Written by Darrel H. Pearson, Sabrina A. Bandali, Jessica B. Horwitz, Jessica L. Roberts, Margaret M. Kim, and John M. Weekes
After 13 months of negotiations, the United States, Mexico and Canada have concluded the United States-Mexico-Canada Agreement (USMCA). The USMCA is designed to replace the quarter-century-old North American Free Trade Agreement (NAFTA). The new agreement, reached on September 30, 2018, should temper the uncertainty that has hung over access for Canadian goods and services to the U.S. market and improve business confidence in Canada. However, the USMCA will not come into force until it is ratified, which may not occur before early 2019.
Overall, the USMCA maintains the regional integration of the North American market, while providing some greater market access, higher regional content requirements, and mechanisms for inter-governmental cooperation. This update provides an overview of some of the key changes that the USMCA introduces.
Market Access and Regulatory Measures for Agricultural, Food and Beverage Products
The USMCA retains largely the same duty-free market access that exists under the NAFTA, with some notable concessions by Canada for dairy, poultry and eggs. These goods have traditionally been protected in Canada, which was a political focal point for the U.S. even prior to the negotiations.
The concessions that Canada made to increase U.S. access to Canada's dairy market have received considerable attention. Canada agreed to increase its Tariff Rate Quotas (TRQs) for U.S. milk, cream and cheese, meaning more U.S. dairy can enter Canada duty-free. Canadian duties for dairy products outside access to quota range upward to nearly 300%. Canada will grant duty-free access to U.S. dairy products representing approximately 3.6% of Canada's annual market. This is a slightly larger volume of dairy access than Canada granted to the ten Pacific Rim trading partners under the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) agreement.
In a perhaps even more significant move on the dairy front, Canada agreed to eliminate Classes 6 and 7 from the milk pricing structure under Canada's dairy supply management system, and to limit exports of Canadian milk protein concentrates, skim milk powder and infant formula. Canada created the "Class 7" milk-pricing category to allow certain quantities of domestic milk to be sold at very low prices under Canada's supply managed milk-marketing system, making domestic milk more competitive with imported Milk Protein Products (MPPs). The Canadian International Trade Tribunal ruled in 2005 that MPPs were "protein substances" rather than dairy products, thereby exempting them from Canada's dairy quota. MPPs are produced in large quantities in the United States, particularly in border states such as New York and Wisconsin. The special pricing of Canadian MPPs under Class 6 and 7 was an irritant to U.S. producers of MPPs, and frequently cited by President Trump as evidence of Canada's "unfair" trading practices.
The elimination of Classes 6 and 7 milk pricing could have a more substantial economic impact on Canadian milk sales and pricing than the TRQ concessions because it could result in the displacement of substantial portions of Canadian milk for industrial processing by imported MPP substitutes. In addition, it will make it much more difficult for Canadian producers to dispose of excess milk proteins, placing downward pressure on the domestic quota system. However, the Government of Canada has announced that it is developing a compensation package to help ease the pain of Canadian dairy farmers.
Canadian Poultry and Eggs, U.S. Sugar
Poultry and eggs are also supply-managed, and Canada similarly increased import access to the U.S. for these goods. On the U.S. import side, quotas for Canadian sugar and sugar-containing products were increased.
Notice Requirement for Tariff Changes for Certain Goods
Another interesting new aspect of the USMCA is that it requires Canada to notify the U.S. of any proposed change to Canada's tariff schedule that would increase duty rates on imports of dairy, poultry and eggs from the U.S. or to change existing milk pricing classes. The U.S. must do the same for proposed changes to dairy, sugar and sugar-containing products. Consultation between the two states would be undertaken before any changes are finalized. Canada and the U.S. have also agreed to meet five years after entry into force, and every two years thereafter, to discuss whether the dairy pricing section of the USMCA U.S.-Canada Agriculture Schedule should be updated.
The U.S. and Canada have both agreed to extend national treatment to grain exported from the other party with respect to assigning quality grades, so that foreign grain is not subject to discriminatory grading standards.
Wine, Spirits and Beer
An annex on distilled spirits, wine and beer guarantees national treatment and sets out labelling and marketing standards for the internal sale and distribution of imported alcohol (subject to pre-existing NAFTA carve outs). In addition, the U.S. and Canada entered into a side letter to resolve an ongoing trade dispute between the two countries over restrictions on the sale of imported wine in British Columbia. Canada agreed to eliminate the British Columbia's provincial measures that permitted the sale of wine produced in British Columbia at grocery stores, in exchange for the U.S. dropping its related WTO action.
Chapter 20, the Intellectual Property chapter of the USMCA, also sets out new disciplines to recognize and protect geographic indications for goods produced in particular regions. Annex 3-B on alcohol recognizes certain protected geographic indications for distilled spirit products, including "Bourbon Whiskey" and "Tennessee Whiskey", which may only be used by the U.S., "Canadian Whiskey" which may only be used by Canada, and "Tequila" and "Mezcal" which may only be used by Mexico.
Chapter 6 of the USMCA is dedicated to textile and apparel goods, replacing NAFTA's Annex 300-B. Changes aim at maintaining existing North American supply chains and strengthening the regional market by tightening the rules that permit inputs from non-party states. Notwithstanding these requirements, the USMCA provides for a 10% (by weight) de minimis threshold to tolerate the presence of content from outside the region, subject to limits on elastomeric content.
The USMCA enables the parties to consult if a different rule of origin is required for particular goods to address issues of availability of supply of fibers, yarns or fabrics. It creates an inter-governmental Committee on Trade and Apparel Matters that has a broad mandate to address issues arising from the chapter, including with respect to its implementation. The agreement also strengthens cross-border enforcement, setting out specific procedures for verifications to determine if goods qualify for preferential tariff treatment, including the requirement to notify the host party if a site visit is required.
Rules of Origin
The Rules of Origin chapter contains a number of changes to modernize the rules. These include, for example, an increase of the de minimis threshold from 7% to 10% of FOB adjusted value (i.e., the amount of non-originating parts that can go into a product and still meet applicable tariff shift rules of origin). This brings the USMCA’s origin tolerance limits in line with other more recent Canadian trade agreements, such as the Canada-EU Comprehensive Economic and Trade Agreement, and the CPTPP. The USMCA also adds certain origin rules addressing remanufactured (recycled) materials.
New Rules of Origin for Autos
Auto manufacturing was a major sticking point of the negotiations. The Trump Administration had floated strict "made in America" requirements, including that all vehicles manufactured in Canada and Mexico must contain at least 50% U.S. content to qualify for duty-free access to the U.S. The U.S. also proposed that all vehicles be subject to a 85% North American content requirement to be considered "originating" in North America (up from 62.5% under the old NAFTA). After heated negotiations, the new tentative agreement represents a compromise. Revised rules of origin for automotive goods require the following (and most provisions phase-in before 2023):
- Higher levels of North American content, but not as high as the U.S. had suggested, and without any U.S.-specific content for Canadian and Mexican vehicles or automotive parts. For most passenger vehicles and light trucks, the USMCA requires a regional (North American) value content of not less than 75% (under the net cost method of calculation). Automotive parts will also be subject to regional value content requirements of between 65% and 75%.
- At least 70% of an auto producer's steel and aluminum purchases must be "North America-originating" for that producer's vehicles to qualify for USMCA duty-free treatment. Auto producers must keep records of steel and aluminum purchases and certify on an annual basis that it is keeping the required records.
- Auto producers must also comply with a new "Labour Value Content" (LVC) provision for their vehicles to qualify for USMCA treatment. The LVC provision requires that workers who earn at least US$16 per hour must carry out 40 to 45% of an auto producer’s activities (i.e., manufacturing, technology, assembly). Auto producers will need to keep records and certify that they meet these requirements.
The USMCA provisions, and in particular the LVC provision, are intended to keep high-paying auto-manufacturing jobs in the U.S. and Canada, and to stop the flow of these jobs to Mexico (US$16 per hour is about four times the standard wage for an auto sector worker in Mexico). It remains to be seen whether the new rules will have the intended effect. If the costs of meeting the USMCA's rules of origin exceed the World Trade Organization most-favoured-nation (MFN) tariffs (which for the U.S., is about 2.5% for vehicles and parts), Mexican firms could simply sidestep USMCA qualification, and export to the U.S. under MFN tariff rates. This option may be particularly attractive if the U.S. imposes section 232 tariffs under the U.S. Trade Expansion Act on other countries, while exempting Canada and Mexico up to a maximum quota volume, as discussed below.
Exemption from U.S. Section 232 Measures for Autos
A key Canadian objective in the renegotiations was to avoid the threatened future use by the U.S. of section 232 of the U.S. Trade Expansion Act to impose tariffs against Canada's auto sector on alleged national security grounds. Section 232 is the same provision used by the Trump Administration in early 2018 to impose tariffs on imports of steel (at 25%) and aluminum (at 10%) from almost all countries (the tariffs were extended to apply against Canada and Mexico in June 2018) on the basis that imports of these products threatened U.S. national security. In May 2018, the U.S. initiated a similar investigation under section 232 into auto imports.
Canada's objective was achieved by way of side letter. The U.S. has agreed that, in the event it imposes section 232 measures against auto imports, the measures shall exclude imports from Canada for up to 2.6 million passenger vehicles on an annual basis, US$32.4 billion worth of auto parts from Canada in any calendar year, with all light trucks being exempt entirely. Mexico was given the same deal, but with a higher value for auto parts (US$108 billion).
These figures are comfortably above Canada's 2017 sales into the U.S. Put in perspective, according to U.S. Department of Commerce trade data, Canadian firms sold just over 1.8 million new passenger vehicles into the U.S. in 2017, and have not sold more than 2.1 million vehicles annually in the past five years. Likewise, the ceiling on Canadian auto parts is well above current trading volumes – the total value of U.S. imports of automotive parts from Canada was approximately US$16.4 billion in 2017.
Section 232 Generally
While the USMCA does not address section 232 U.S. tariffs on aluminum and steel, Canada and Mexico each obtained a second side letter that addresses future section 232 measures. The side letters contain little by way of real protection, amounting to essentially a notice requirement. The U.S. agreed that if it imposes future section 232 measures, such measures shall not apply against Canada or Mexico until 60 days after they are imposed. During the notice period, the U.S. and Canada (or Mexico) shall "seek to negotiate an appropriate outcome". Once the 60-day time limit runs out, the exemption expires and the tariffs would apply to Canadian and/or Mexican goods if no agreement is reached. The side letters expressly permit Canada and Mexico to take retaliatory measures of "equivalent commercial effect" if the U.S. section 232 action is "inconsistent" with the USMCA or the WTO (or the NAFTA, if applicable). Canada and Mexico also retain the ability to challenge a section 232 measure at the WTO. Notwithstanding, the USMCA does nothing to delegitimize the application of section 232 measures against the close trading partners of the U.S., and does not answer the question of how a free-trading partner may represent an access risk relating to needed materials to defend the security of the U.S.
Intellectual Property (Chapter 20)
The IP Chapter of the USMCA is “NAFTA-plus,” adding several obligations beyond those previously agreed upon in the original NAFTA, and potentially changing the legal landscape for patent, copyright, pharmaceuticals, trademark and industry design owners.
In the areas of patents and pharmaceutical IP, the USMCA requires a minimum of ten years of government-granted marketing exclusivity for biologics, which include many of the most important and expensive new medical technologies. Canada currently provides a term of eight years, whereas the U.S. provides twelve years under the Biologics Price Competition and Innovation Act (BPCIA) of 2009.
The USMCA also provides that the parties confirm patents are available for at least one of the following: new uses of a known product, new methods of using a known product, or new processes of using a known product.
Another significant patent-related provision requires the parties to offer multi-year extensions on patent terms when reviews by their regulatory or patent office take longer than terms deemed "reasonable" for the purpose of compensating the applicants for such delays.
With respect to copyright protection, the USMCA requires that copyright terms last 70 years following the life of the creator for works, and 75 years for performances and sound recordings. Canada’s current copyright terms are "life of the author plus 50 years" and 70 years, respectively.
Another notable provision is on the exclusion of "fair use" exceptions to copyright law. However, Canada is not required to adopt the U.S.-style notice-and-takedown regime for internet service providers.
The IP Chapter provides stronger protection and enforcement of IP rights. Significant criminal and civil trade secret remedies and penalties may require Canada to develop new legislation. It also includes border measures for counterfeit and pirated goods to apply to in-transit shipments—Canada currently does not provide such authority for in-transit goods.
New De Minimis Thresholds for Duty and Tax Assessment
Canada has agreed to new de minimis thresholds for assessment of duties ($150) and taxes ($40) on express shipments coming into Canada. Most shipments valued below $20 are already not subject to duties or taxes under Canada's Postal Imports Remission Order and Courier Imports Remission Order, in place since 1985.
The changes could be confusing for businesses and consumers.
For one, duty rates for many products are much lower than sale tax rates (e.g., 13% HST in Ontario). Decoupling the threshold for duties from the threshold for taxes means that for many shipments, the changes will not actually have much of a practical effect. Sales taxes still apply to all shipments over C$40.
Second, the change applies only to "express shipments", meaning the new thresholds do not appear to apply to regular mail. Regular mail shipments would remain subject only to the old C$20 threshold.
In sum, the USMCA has potentially created multiple categories for duty and tax assessment purposes—with the old C$20 threshold for regular mail shipments, C$40 for tax on express shipments, and C$150 for duty on express shipments. It remains to be seen how Canada and the Canada Border Services Agency will implement and administer this provision, and to what extent it will actually facilitate trade and benefit Canadian consumers (or harm Canadian retailers).
The USMCA also covers subject matters that the NAFTA did not address, such as anti-corruption. The new chapter reflects the many other international conventions addressing corruption, but is the first North American framework to do so. Like other agreements, the USMCA requires parties to criminalize both the supply and demand sides of the bribery transaction, and condemns facilitation payments. It also recognizes non-criminal mechanisms to prevent and deter corruption, including by promoting integrity in public officials and encouraging businesses to adopt internal controls and establish compliance programs to prevent and detect corruption offences.
Given the enforcement asymmetry between the United States, Canada and Mexico with respect to corruption offences, it is noteworthy that the USMCA includes a renewed commitment to enforcement, albeit one without consequences, as this article is not subject to dispute settlement.
Trade Remedies, Dispute Settlement, and Safeguards
The USMCA retains the Binational Panel Dispute Settlement Mechanism
The USMCA preserves the binational panel "dispute settlement mechanism" presently found in NAFTA Chapter 19, and confers on all parties the right to challenge each other’s anti-dumping and countervailing duty decisions before an independent, expert panel. Chapter 19 became a red line issue for Canada during the negotiations and was hotly contested by U.S. negotiators.
Retention of the mechanism is viewed by many as a political win for Canada. It has been used to adjudicate important trade disputes involving softwood lumber, apples and pork. Historically, Canada has used Chapter 19 dispute settlement panels to challenge U.S. trade remedy decisions, including the softwood lumber case.
With respect to global safeguards, the USMCA is almost identical to the existing global safeguards exclusion under Chapter 8 of the NAFTA, and continues to provide preferential treatment to imports from the other parties. Similar to the NAFTA provisions, the USMCA states that when a safeguard measure is applied, the country applying it will provide the trading partner against whose exports the measure has been applied “trade compensation” in the form of concessions, meant to re-balance the trade equation between the parties. Another interesting observation is that the safeguards agreed upon in the US-Mexico bilateral talks are markedly different from the USMCA safeguard provisions insofar as they eliminate some compensation requirements and immunity for Mexico from future safeguard actions, according to U.S. trade advisory committee reports.
The USMCA substantially changes the landscape of investor-state dispute settlement (ISDS) for Canada and the U.S. For three years after the termination of NAFTA, existing "legacy investments" will maintain their protections under NAFTA Chapter 11. Thereafter, ISDS will not be available for Canadian investments in the U.S. or U.S. investments in Canada. There is narrower but continued access to ISDS for US-Mexico investments. Canada-Mexico investments will have access to ISDS through the CPTPP once it enters into force. Outside of these mechanisms, parties may challenge violations of the investment protections through state-to-state dispute settlement under Chapter 31 of the USMCA, or not at all.
It may be possible to read into the changes the parties' experiences with ISDS under the NAFTA. When the NAFTA was negotiated, many assumed that ISDS would be most important for Canadian and U.S. investors operating in Mexico. Instead, the Canadian government has been a frequent target of claims. Removal of U.S.-Canada ISDS is not likely to change the position of Canadian investors (the U.S. has never lost a NAFTA case), and will remove a source of litigation risk for the Canadian government.
Non-Market Country FTA
A provision under this heading establishes a consultation procedure should any party to the agreement initiate free trade negotiations with a non-market economy country (e.g., China). It further clarifies the right of the other parties to terminate the agreement on six months’ notice. Of course, the USMCA provides for the absolute right of withdrawal elsewhere in the agreement. Nonetheless, this provision can be read as a clear warning from the Trump Administration to Canada and Mexico that they must be cautious when negotiating an FTA with China.
The USMCA is still subject to legal scrubbing. It is expected that it will be signed before the end of November and that will initiate the ratification period. Perhaps the biggest hurdle will be imposed by the United States Congress should opposition be taken for political reasons. The agreement also requires the approval of the Mexican Senate. In Canada, no serious opposition to Parliamentary approval is expected and no action by the provinces conditions the bringing into force of the agreement.