1. (SBU) On July 7, EU Enlargement Commissioner Gunter
Verheugen presented the Commission's plan fulfill the EU's
pledge to end the isolation of the Turkish Cypriot community
following their support for the Annan Plan. The two main
proposals are: 1) a new "preferential trade regime" allowing
direct trade between northern Cyprus and EU Member States,
including the rest of Cyprus; and 2) an EU aid package of 259
million euros to be spent in the North and dedicated
primarily to infrastructure development and alignment with EU
legislation and policies. Verheugen emphasized the political
significance of the package, and acknowledged that the EU has
a special obligation to Turkish Cyprus following its approval
of the UN reunification plan, which was rejected by the
South. In discussions with us, Commission officials have
said this package represents all that the Commission can do
for the north.



2. (U) Summary (continued): The aid package should win
unanimous Council backing, although the means of delivering
the aid has still to be sorted out. The trade package is
more controversial, as Commissioner Verheugen is attempting
to use a qualified majority vote (QMV) procedure which
neutralizes the influence of Cyprus and Greece on the
package. For this reason the trade proposals are already
facing stiff opposition from the Greek Cypriots and from
Greece itself, who argue, despite Verheugen's assurances to
the contrary, that direct trade with the North will entail
the tacit recognition of Turkish authorities. Nicosia has
indicated considerable dissatisfaction with Verheugen's
QMV-based approach, and has expressed its determination to
oppose the trade proposals in the European Court of Justice
(ECJ). END SUMMARY.

PREFERENTIAL TRADE REGIME


--------------------------





3. (U) The Commission's proposal would establish direct
trade between Turkish Cyprus and the EU under a preferential
regime. The Commission says that this "should take the form
of a tariff quota system." Goods originating in Northern
Cyprus would have to be labeled as such, and measures would
be in place to prevent what the Commission calls "artificial
trade patterns" (i.e., transshipped goods from Turkey).
Responsibility for this and for regulating exports in general
would rest with the Turkish Cypriot Chamber of Commerce.
Additionally, the Commission proposal sets rules on taxation,
food and product safety, inspections, and communication
obligations, which the Turkish Cypriots would have to abide
by. Finally, the Commission would allow ports of Northern
Cyprus, for the first time since 1974, to reopen to
commercial traffic with the EU.

SUBSTANTIAL AID PACKAGE


--------------------------





4. (SBU) The Commission has proposed a total package of 259
million euros for 2004-2006, and the Council has previously
approved this figure. The Commission says the money will be
directed towards aligning Turkish areas with EU regulations
and law, programs to improve contacts between the North and
the South, social and economic developments, and
infrastructure improvements. Verheugen singled out water
treatment, tourism, agriculture, and small and medium sized
enterprises as special areas of interest.

APPROVAL LIKELY, BUT IT'S NEVER EASY


--------------------------





5. (SBU) The Council is likely to approve the Commission's
aid package, and the money should begin flowing into northern
Cyprus in the near future. The idea of providing aid is
accepted by all in principle. The real question is the
degree to which Nicosia will seek to influence allocation
decisions and methods. Notably, Verheugen said the Commission
had not decided which delivery mechanism to use. This is
significant because the method of distribution promises to be
a source of debate in the Council, as it was last time the
Commission's aid proposal was discussed (REF A). The
Commission wants to be able to disburse the funds independent
of the Cyprus government in Nicosia, while the latter wants a
hand in deciding how the money will be spent. Whether or not
the EU will open a liaison office in the North remains an
open question. A member of Commissioner Patten's cabinet
told us that the two most serious options under consideration
are either an "ad hoc" agency with an office in northern
Cyprus, or administering the aid via the European Agency for
Reconstruction based in Thessaloniki, which currently runs
Commission aid programs for Kosovo, Serbia and Montenegro,
and Macedonia. Cyprus is concerned that a EU liaison office
would imply tacit recognition of the Turkish Cypriot
authorities. While the Council (and therefore the Cypriot
government) will have a say in this decision, the Commission
expects to be able to implement whichever course it chooses.



6. (SBU) The Commission's trade proposal is even more
controversial. Verheugen's decision to use Article 133 of
the EU's treaties as the "legal basis" for the package --
which specifies that trade agreements with non-EU states are
to be approved by qualified majority voting in the Council --
means that the measures should be easily passed in Council.
But it is a highly contentious approach for Cyprus and
Greece, who argue that Article 133 cannot be used for a
territory that is legally part of the EU. The Greek Cypriots
have voiced their determination to challenge the Commission
at the ECJ; and it is by no means certain that the Commission
's proposed regulation would survive the court challenge.
Our Commission contact pointed out, however, that the new
trade arrangement should remain in effect while an ECJ ruling
is pending, and the ECJ "generally takes years to decide
cases." He also noted that Greek Cypriot motivations for
their legal arguments about the applicability of Article 133
are transparent, since Nicosia would almost certainly block
the trade package under a consensus procedure, unless the key
element -- the opening of direct trade between the north and
the rest of the EU -- were withdrawn.

IMPACT ON TURKISH CANDIDACY


--------------------------





7. (C) Our Commission contact noted that there was now
overwhelming pessimism within the EU regarding the prospects
for progress toward a Cyprus settlement prior to the EU
Summit's decision in Decemeber on whether to open accession
negotiations with Turkey. But he did not expect a continued
divison of Cyprus to be an obstacle to a favorable decision,
for all but Nicosia. (NOTE: As Ref B explains, a settlement
on Cyprus is a distinct issue from whether Turkey is treating
the Republic of Cyprus, a full EU member, in a
non-discriminatory manner. On that question, we agree with
Embassy Nicosia's assessment that Nicosia's legal arguments
enjoy broad EU support. End Note.) While he noted that
Greek PM Karamanlis had "not been doing much to stand up to"
the Greek Cypriots, Athens was expected to be generally
supportive of Turkey's candidacy. But there was far less
certainty about what Cypriot President Papadopoulos might do.
Most worrisome to him was that it appeared there would be no
domestic political price for Papadopoulos to pay if he
blocked Turkey solely on the basis of a lack of a
reunification agreement for the island. It would lead to the
risk of a Cypriot government isolated within the EU, but
stronger at home.

COMMENT


--------------------------





8. (SBU) From our discussions with EU officials and the
press reports coming out of Brussels, it is clear that the
Cyprus government's intransigence over the Commission
proposals continues to raise hackles in the Commission.
While Turkish Cypriot authorities continue to benefit from
post-referendum good will in Brussels, the reality of EU
institutional functioning limits the ability of the
Commission to play a strong hand in attempting to reward them
for their yes vote on the Annan plan. The Commission is
hoping to proceed as quickly as possible to improve economic
conditions for the people of the north, despite fierce
resistance from Nicosia. But the Commission is probably at
the limit of what it will be able to do. It may even prove
to be beyond that limit; while Verheugen's effort to channel
trade through QMV is clever strategy, it is not clear that it
will in the end be able to survive a challenge at the ECJ.

MCKINLEY