The Situation: The United States, Canada, and Mexico recently reached an agreement in principle to revise and replace the North American Free Trade Agreement ("NAFTA") with the United States-Mexico-Canada Agreement ("USMCA").
The Result: While the USMCA maintains the status quo in many respects, certain key changes could significantly impact companies trading in the North American market. For example, the trade pact could create new industry-specific obligations that present unique challenges for businesses seeking to avoid tariffs and effectively operate in this new terrain.
Looking Ahead: Companies should evaluate their rights and obligations under the USMCA and adopt proper modifications to their supply chain logistics to adapt to the new rules.
On September 30, 2018, the United States, Mexico, and Canada agreed to the USMCA following months of negotiations. Although the parties each signed the agreement on November 30, 2018, the USMCA will not take effect until the signatories complete their respective domestic implementation requirements, a process that may not be complete until mid- to late 2019 or even 2020.
SOLIDIFYING THE DEAL
The United States and Mexico entered into bilateral negotiations shortly after the Trump administration announced its intent to renegotiate NAFTA in May 2018. On August 27, 2018, the United States and Mexico reached a preliminary agreement. After initial reluctance to renegotiate the regional trade agreement, Canada ultimately acquiesced and joined the negotiations. Approximately one month later, the three countries announced an agreement in principle to adopt the USMCA in place of NAFTA and released the full text of the revised agreement.
Before the USMCA can take effect, the parties must implement it through their respective legislative processes. The signing of the deal on November 30, 2018 coincided with the end of Mexican President Enrique Peña Nieto's term and complied with the United States' minimum public notice requirement of 60 days under the current Trade Promotional Authority ("TPA"). The Trump administration now has 60 days to submit a memorandum to Congress detailing what changes to existing law would be required to implement the USMCA's provisions. The TPA also requires that the Trump administration submit a final text of the agreement and a draft statement detailing any administrative action proposed to implement the trade pact at least 30 days before a bill seeking to enact the USMCA into law is formally introduced.
Because of these and other procedural requirements, Congress is not expected to approve the USMCA until 2019. While the outcome of the United States' 2018 midterm elections may impact whether Congress will be able to implement the USMCA as currently constructed, the Trump administration has yet to publically announce any coming alterations to the agreement or appeals for bipartisan support.
The USMCA will enter into force on the first day of the third month after it is approved by all three countries. With this in mind, depending on how long the parallel approval processes take in Canada and Mexico, the USMCA may not enter into force until 2020.
SUMMARY OF NOTABLE CHANGES
Country of Origin: An Emphasis on Supply Chain Localization for Automobiles
The USMCA would impose more stringent origination requirements for automakers seeking to avoid tariffs on their products. To obtain a certificate of origin, automakers must verify that the content percentage of the vehicle produced in North America satisfies a specified content ("Regional Content Value" or "RCV") and that a certain percentage of the labor involved in producing the car is compensated at or above a threshold rate, currently the equivalent of $16.00 ("Labor Content Value" or "LCV"). The LCV requirement is a new feature of the USMCA.
Light Vehicles. Automobiles qualifying as "light vehicles," such as passenger vehicles and light trucks, must have a RCV of 75 percent and LCV of 40 percent under the net cost method. This represents a significant upward departure from NAFTA origination requirements, which imposed a more modest 62.5 percent RCV and no LCV threshold. Moreover, 70 percent of steel and aluminum and all "essential" auto parts used in the light vehicle assembly must originate from North America. Currently, the engine, transmission, body and chassis, axle, suspension, steering system, and advanced battery are classified as "essential." RCV and LCV requirements for light vehicles are subject to increases in four increments throughout the initial 16-year term of the USMCA.
Heavy Vehicles. "Heavy vehicles" must also satisfy the 70 percent steel and aluminum origination requirement to qualify for duty-free treatment and must have an accompanying RCV of 70 percent and LCV of 45 percent. The USMCA groups auto part components for heavy vehicles into three principal categories: essential, main, and complementary. The RCV requirements for these parts are set at either 70 percent, 60 percent, or 65 percent depending on the part and are subject to increases in seven increments throughout the initial 16-year span of the USMCA.
The three member states also reached numerous side agreements, the net effect of which provides an initial 60-day guarantee that the United States will not impose tariffs on Canadian or Mexican vehicles or auto parts under Section 232 of the Trade Expansion Act of 1962. Additionally, the side agreements effectively exempt Canada from approximately 2.6 million cars and $32.4 billion worth of auto parts and exempt Mexico from tariffs on $108 billion worth of exported parts should the United States subsequently seek to impose such tariffs under Section 232 for national security reasons. Given that Canada annually exports 1.8 million vehicles to the United States, these exemptions would effectively insulate approximately 18 months' worth of Canada's auto exports to the United States from such duties after the USMCA becomes effective.
As our colleagues previously explained in more detail, the USMCA sharply curtails the procedure that enables Canadian, Mexican, and U.S. investors to bring arbitration against the Canadian, Mexican, and U.S. governments for violations of guarantees of national treatment, most-favored-nation treatment, the minimum standard of treatment, and protection against unlawful expropriation. The USMCA also would eliminate investor-state dispute settlement involving Canada or Canadian investors altogether, forcing U.S. and Canadian investors with investments in the respective host state to seek relief in that state's domestic courts, whereas Canadian or Mexican investors with investments in the respective host state can soon seek relief under the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, which is set to enter into force on December 30, 2018.
Access to the Canadian Dairy Market
The USMCA effectively eliminates certain aspects of Canada's milk class pricing system for certain milk ingredients. As a result, American milk producers would be able to supply approximately 3.6 percent of Canada's roughly $16 billion annual domestic dairy market. This represents an upward departure from the existing one percent market access that American firms currently have under NAFTA. Moreover, if Canada's total exports surpass certain thresholds, Canada would be required to impose export duties on milk protein concentrates and skim milk powder.
The USMCA contains a 16-year sunset clause pursuant to which the agreement will automatically terminate unless the parties all agree to extend for another 16 years. The deal also provides for a periodic review every six years, at which point the parties can decide to extend the trade pact.
The USMCA provides extensive intellectual property protections, including: (i) increasing patent protection for biologic drugs in Canada and Mexico from eight to 10 years; and (ii) imposing a minimum copyright term of life for the author plus 70 years (which is an increase of 20 years from NAFTA).
The USMCA imposes requirements regarding currency manipulation. For example, under the USMCA, the parties would be required to "achieve and maintain a market-determined exchange rate regime" and to "refrain from competitive devaluation," although activities by the parties' "exchange rate or fiscal or monetary authority" are exempted.
The USMCA includes provisions that potentially could reduce Canada's access to certain U.S. government procurement projects.
Rules of Origin
Other provisions of the USMCA impact rules of origin related to chemical products, televisions and electronic products, arabic gum, and products incorporating fiber optics, titanium, and steel.
Three Key Takeaways
- The USMCA would, among other things, limit the viability of arbitration as a form of alternative dispute resolution, enhance access to foreign markets for certain industries, and create new industry-specific obligations that present unique challenges for businesses seeking to avoid tariffs and to effectively operate in this new terrain.
- Companies should consider adopting strategic modifications to their supply chain logistics to capitalize on increased industry access to foreign markets for certain industries and products.
- The current version of the USMCA is not the final word. Contentious disagreement may produce further modifications during the approval process, so interested parties must continue to be diligent as the process moves forward.