is the most likely outcome at the end of the year, a 60% probability," analysts at consulting firm Eurasia Group said Wednesday.

Former European Commission President Jean-Claude Juncker said Tuesday that no deal was the most likely outcome too.

Others believe the legal changes are "negotiating tactics" from the U.K. government to get concessions in the trade negotiations with the EU.

Both sides have said they have only until mid-October to agree on new trade rules.

The U.K. is currently in a transition phase after it stopped being a member of the EU in January, but this will expire on Dec. 31.