United States-Mexico-Canada Agreement (USMCA): Impacts on sourcing and production investment decisions

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Why the USMCA could set off a stampede

The USMCA is a trade professional’s trade agreement: page upon page detailing what it takes for a product to meet the threshold to be considered “made here” and thus qualify for low to no-tariff access to North American markets.

Up against the real and potential dislocations being generated by the US-China and UK-EU trade resets, the USMCA maintains the rules of the road that businesses crave. Yet it’s been given back burner treatment by many that do not source or produce in North America. A keyword search of a database of transcripts of company earnings calls with investors turned up 35 mentions of “USMCA” specifically over the past three months. This compares with over 1,000 mentions of “weather.”

What are the implications of USMCA for companies?

Downplaying is understandable. Most products – there are tens of thousands - will experience minimal to no change vs. terms used to qualify for the North American Free Trade Agreement (NAFTA), with significant exceptions in the auto industry, followed by agriculture, textiles, apparel and chemicals. Yet a technical reading of the USMCA impact can be misleading. If ratified by legislatures in the US and Canada, as we continue to expect although US political uncertainties are rising, the USMCA is likely to accelerate sourcing and production investment decisions that have been idling. Mexico has already ratified the agreement.

As the costs add up for waiting out a resolution to US-China tariffs, more businesses are likely to probe where and whether meeting USMCA terms can move the needle on their costs of goods in North America. US two-way trade with Canada totaled $617.2 billion 2018 and $611.5 billion with Mexico, US government figures show. Some will find opportunities that tilt toward sourcing or producing in North America or the US, others won’t. At a minimum, many more are equipped to do so after a year spent exploring the world of duty drawbacks, bonded warehouses, exemption processes and import substitutes to mitigate tariffs on China imports.

US, Mexican and Canadian suppliers able to verify and validate the source (origin) of their input products for USMCA terms will likely see advantages as businesses look for components that add to the tally of local content in their end-products. For example, to qualify for USMCA preferences, 75% of a car must be region-made, up from 62.5% under NAFTA. There are other, more stringent content requirements that are unique to auto, as well as a three-year, phase-in transition period to make changes to their supply chains, but for this example, consider how procurement professionals will approach meeting the higher origin content rules. Businesses in Mexico that are also able to address concerns about capacity and readiness to substitute inputs manufactured in Asia are also likely beneficiaries.

Transparency in supply chain sourcing is advantageous under USMCA

Once uncertainty over ratification lifts, more businesses are likely to move on global sourcing and production decisions

Any slide into the ‘certain’ from the ‘uncertain’ column in this trade environment creates more of the support needed to make long-term bets, which will incentivize suppliers. There are other motivations for moving production back to North America that USMCA will serve to reinforce, such as US corporate income tax reform in 2017. And there are also a multitude of other free-trade trade arrangements (FTAs) for reduced duty or free duty entry, established or new, such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which excludes the US but includes Mexico and Canada. FTAs have lot of variation between them in terms of coverage and ambition. When businesses look into these in detail, they’ll often find that there are already preferences that may suit. The USMCA preferences will be weighed against location-based determinants like these as manufacturers and importers model supply chain scenarios.

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Costs of importing from outside the region are adding up

Keep in mind that many imported products of Chinese origin are already subject to “normal” duties at an average rate of 4-6% at the time of importation to the US, and that the May hike to 25%, and planned increase to 30% for Lists 1-3, now on Oct. 15, will come on top of that. Similarly, 15 % tariffs on an additional $300 billion worth of products from China, many of which are subject to average normal duty rates upwards of 16%, go into effect on Sept 1 and Dec 15, effectively doubling their overall import cost. To take one slice of impacted activity, US sellers of backpacks, hiking boots and other types of gear have paid over $1.5 billion more in tariffs since September 2018, according to the Outdoor Industry Association.

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Tougher customs enforcement ahead

Trade compliance audits tend to step up after a new trade agreement. There is reason to expect so with USMCA, as the agreement specifically creates opportunities for US border authorities to collaborate with Canadian and Mexican Customs. For example, authorities from each of the countries can audit companies within the region, meaning they can go on site and review how the product is qualifying.

Increased automation at the border has made trade data more visible to traders as well as governments. As a result, trade audits and sampling methods are improving. This trend is not likely to reverse. US Customs and Border Protection (CBP) expects to continue to experiment with advancing digital technologies, after a pilot test of blockchain to verify certificates of origin on imported goods to claim eligibility under NAFTA and Central American Free Trade Agreement (CAFTA).

Keep in mind that CPB also enforces US trade laws and regulations on behalf of other federal agencies. There is simply more information on products and more agencies with faster access to review and enforce compliance. This puts a premium on providing accurate content data.

For these reasons, what may not have been expected to cause much change can be the trigger for moves that have been building up over time.

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What can your business do to prepare for USMCA?

Suppliers: Be prepared to verify and validate the source of your product(s). Manufacturers are reliant on their suppliers to understand USMCA requirements and provide them accurate information. Depending on purchasing or sales teams who lack technical expertise to complete FTA origin certifications may not be adequate as the USMCA rules can differ from NAFTA, which in turn can differ from other trade agreements like the US-Korea FTA (2012). Eligibility verification procedures conducted by Customs authorities will be different than many suppliers are used to with NAFTA. Ultimately, meeting the rules is where the opportunities lie with USMCA and other agreements.

Manufacturers and importers: Survey your suppliers for certification under USMCA and other trade agreements. Explore your options for sourcing and understand the exposures in bill of material (BOM) costs. Indirect exposures, e.g. North American suppliers using parts from China, create additional complexity as they flow through the supply chain. Do the legwork to make sure that the content recipe you’re using is going to satisfy USMCA requirements and be eligible for benefits. Conversely, if receiving goods that qualify for NAFTA, make sure that the goods you’re currently receiving into Canada, the US or Mexico maintain their qualification. Also, pay attention to historical agreements. Part of the transition will involve updating purchase agreements that currently reference NAFTA as a part of holding vendors responsible.

How PwC can help

PwC has seen the evolution and the payoffs that come with using automation and analytics in trade programs. We work with clients to run value threshold analysis to check whether the origin content of components meet the standard.

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Maytee Pereira

Maytee Pereira

Managing Director, PwC's Customs and International Trade Practice Co-Leader, PwC US

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