Canada: United States-Mexico-Canada Trade Agreement: After A Year, New Terms Have Been Agreed Upon To Replace NAFTA

On the cusp of yet another missed deadline, the U.S. and Canada have reached agreement on terms to allow Canada to join the U.S. and Mexico in a revision to the North American Free Trade Agreement. The terms of the new United States-Mexico-Canada trilateral agreement (USMCA) were posted Sunday evening by the U.S. Trade Representative (USTR).

There has been considerable ink already spilled by experts, "experts", and partisans on all sides regarding who won, who lost, and what the impacts of USMCA will be. McCarthy Tétrault's International Trade and Investment Law Group will be providing analysis of the major changes in the USMCA, the heritage it shares with the Trans-Pacific Partnership (TPP) and NAFTA, and how best to position you and your company to navigate the new trading landscape.

The USMCA will impact supply chains across North America. There are immediate steps corporations can take to address and prepare for supply chain risks. For example, we would recommend a review of the USMCA rules of origin that apply to your products. They may not be the same as the NAFTA rules of origin on which you have been relying, and this could require a strategic change in inputs and / or production moving forward.

While we will be posting more extensive analyses of the details of the key elements of this deal in the coming days and weeks, the following is a short summary of the most widely-discussed provisions:

Increase in U.S. Market Access to Supply-Managed Industries; Milk Classes 6 and 7 Pricing Removed

  • Canada has agreed to provide increased access to its key supply-managed industries.
  • The most high-profile is an opening of an additional 3.6% quota for U.S. suppliers into the Canadian dairy market, and complete elimination of the Class 7 pricing strategy meant to restrict imports of skim milk.
  • This expansion of quota roughly emulates the concessions made to the U.S. under the TPP. The Class 7 pricing was seen as a major irritant for the Trump administration, even though its total impact was minor.
  • Just as important, Canada has made meaningful concessions in expanding access for eggs, turkey, chicken, and broiler hatching eggs and chicks.
  • While this move faces obvious opposition by domestic producers, it should help bring reduced prices for certain basic staple foods. The Government of Canada has also announced that supply-managed farmers will be compensated for the increased quota.
  • Canada has also made market access gains for its exports of refined sugar and sugar-containing products, and certain dairy products (including cheese, cream, milk beverages, and butter).

Sales Tax: De Minimis Levels Increased

  • Good news for Canadian shoppers: with the de minimis increase, consumers will not have to pay duty or tax on products that are imported with total value under $40.
  • This represents a careful balance between consumers and retailers. The previous de minimis level of $20 had not been increased in more than 40 years, and the increase will ease e-commerce transactions for Canadian consumers. That said, the increased level was much less than the $800 USD demanded by US negotiators.

North American Content Requirements for Automobiles Higher than under NAFTA

  • The regional value content requirement in the rules of origin for automotive products in the USMCA will increase from NAFTA's 62.5% to 75%. This 20% increase in the regional value content requirement will add to the cost of vehicles in North America and increase compliance costs for most manufacturers.
  • In addition, the USMCA introduces a relatively novel requirement - qualification of a car for regional origin will require that 30% of labour costs (relating to costs of manufacturing, assembly, R&D and information technology) be generated by workers earning at least $16 per hour, increasing up to 40% by 2023. While this is clearly a "win" for manufacturing workers in the U.S. and Canada, it is expected to generate higher prices for consumers.

Canada "Regains Control" over Energy

  • NAFTA's Chapter 6 enhanced disciplines on energy export restrictions have been eliminated in the USMCA. Initially included in the Canada-US Free Trade Agreement and continued in NAFTA, this proportionality provision limited Canada's ability to restrict oil and gas exports to other NAFTA parties, thus assuring a level of access to these resources for the United States.
  • These disciplines were imposed under the CUSFTA at the insistence of the United States following Canada's implementation of the National Energy Policy in the 1970s. Since that time, there has been a lessening of U.S. dependence on Canadian energy resources, which made the elimination of NAFTA Chapter 6 politically palatable for all Parties.

NAFTA Chapter 11 is also scaled back significantly – Investor State Dispute Settlement

  • Perhaps one of the most misunderstood provisions in NAFTA, Chapter 11 encouraged cross-border direct investment by ensuring that the rights of those investors would be protected, and that those investors would have access to impartial, binding arbitration. These provisions are now set out in Chapter 14 of the USMCA.
  • Canada will maintain such a mechanism with Mexico, thanks to both countries being party to the TPP, which includes an investment-state dispute settlement mechanism. However, the Chapter 11 mechanism as between Canada and the U.S. has been eliminated almost in its entirety, aside from certain "legacy investment" claims (referring to investments established prior to the entry into force of the USMCA). The Parties' consent to allow legacy investment claims to proceed to arbitration under USMCA Chapter 14 expires 3 years after the termination of the NAFTA.
  • Historically the U.S. has been seen as the prime "beneficiary" of Chapter 11, as no investor that sued the U.S. under Chapter 11 has been successful, but American investors have a reasonable track record of success against Canada and Mexico. Keeping investment protection with Mexico while losing it with the U.S. is seen by some as a "win" – Canadian investors continue to receive protection in a comparatively "risky" investment environment while the Government of Canada, a relatively frequent target of Chapter 11 litigation, no longer runs the risk of being sued by U.S. businesses.
  • However, this misunderstands the purpose of Chapter 11 – its principal value was to assure investors that their investments would be treated fairly and protected. Certain actions taken by provincial governments have shown that this assurance is indeed needed for some kinds of investments.
  • It is worth noting that investor-state dispute mechanisms remain in place as between Mexico and the U.S., in respect of only limited sectors, including telecommunications, energy and transportation. These claims are subject to a revised dispute settlement framework, as set out in Annex 14-D to the USMCA.
  • Investors may want to consider whether there are other subsidiary or affiliated entities through which the investment should be made in order to continue to benefit from binding investor/state arbitration.

Expanding the National Security Exception

  • The new national security exception in USMCA Article 32.2 provides that nothing in the agreement precludes a Party from applying measures that "it considers necessary for the [...] protection of its own essential security interests".
  • Unlike with its NAFTA predecessor (Article 2102) or the WTO security exception (Article XXI of GATT 1994), there is no requirement under the USMCA that such measures be related to traffic in arms or nuclear non-proliferation or that they be "taken in time of war or other emergency in international relations".
  • The weakening of the disciplines on the use of the national security exception likely reflects increased attempts by the Trump Administration to justify more protectionist and trade-distorting measures on the basis of national security.

FTA Negotiations with Non-Market Economies

  • USMCA Article 32.10 spells out that, if a Party enters into a FTA with a non-market country, the other Parties can terminate the agreement on a six-month notice and replace it with a bilateral agreement.
  • Some have viewed this as a warning to Canada and Mexico not to negotiate a free trade deal with China, or at least to proceed very carefully.
  • Realistically, this provision may have little utility beyond what is already contemplated in the USMCA, as any Party can, in any event, choose to leave the USMCA on six-months' notice to the other Parties.
  • This clause is likely meant to ensure that Canada carefully considers any concessions it will make in negotiations with China, and ensure that proper protections are put in place to protect the integrity of the North American market.

Chapter 19 – Dispute Resolution Win for Canada?

  • Throughout the 1980s there was considerable doubt about the integrity of domestic review mechanisms in the United States for reviewing anti-dumping and countervailing duty determinations, as they were generally viewed to be deficient and biased in favour of U.S. industries.
  • As a result, Chapter 19 became a "red line" for the Mulroney government, and its inclusion in the CUSFTA was a monumental win for Canada and for its exporters, albeit a second best solution to the elimination of trade remedies in a free trade area. It ensured that all reviews of anti-dumping and countervailing duty rulings could be conducted by an impartial panel of independent trade law experts.
  • Panels were used heavily in the softwood lumber disputes between Canada and the U.S., and were seen as critical in ensuring that proper rules and international trading standards would be applied by the U.S.
  • Chapter 19 became a major flashpoint between the two sides, with the Trump administration being particularly hostile to its continued existence in any form.
  • The continuance of Chapter 19 (now USMCA Chapter 10), more or less completely intact, is a major political victory for Canada and the Trudeau government.

Patent Protection and Copyright Extensions

  • The USMCA largely replicates provisions that the U.S. advocated for in the TPP. This includes extending copyright by an additional 20 years (to life of the author plus 70 years), which is a victory for rights-holders but may result in higher costs for consumers.
  • One key concession made by Canada relates to "biologics" – drugs made by growing biological cell lines rather than crafting small-molecule chemicals. Canada, both through Health Canada policy and our other trade agreements, had provided "data protection" of eight years, limiting. the ability of generic drug manufacturers to use data from innovators to justify approval of their own copy-cat versions. This has been extended to ten years. While two years is perhaps a small increase, it will be a boon to innovator companies and help spur R&D. It may also increase prices.
  • The USMCA also contains provisions dealing with geographic indications – rights that guarantee that only certain products made in specific locations and methods can bear appellations such as "Tennessee whiskey", "Tequila", and "Mezcal".

Preservation of Cultural Protection for Canadian Media

  • NAFTA provisions limiting foreign ownership of Canadian media, including newspapers, TV stations and TV networks, will remain in place.
  • Questions remain as to how these exemptions will apply in the digital space.

Steel and Aluminum Tariffs Remain Unchanged

  • On May 31, 2018 the U.S. announced the implementation of tariffs under Section 232 of the Trade Expansion Act of 1962, against imports of steel and aluminum from Canada and Mexico. Canada promptly announced retaliatory tariffs – this round of "tit-for-tat" tariffs overshadowed the entirety of the NAFTA renegotiations.
  • The USMCA contains no provisions to repeal or otherwise mitigate the steel and aluminum tariffs.
  • However, rumblings persist that the Parties have agreed that these tariffs will be reduced or eliminated once the USMCA is signed.

Exemption Secured for Exports of the Canadian Auto Industry

  • Unlike the steel and aluminum tariffs, the USMCA directly addresses the threatened application of similar Section 232 (national security) Tariffs on the auto industry. The tariffs which President Trump threatened amounted to a 25% duty on a multi-billion dollar industry, so this concession alleviates a major pressure point against Canadian and Mexican interests.
  • Canada obtained an exemption from any future Section 232 Tariffs for up to 2.6 million passenger vehicles per year, all light trucks, and up to $32.4 billion USD in parts.
  • These amounts are greater than current capacity for shipments between Canada and the U.S., and has left considerable room for growth over the next decade.
  • This represents both a win and a loss for Canada. From a practical perspective, this move seals a privileged position for Canadian vehicles in the U.S. market and protects Canada from the actions of an unpredictable U.S. Administration. Indeed, the heightened content requirements mentioned above should encourage the parts suppliers who rely on the automobile industry's ability to place production on either side of the border. On the other hand, though the Canadian concession is minor in practical terms, it does perhaps send the message that unilateral bullying can bring results at the negotiating table.
  • This will not put an end to the threat posed by the U.S. to the traditional international trading order. Indeed, as noted above, the USMCA appears to have broadened the scope of the national security exception.

Review and Term Extension

  • The USMCA does not provide for a "sunset clause", at least not like the one President Trump tried to impose throughout the negotiations. However, the Agreement does include terms with respect to its review and extension.
  • In short, the initial term of the USMCA is 16 years, with a complicated review and extension process. Specifically, a joint Commission comprised of representatives of each Party will undertake a "joint review" of the operation of the Agreement after 6 years. The 6 year joint review process contemplates that the head of government of each Party will at that stage be required to signal whether they wish to extend the Agreement for a further 16-year term.
  • If all of the parties indicate that they wish to continue the agreement, then the agreement is renewed for another 16 years with a further 6 year joint review.
  • If any of the parties dissent, then the parties will immediately begin the review and negotiations for an extension. These negotiations will continue up until the expiration of the agreement. If the parties reach an agreement, the USMCA will be renewed subject to any required revisions of the parties.

Up Next?

This deal generally illustrates the intent of Canada, the U.S. and Mexico to remain committed to free trade. The USMCA could be signed before December 1st, but still needs to be put before the U.S. Congress for a mandatory 60-day review period.

In the coming days and weeks, the International Trade and Investment Law Group at McCarthy Tétrault will provide further details on these areas, and provide insight to help you and your company maximize the opportunities, and address the threats, arising from the replacement of NAFTA with the USMCA.

Sources

Energy: https://www.thestar.com/opinion/contributors/thebigdebate/2018/06/18/should-canada-give-up-on-nafta-yes.html

Culture/Media: https://www.cbc.ca/news/politics/nafta-culture-politics-1.4822117

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