US-Mexico-Canada Trade Deal Draws Scrutiny as Partners Prep for Signature, Ratification Processes

4 October 2018

Canada, Mexico, and the United States have clinched a deal to revise and replace the North American Free Trade Agreement (NAFTA), the trade accord that has governed regional cross-border commerce since 1994. The updated accord has been rebranded as the US-Mexico-Canada Agreement (USMCA) and will need to be signed and ratified to enter into force, a process that will last through at least early 2019.

News that Canada and the United States had reached a deal broke on Sunday 30 September, just before that day’s deadline for the US and Mexico to release the text of a preliminary accord that they had reached among themselves in late August. Washington and Mexico City had spent much of July and August negotiating between themselves on key issues of shared bilateral interest, with Ottawa and Washington then resuming bilateral talks thereafter. (See Bridges Weekly, 13 September 2018)

Leaders from the three countries are now aiming to sign the deal by the end of November, before Mexican President Enrique Peña Nieto’s term in office ends. Ratification is not expected before 2019 at the earliest, due to domestic legislative requirements in the countries involved.

For example, the US Trade Promotion Authority (TPA) legislation sets a minimum 60-day period where a proposed trade agreement text must be made publicly available online at the USTR site before signature is permitted. That sets the signature date at 30 November at the earliest, after the US midterm elections but before the swearing in of a new Congress, which would take place in late January 2019. Meanwhile, the accord will also need to undergo a legal scrub and authentication in the three agreed languages, specifically English, Spanish, and French.

“USMCA will give our workers, farmers, ranchers, and businesses a high-standard trade agreement that will result in freer markets, fairer trade, and robust economic growth in our region. It will strengthen the middle class, and create good, well-paying jobs and new opportunities for the nearly half billion people who call North America home,” read a joint statement from US Trade Representative (USTR) Robert Lighthizer and Canadian Foreign Affairs Minister Chrystia Freeland.

The USMCA text has 34 chapters, covering various aspects of goods and services trade, investment, public procurement, environment and labour, digital trade and telecommunications, intellectual property, competition policy, small and medium-sized enterprises, anti-corruption, macroeconomic policies and exchange rate matters, dispute settlement, and good regulatory practices, among others.

“It is a great deal for all three countries, solves the many deficiencies and mistakes in NAFTA, greatly opens markets to our Farmers and Manufacturers, reduces Trade Barriers to the U.S. and will bring all three Great Nations together in competition with the rest of the world. The USMCA is a historic transaction!” said US President Donald Trump in a multi-part post on Twitter issued on Monday 1 October.

The deal’s future, however, will depend on whether lawmakers in the countries involved view the text’s final outcomes favourably, particularly given its significance for regional trade. Analysts, private sector actors, and civil society representatives are poring through the text to determine how much the USMCA has changed from the original NAFTA, along with predicting how it will affect trade flows, working conditions, the environment, and supply chains across North America.

Automobiles: rules of origin details explained

The USMCA text released on Sunday shows the various compromises reached among negotiators on a host of challenging issues, including automobile rules of origin and agricultural market access. Some details on the former had already emerged when the US and Mexico announced their bilateral agreement in August.

Chapter 4 of the USMCA deals with rules of origin, including the highly contentious subject of product-specific rules for automotive trade, which according to a 2017 report from the US Congressional Research Service is responsible for one-fifth of the US’ goods trade with its North American partners.

The USMCA outlines in an appendix to Annex 4-B how regional value content will be calculated for these products, along with what threshold automotive vehicles and parts must surpass to benefit from preferential treatment.

For example, passenger vehicles and light trucks will face a progressively increasing requirement for regional value content, starting at 66 percent from when USMCA takes effect or from January 2020, depending on which date comes last. It will increase annually by three percentage point increments, ultimately finishing at 75 percent in January 2023 or three years from when USMCA takes effect. These percentages will be calculated via a “net cost method.” This marks an increase from the 62.5 percent threshold in the original accord.

Heavy trucks, meanwhile, will face a progressively increasing requirement for regional value content that begins at 60 percent, rising to 64 percent and finally to 70 percent. The timeframe for these changes is from 2020 to 2027, unless the deal is ratified later than expected, in which case it would apply progressively from the deal’s entry into force and hit the maximum level after seven years.

Automotive parts for such vehicles will also face a progressively increasing requirement for regional value content over the same timeframe. These levels vary depending on which type of automotive part is involved, and whether the “net cost” or “transaction value” methods are used. Regional value content can be determined either by subtracting the product’s net cost or its transaction value, and then dividing the difference by that same number and multiplying by 100.

Other conditions include requiring that 70 percent of the steel and aluminium used in the product be purchased from North America, as well as setting rules on “labour value content” such that a set percentage of the passenger vehicle or truck is made using “high-wage” material, manufacturing, technology, and assembly expenditures. This percentage increases progressively from an initial 30 percent overall for passenger vehicles to 40 percent, while it is set at 30 percent for trucks. A high wage, in this context, is considered US$16 per hour.

USMCA: Dispute settlement changes

The original NAFTA covers the subject of dispute settlement in three different areas: trade remedies, investment, and state-to-state cases.

The fate of these three types of dispute settlement had been among the more challenging negotiating issues to address. The US had argued for eliminating the dispute settlement mechanism for trade remedies, codified in the original NAFTA under Chapter 19.

The USMCA chapter on trade remedies, now known as Chapter 10, keeps trade remedy dispute settlement in place, despite an earlier US proposal to eliminate the system, which Canada had pushed back against. This dispute settlement system is now outlined under Chapter 10 Section D: “Review and Dispute Settlement in Antidumping and Countervailing Duty Matters Between the United States and Canada.”

State-to-state dispute settlement is featured in USMCA Chapter 31. A key question for state-to-state dispute settlement had been whether negotiators would address a weakness in the original NAFTA dispute settlement terms that had limited the actual use of that chapter.

Under NAFTA, panellists for possible use in adjudicating disputes were named to a “roster” for an initial three years, with their terms then expiring unless NAFTA parties agreed to reappoint them. Any party to a dispute could also file a “peremptory challenge” to a proposed panellist who is not on the roster. According to an analysis published by  trade law experts Simon Lester, Inu Manak, and Andrej Arpas earlier this year, the NAFTA system provides a loophole for a responding party to effectively block a panel from being composed when there is no active roster of panellists. According to the same experts, in practice, the  roster’s status has been unclear, specifically regarding whether it is at its 30-person full capacity and whether parties have actively established a new roster after an old one lapsed. No panel has been composed since 2000.

Under the USMCA terms, the chosen panellists on the initial roster must still be approved by consensus and stay in place for an initial three years, as do their replacements. However, their term can last longer should USMCA parties need more time to set up a new panellists’ roster – in other words, constituting a continuation of the original term rather than a reappointment.

The USMCA text also limits the scope of investor-state disputes, allowing them only in select situations involving the US and Mexico, though an annex on “legacy investments” would apply to all three USMCA parties. This “legacy” situation refers to those investments made while the original NAFTA was in effect, with the relevant annex outlining how arbitration would work for disputes regarding such investments. The consent to arbitration by the three parties under this annex, however, “shall expire three years after the termination of NAFTA 1994.” USMCA deals with investment under Chapter 14.

An annex on Mexico-US investment disputes related to covered government contracts sets out five sectors that would be covered in those specific cases, namely infrastructure, telecoms, power generation, transport, and oil and gas processes ranging from exploration to sale.

Environment, labour chapters included

The original NAFTA did not have dedicated chapters for environment and labour issues. Instead, the three parties put in place side deals known as “cooperation agreements” to deal with these subject areas, known as the North American Agreement on Environmental Cooperation (NAAEC) and the North American Agreement on Labour Cooperation (NAALC).

Both side agreements set out a series of cooperation activities, along with outlining how consultations and disputes will proceed in cases where a party has allegedly not enforced its trade-related domestic environmental or labour laws, respectively. The NAAEC and NAALC also envision the possibility of imposing “monetary enforcement assessment” in cases where the respondent has not resolved the issue following a panel review and establishment of an action plan.

The USMCA brings environment and labour into the overall trade agreement itself, dedicating a full chapter to each subject area. It also envisions using the USMCA’s own dispute settlement mechanism to adjudicate cases, should efforts to resolve disagreements through consultations outlined under the subject-specific chapters fail.

For disagreements that arise under the labour chapter, the USMCA first envisions a process of confidential consultations to resolve the accord, which can be bumped up to ministers’ level at a party’s request. Any agreement reached to address the issue would be made public, unless the parties involved decide not to do so.

Should consultations fail to resolve the matter within 60 days, the complainant can then request a dispute panel to review the case, within the context of USMCA Chapter 31 on state-to-state dispute settlement. Parties can agree to apply a different consultations time limit if they choose. A similar process applies to disagreements arising under the environment chapter, and an environmental dispute can have four layers of consultation processes and the participation of third parties in consultations. In both types of disputes, panellists appointed to serve on those cases must have related expertise in those subject areas. In both types of disputes, panellists appointed to serve on those cases must have related expertise in those subject areas.

In terms of substantive provisions, the USMCA environment chapter covers the enforcement of domestic environmental laws and the promotion of public awareness on these; recognition and affirmation of multilateral environmental agreements that USMCA members may be involved in; ozone layer protection; marine litter and the reduction of marine pollution from ships; air quality; biodiversity; various aspects of fisheries policy, including subsidies; and illegal wildlife trade, among other subjects.

Meanwhile, the USMCA labour chapter covers the enforcement of domestic labour laws; forced labour; migrant workers; sex-based discrimination in the workplace; the improvement of public awareness of such laws; and select other subjects.

Some trade analysts have also noted the addition of several footnotes that could provide “greater certainty” in both chapters, especially in relation to the standards of enforcing domestic laws. “This is to respond to the US-Guatemala labour case panel report,” said Kathleen Claussen, an Associate Professor of Law at the University of Miami, in a blog post. She was referring to a labour rights-related dispute between the US and Guatemala that went to arbitration under the Dominican Republic-Central America-United States Free Trade Agreement (CAFTA-DR). That case is the one instance of a labour issue actually being filed under a trade agreement’s dispute settlement mechanism.

The result of that case was “criticised by Democrats and Republicans for having misunderstood some of the key language found in recent US trade agreements, particularly the phrases ‘through a sustained or recurring course of action or inaction’ and ‘in a manner affecting trade between the Parties’,” she added.  (See Bridges Weekly, 6 July 2017)

Currency chapter included, with limited dispute settlement

The USMCA also includes a chapter devoted to “Macroeconomic Policies and Exchange Rate Matters,” specifically Chapter 33. This inclusion is an innovation from the original NAFTA, which did not cover currency.

The chapter sets out a series of shared objectives on exchange rate practices, such as refraining from competitive devaluation of their exchange rates and working to establish and keep in place a “market-determined exchange regime,” among others. It also has each party “[confirm] that it is bound under the Articles of Agreement of the IMF to avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage.” The IMF refers to the International Monetary Fund.

Additionally, the chapter requires the public disclosure of various types of data, relating to exports, imports, foreign exchange reserves, sport and forward foreign exchange market interventions, and capital flows, along with making sure that the IMF Article IV Staff Reports on a particular USMCA country are released, among other agreed information.

It also provides for expedited bilateral consultations at principal representative level for disagreements involving exchange rate practices, transparency, and reporting obligations. Should this process fail to lead to a mutually agreed solution, the parties can ask the IMF to get involved. For the use of the USMCA’s dispute settlement chapter, this is limited only to instances where a USMCA party has allegedly not met the chapter’s transparency and reporting requirements “in a recurring and persistent matter.” Furthermore, the parties involved must have held consultations first on the subject.

Panellists in these cases will have to meet the particular requirement of having “served as a senior official of an exchange rate or fiscal or monetary authority of a party or the International Monetary Fund,” in addition to the requirements set out in the dedicated chapter on settling disputes. The chapter also foresees the possibility of asking the IMF’s input in determining countermeasures, should non-compliance be found.

Cultural exception secured

Chapter 32 on “Exceptions and General Provisions” shows that Canada was able to keep its clause on cultural exception, with Article 32.6 devoted to the subject of “Cultural Industries.” Cultural exception was a feature of the original NAFTA. It is a key ask of Canada’s when negotiating trade deals, given the country’s history of federal and provincial support to those industries, as well as the value the country places on the role of those industries in shoring up the country’s identity.

The provision states that the USMCA “does not apply to a measure adopted or maintained by Canada with respect to a cultural industry, except as specifically provided” in the relevant provisions on national treatment and in the services chapter annex on “simultaneous substitution.” The latter of which deals with the substitution of commercials when broadcasting programmes in Canada that were originally transmitted in the United States.

The provision on cultural industries covers the production, distribution, sale, and in some cases exhibition of books, magazines, periodicals, newspapers, films, video recordings, music recordings, and radiocommunications aimed for viewing by the general public. That article also has related sub-articles on dispute settlement, among other topics.

USMCA renewal terms

The USMCA also outlines how the three countries will take stock of the accord’s ramifications, along with when and how it shall be extended. Whether to include a “sunset clause” or other type of review mechanism was one of the top sticking points in the NAFTA modernisation talks, with the US reportedly pushing for the updated deal to terminate within five years of entry into force unless all parties agreed otherwise.

Ultimately, the final language on this combines a review and sunset mechanism, stretched out over a longer period and with multiple opportunities to consider the deal’s extension. Article 34.7, entitled “Review and Term Extension” and included in the chapter on “Final Provisions,” provides for a regular “joint review” process. This would begin at latest six years after the accord takes effect and involve an examination of the deal’s performance to date. It will also allow countries to say whether they wish to extend the period for the deal’s application, and outlines the timing for subsequent reviews depending partly on that feedback. Under Article 34.7.1, the USMCA will lapse 16 years from taking effect unless all three countries agree otherwise.

Agreements with non-market countries

Separately, the chapter on final exceptions also includes a key provision regarding the negotiation of any free trade agreements with a non-market economy country, as defined by any one USMCA member for the purpose of trade remedy probes, in a move that analysts say may target potential negotiations with countries such as China. Canada, for example, has been weighing whether to launch formal trade talks with Beijing.

The relevant provision requires that a USMCA country wishing to undertake such a negotiation notify and consult with other USMCA parties in advance, along with providing the full agreement text for analysis once completed. Should that trade agreement move forward, the remaining parties would have the right to end the USMCA and move to a bilateral deal among the remaining parties, and to provide six month’s warning in doing so.

Section 232 side letters

The US has also inked side letters with both Canada and Mexico regarding the imposition of Section 232 measures. Section 232 refers to the provisions of the Trade Expansion Act of 1962 that allow for the investigation of whether imports of a good are a threat to US national security, and if so, allows for taking steps to “adjust the imports of an article and its derivatives” accordingly.

For both Canada and Mexico, there are side letters from the US that deal with how Section 232 measures will be applied, stating that should the US move to adopt such measures, it would provide each country with a 60-day window for attempting to “negotiate an appropriate outcome based on industry dynamics and historical trading patterns.” It also recognises that, should the US pursue a Section 232 action in violation of the original NAFTA, the USMCA, or the WTO Agreement, Canada and Mexico “may take a measure of equivalent commercial effect in response.” Furthermore, the side letters recognise that Canada and Mexico will each hold onto their rights to file WTO disputes on such measures.

Additionally, there are also side letters involving the possibility of a US Section 232 measure(s) on automotive trade, in light of an ongoing investigation by the US Commerce Department on the subject. Namely, should the US pursue such measures, it would exempt annually a set quantity of passenger vehicles from Canada and Mexico, with the number set at 2.6 million cars each, along with all light trucks, as well as US$108 billion in auto parts from Mexico and US$32.4 billion “in declared customs value in any calendar year.”

The side letters also envision additional talks to hammer out the details, while clarifying that Canada and Mexico can pursue a dispute under NAFTA or the USMCA, depending on which agreement is being applied at that moment, in cases where the side letter’s above-mentioned exceptions are being applied in practice.

ICTSD reporting.

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