USMCA Trade Agreement:
Implications for North American Manufacturing Supply Chains

USMCA Trade Agreement:
Implications for North American Manufacturing Supply Chains

Executive Summary

  • On December 10, 2019, Canada, Mexico, and the United States signed a protocol officially amending the U.S.-Mexico-Canada Agreement (USMCA) trade deal that will replace the previous North American Free Trade Agreement (NAFTA) which has been in effect for 26 years since 1994. The entry-into-force date is set for July 1, 2020. 
  • The new USMCA trade deal introduces a number of new rules and changes that will impact North American supply chains including major amendments to rules of origin (ROO), higher de minimis thresholds, labor rights obligations, customs facilitation, intellectual property, environmental protections, and digital trade and eCommerce.
  • New ROO provisions under USMCA threaten to seriously disrupt automotive and mobility supply chains due to highly restrictive Regional Value Content (RVC) and Labor Value Content (LVC) requirements that will significantly raise costs for auto production in North America. In particular, producers will be required to increase the amount of production that occurs in North America for passenger vehicles to 75 percent by 2023 (up from 62.5 percent under NAFTA) and ensure that 40-45 percent of a vehicle’s value comes from “high wage” areas paying workers at least USD 16 (EUR 14.84) per hour. 
  • Conversely, digital trade and eCommerce, retail manufacturers, and agriculture producers are set to benefit from greater market access and trade liberalization measures. However, USMCA is largely expected to have a more minimal effect for manufacturers and suppliers in the energy, chemicals, life sciences and healthcare, and technology sectors. 
  • Whether the USMCA will be successful in restructuring global supply chains and bringing manufacturing back to North America remains to be seen. Over the long term, companies may decide to increase or shift production to their existing plants in North America to comply with higher regional content requirements. However, such restrictions could also have the unintended consequence of reducing North American production by incentivizing foreign companies to move production elsewhere to avoid additional trade restrictions.

Background

On December 10, 2019, Canada, Mexico, and the United States signed a protocol officially amending the U.S.-Mexico-Canada Agreement (USMCA) trade deal that will replace the previous North American Free Trade Agreement (NAFTA) which has been in effect for 26 years since 1994. In a notice addressed to U.S. Congress, U.S. Trade Representative (USTR) confirmed on April 24, 2020 that Washington informed the Canadian and Mexican governments that it has successfully completed its domestic procedures. The entry-into-force date is set for July 1, 2020. 

The new USMCA trade deal introduces a number of new rules and changes that will impact North American supply chains including major amendments to rules of origin (ROO), higher de minimis thresholds, labor rights obligations, customs facilitation, intellectual property, environmental protections, and digital trade and eCommerce. These changes will have implications for the automotive and mobility, retail, agriculture industries as well as energy, chemicals, technology, life sciences and healthcare manufacturing sectors. The entry-into-force date comes at a sensitive moment as the U.S., Mexico, and Canada are all coping with the COVID-19 pandemic that has forced companies and suppliers to suspend production at their North American factories over recent months.

This Everstream Analytics Special Report takes a closer look at how the USMCA could shape North American manufacturing and analyzes specific provisions that supply chain professionals will need to prepare for going forward. It also provides a breakdown of some of the key changes in the trade deal and the sectors that will most likely be impacted under the new agreement. 

Key Changes Under USMCA

Although characterized as something closer to a ‘NAFTA 2.0’ as opposed to an entirely new trade deal, the USMCA introduces important new provisions and updates compared to the previous NAFTA agreement (see Appendix A for a timeline on major developments and key dates for the USMCA). Everstream Analytics highlights some of the major changes that are likely to impact manufacturing and supply chain operations in North America.

Rules of Origin (ROO)

The USMCA adopts significant changes established under NAFTA to Rules of Origin (ROO) provisions, which refers to the criteria used for determining whether products have undergone sufficient production in North American countries to qualify for duty-free treatment. The updated ROO rules threaten to seriously disrupt manufacturing and supply chains across various industries as certain products that are currently eligible for duty-free treatment under NAFTA will no longer qualify under new USMCA provisions. A more detailed analysis on the Regional Value Content (RVC) and Labor Value Content (LVC) requirements for the automotive sector is outlined in the next section.

The USMCA also introduces important new procedures for certifying a good as ‘originating’ that differs from NAFTA and adopts the model set forth in the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). A uniform Certificate of Origin (COO) — which was used under NAFTA to certify that imported goods qualify for preferential treatment and can only be signed by the exporter of the goods — has now been replaced by a certification signed by the producer, exporter, or importer. This can be provided on an invoice or commercial document and does not need to follow a prescribed format so long as it contains certain minimum data elements.

Higher de minimis thresholds

A positive aspect of the USMCA sees Mexico and Canada adopting higher de minimis thresholds, which determines how low-value parcels can be shipped across international borders tax and tariff free. Although the U.S. has allowed the purchase of goods up to USD 800 (EUR 740.61) duty-free since 2016, Canada and Mexico have maintained comparatively low de minimis thresholds that has arguably hampered the potential of express shipments within North America. Under the USMCA, Canada will now raise its de minimis threshold from CAD 20 (USD 14.21; EUR 13.22) to CAD 40 (USD 28.42; EUR 26.20) and provide duty-free shipments for items valued up to CAD 150 (USD 117; EUR 99.15). Likewise, Mexico’s de minimis level will remain at USD 50 (EUR 46.10) and its duty-free limit will be USD 117 (EUR 99.15).[iii] The changes are anticipated to help reduce costs for lower-value cross-border shipments for eCommerce orders that has increased in recent years. 

However, the reprieve from taxes and duties will only be for private couriers. The USMCA changes therefore will not apply to public couriers such as Canada Post, for which all tax and duties will continued to be applied after CAD 20 (USD 14.21; EUR 13.22). This could prove to be problematic for eCommerce shipments in Canada as many domestic consumers may not have a choice in how their package is shipped and be able to avoid paying GST by picking a private courier.

Labor requirements

Receiving bipartisan support in the U.S., the USMCA labor rights provisions go beyond the scope of previous U.S. trade agreements and are largely aimed at ensuring Mexico’s compliance through stricter enforcement. The new labor obligations are problematic in that they could place greater strains on companies doing business in Mexico and significantly heighten the risk of industrial action among labor unions at non-compliant facilities. These include:

  • A requirement that Mexico passes legislation recognizing the right of workers to engage in collective bargaining. 
  • A new “facility-specific rapid labor response mechanism” (RRLM) that will serve as a dispute-settlement mechanism for fielding complaints around violating the rights of freedom of association and collective bargaining at particular companies and plants. 
  • New enforcement and monitoring mechanism that enable inspections of factories and facilities that are not meeting labor obligations. 
  • New Labor Value Content (LVC) rules for the automotive sector.

From a supply chain perspective, the new provisions are concerning on a number of fronts. For the RRLM, the burden will be on the defendant to demonstrate that an alleged labor rights violation is not in a manner that would affect trade or investment between parties. This will likely create greater burdens on Mexico. On the new labor monitoring mechanism, the U.S. and Mexico have since resolved a recent dispute after agreeing that U.S. labor inspectors/attachés would work with Mexican authorities rather than acting unilaterally. U.S. Democrats previously pushed for stricter enforcement that would give U.S. labor inspectors access to Mexican factories, but Mexico resisted which resulted in specialized expert panels being adopted instead for settling complaints.

Section 232 exemptions from U.S. auto tariffs

As part of the NAFTA renegotiations, the U.S. provided Canada and Mexico with two separate side letters to the USMCA that will exempt both countries from a set quota of passenger vehicle and all light truck imports as well as auto parts from Section 232 tariffs under the U.S. Trade and Expansion Act. The U.S. also agreed to not impose Section 232 tariffs on Canada or Mexico for at least 60 days should it be imposed in the future, which would allow Washington to negotiate separate agreements within that period. Canada and Mexico were granted exemptions for 2.6 million passenger vehicles imported annually from each country; light trucks imported from each country; and such quantity of auto parts amounting to USD 32.4 billion (EUR 29.9 billion) and USD 108 billion (EUR 99.8 billion) worth of annual auto parts imports respectively. Both exemption levels are high enough that all auto exports from Canada and Mexico to the U.S. should be exempt. 

On June 24, 2020, reports surfaced that the Trump administration was considering re-imposing 10 percent tariffs on Canadian aluminum imports by July 1. If enacted, the tariffs would be imposed on the same day the USMCA comes into effect and would likely result in reciprocal retaliatory tariffs from Canada on U.S. exports. Washington has called on Canada to voluntarily restrain its own aluminum exports after several U.S. aluminum producers represented by the American Primary Aluminum Association (APAA) lobbied for greater protection, citing that Canadian aluminum imports have risen since the USMCA was signed. The Aluminum Association, which represents U.S. and foreign-based companies that make up the majority of the industry, has conversely opposed the potential reinstatement and stated that the uptick in imports was consistent with historical trends.

Sunset clause

Under a newly-introduced ‘sunset clause’, the USMCA will expire 16 years after its entry-into-force. However, it may also be renewed for an equal period of time. The agreement will be subject to a joint review no later than six years after its entry-into-force from which all three countries can decide on whether to extend the trade deal. For North American companies, the sunset clause adds to additional uncertainty given that the USMCA could face possible termination.

Future free trade agreements with non-market economies

The USMCA also introduces a clause that requires a member country to give at least three months’ notice prior to commencing negotiations of its intention to engage in free trade agreement (FTA) negotiations with a non-market economy (NME), such as China, prior to commencing such negotiations. While the provision is unlikely to have an immediate impact, it could put limitations on potential FTAs that Canada and Mexico will be able to enter with NMEs in the future.

Impact of USMCA on Manufacturing Sectors

Automotive and Mobility

Some of the most disruptive aspects of the new USMCA provisions are arguably set to target the automotive and mobility sector, which threaten to significantly raise costs for auto production in North America. The auto provisions can be broken down into several sections: RVC, auto parts content requirements (core, principal, and complementary), LVC rules for vehicles, as well as steel and aluminum purchase requirements. Figure 1 below provides an overview of the ROO requirements for passenger vehicles and light trucks under USMCA.

Figure 01: Components of USMCA automotive rules of origin requirements. Source: U.S. International Trade Commission

In an attempt to encourage more auto manufacturing and investment into the U.S., the Trump administration actively sought to eliminate previous NAFTA rules that allowed producers to deem non-North American content as ‘originating’ regardless of origin by introducing more stringent rules that require manufacturers to produce more North American content. In order to qualify for duty-free entry under the new RVC rules, producers will now be required to significantly increase the amount of production that occurs in North America for passenger vehicles and light trucks to 75 percent by 2023. This is up from the 62.5 percent requirement under NAFTA and will start at 66 percent before gradually increasing over three years to 75 percent (see Figure 3).

Effective DateRVC Requirement (Percentage)
July 1, 202066
July 1, 202169
July 1, 202272
July 1, 202375
Figure 02: RVC requirements for finished passenger vehicles and light trucks. Source: USMCA Agreement, Everstream Analytics

Auto parts are also subject to RVC requirements and can be broken down into three main categories: core parts (75 percent, 15 parts), principal parts (70 percent, 43 parts), and complementary parts (65 percent, 28 parts). In addition, at least 70 percent of a vehicle producer’s steel and aluminum purchases must be “melted and poured” in North America with a 7-year phase-in period for steel and 10 years for aluminum. Figure 3 below provides a brief breakdown of the specific auto parts and RVC requirements that are classified under each category.

CategoryRVC Requirement (Percentage)Total PartsNotable Products
Core parts7516Drive axles, bodies for motor vehicles, engines, steering and suspension systems, chassis with engine, lithium batteries
Principal parts7043Brake system, air conditioning and cooling engine, exhaust, tires and wheels, seats and their parts, bumpers, fuel systems
Complementary parts6528Audio equipment, pipes, catalytic converters, locks, lighting, valves, locks, tubes, motors, and generators
Steel70N/AN/A
Aluminum70N/AN/A
Figure 3: RVC requirements for automotive parts under USMCA. Source: USMCA Agreement, Everstream Analytics

In addition, new LVC rules mandate that 40-45 percent of a vehicle’s value must come from “high wage” areas paying workers at least USD 16 (EUR 14.84) per hour, which is aimed at protecting U.S. auto manufacturing jobs and at slowing the industry’s migration from the U.S. to lower-wage countries such as Mexico. At least 25 percent (30 percent for light trucks) are required to come from high wage materials and manufacturing costs, while no more than 10 percent from research and development (R&D) and IT, and no more than 5 percent credit for engine, transmission, or advanced battery assembly. Vehicles that fail to meet the LVC standards will be subject to U.S. tariffs.

For foreign-brand automakers in North America, the new ROO rules will put Original Equipment Manufacturers (OEMs) at a heavy disadvantage by forcing them to invest in new U.S. or Canadian plants for higher-value components (such as engines and transmissions). Major foreign OEMs will need to cope with higher production costs along with a more limited supply from foreign suppliers and be forced to turn to locally-based suppliers in order to comply with North American RVC content requirements for auto parts and components. Although it may be feasible for OEMs to transition to local sub-tier suppliers for key auto components over the long term, carrying out such a process could take years and result in higher financial pressures for both U.S. suppliers that rely on imports for intermediate products and foreign-based suppliers for exports to the U.S. 

The restrictions also run the risk of resulting in less North American content by incentivizing OEMs to shift production out of the continent for export-oriented plants which rely heavily on auto parts imports. Major non-U.S. OEMs that produce cars outside of the U.S. before shipping and importing them into the U.S. as finished vehicles will now have a greater incentive to simply export more cars to the U.S. and pay the 2.5 percent import tariff rather than comply with more complicated and burdensome restrictions. For instance, BMW has started building more SUVs in China due to U.S. tariffs on steel and aluminum cutting significantly into the company’s earnings.

Retail and Textiles


The USMCA includes updates and revisions to NAFTA for the retail sector that eases the duty-free treatment for some textile and apparel products while tightening requirements for others. For instance, it eliminates a previous NAFTA requirement that visible linings for certain coats, jackets, suits, and skirts must be knit or woven within a member country. 

However, it sets new limitations for narrow elastic fabrics, sewing thread, and pocket bag fabric and mandates that no more than 10 percent of the value of a set (e.g., bed-in-a-bag items, pants with belts) can be foreign content. The provisions may lead to the establishment of more domestic suppliers as these materials are often imported from Asian countries. The USMCA also eliminates merchandise processing fees on imports of tariff preference level (TPL) goods, which refers to a limited quantity of preferential duty rates for textile and apparel products.

Agriculture

In what could be considered a win for U.S. farmers, Washington will gain access to around 3.59 percent of Canada’s USD 16 billion (EUR 14.8 billion) dairy market and  be able to increase exports of some milk, cream, butter and cheese products into Canada. The market share is greater than the 3.25 percent that was previously negotiated under the CPTPP and will also eliminate Canada’s Class 7 milk category (including milk powder and milk protein) that established a pricing scheme that would-be U.S. exporters argued made their products uncompetitive. The concessions came in exchange for getting the U.S. to back off from efforts to have Canada scrap its “supply management program”, which imposes high dairy tariffs and production quotas aimed at limiting foreign competition. 

Life Sciences and Healthcare

For life sciences and healthcare, the USMCA does not include a clause that would have protected cutting-edge biological drugs from generic imitators for 10 years before they would be forced to contend with generic competition after U.S. Democrats pushed for the provision to be removed, citing that it would make it harder to cut drug prices domestically. U.S. law allows pharmaceutical companies 12 years of protection, but they are afforded only 5 and 8 years in Mexico and Canada. The Pharmaceutical Research Manufacturers of America argued that companies needed a longer protection period to allow for sufficient investment into R&D.

Digital Trade and eCommerce

In the case of digital trade, the USMCA provisions remain very similar to those adopted under the CPTPP. The rules should boost eCommerce with rules that prohibit “customs duties and other discriminatory measures” on digital products such as music, videos, games, and e-books. It also includes rules that ensure that suppliers are not restricted in their use of electronic authentication or signatures to help facilitate more digital transactions. Global eCommerce vendors, which depend on customer and commercial data to track orders and products, are likewise expected to benefit from a ban on data localization requirements that could limit cross-border data flows. 

Energy and Chemicals

The energy sector is not expected to be significantly impacted by the USMCA given that all three countries already benefit from very low most-favored-nation (MFN) tariffs. However, the American Petroleum Institute (API), a major U.S. oil and gas industry association, has expressed concerns over recent actions by the Mexican government, citing that U.S. investors were coming across problems acquiring permits in Mexico for fuel stations, storage facilities, and imported fuel terminals.

For the chemicals industry, provisions have been modernized that will introduce new compliance alternatives that recognize the various chemical processes that transform materials: chemical reaction, particle size change, isomer separation, and purification. The ROO has also been simplified and requirements were reduced to enable chemical manufacturers to no longer be required to determine RVC and submit conferred documentation. The provisions also call for greater regulatory cooperation in the chemicals sector through data sharing, risk assessments, and developing chemical inventories. 

Recommendations

Everstream Analytics outlines below a series of recommendations for how companies can adapt to the new changes introduced under the USMCA:

  • Ensure compliance with new ROO and RVC requirements: Companies should work with their suppliers and validate the source of their products as indirect exposures in bill of material (BOM) costs could compromise the ability of manufacturers and importers to comply with the USMCA ROO and RVC requirements. For instance, if a North American supplier is using auto parts from China, this could complicate the ability of firms to comply with the USMCA’s new requirements for North American-made content. 
  • Survey suppliers for certification under USMCA: Manufacturers and importers should conduct a survey of their supplier networks to ensure that they have sufficient certification under USMCA as eligibility verification procedures will be different than what many suppliers are accustomed to under NAFTA. Part of the USMCA transition will involve updating purchase agreements that currently reference NAFTA as part of holding vendors responsible. 
  • Develop compliance plans for tougher labor obligations: The extensive labor obligations under the USMCA, particularly with regards to Mexico, means that companies doing business there or sourcing from Mexico will need to develop compliance plans. This includes ensuring supplier, manufacturing, and service contracts reflect USMCA labor rights obligations and that a robust internal control process is established to monitor compliance with code of conduct obligations to avoid loss of duty-free treatment or sanctions.
  • Anticipate enhanced customs enforcement: Trade compliance audits are typically enhanced after a new trade agreement comes into effect and this will also likely be the case for USMCA. U.S., Mexican, and Canadian customs authorities will be able to audit companies within the region and go on-site to evaluate whether products still qualify for duty-free treatment and comply with new requirements. 
  • Prepare for long-term contingency planning: The added uncertainty brought due to the USMCA’s ‘sunset clause’ will mean that North American businesses will need to make contingency plans over the long term due to its possible termination. Given the strict ROO and RVC requirements imposed under USMCA, companies will need to think carefully of how they may need to restructure their supply chains keeping the sunset clause in mind. 

Outlook

The entry-into-force on July 1, 2020 marks an important date that could both create potential new market opportunities but also compliance burdens for companies operating global supply chains in North America. For now, it appears unlikely that the USMCA entry-into-force date will be delayed despite U.S. and Mexican auto manufacturers, in particular, actively calling for reconsideration, citing that companies will not be able to comply with the new rules due to serious supply chain disruptions posed by the COVID-19 pandemic that has caused firms to suspend production at their North American factories. It also comes at a moment in which regional economic integration is being severely tested amid clashes between the U.S. and Mexico over the closing of Mexican factories considered essential for providing components for U.S. industries. 

Whether the USMCA will be successful in restructuring global supply chains and bringing manufacturing back to North America remains to be seen. Given that it can take years for a company to expand or reduce its manufacturing footprint in a particular country, firms are faced with limited options for modifying their supply chains at least in the short and medium term. Over the long term, companies may eventually decide to increase or shift production to their existing plants in North America in order to comply with higher regional content requirements. However, this could also have the unintended consequence of incentivizing foreign companies to move or shift production elsewhere and result in less North American content to avoid burdensome restrictions. 

Appendix

DATEEVENT
2026USMCA members will hold first review and revision of agreement with a possibility of extending the sunset clause.
2023The U.S., Mexico, and Canada must enforce the full USMCA stipulations. 
July 1, 2020USMCA entry-into-force date comes into effect.
June 24, 2020,Trump administration considers re-imposing 10 percent tariffs on Canadian aluminum imports.
December 10, 2019Canada, Mexico, and the United States sign a protocol officially amending the USMCA trade deal that will replace NAFTA. 
May 20, 2020Mexico repeals retaliatory tariffs against the U.S. after lifting of Section 232.
May 19, 2019Canada repeals retaliatory tariffs against the U.S. after lifting of Section 232.
May 17, 2019U.S. announces deal with Mexico and Canada to lift retaliatory tariffs.
November 30, 2018U.S. sends separate side letters to Mexico and Canada that allow for exemptions from import quotas on automobiles and auto parts. The U.S. also agrees to grant both countries at least a 60-day exemption period from any future tariff measures under Section 232. 
September 30, 2018U.S., Mexican, and Canadian negotiators reach deal to replace NAFTA. 
June 1, 2018Mexico and Canada impose retaliatory measures against U.S. after imposing steel and aluminum tariffs.
May 31, 2018U.S. imposes tariffs on steel and aluminum from Mexico and Canada.
May 18, 2017Trump administration submits notice of intent to U.S. Congress to renegotiate NAFTA.
January 23, 2017U.S. President Donald Trump signs executive orders signaling official U.S. withdrawal from the Trans-Pacific Partnership (TPP).
Appendix A: Important Dates For USMCA Trade Agreement

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