Throughout January and February 2023, Baker McKenzie’s Canadian international trade team is publishing a series of articles focusing on developing Canadian trade compliance issues.
This article focuses on developments under Canada’s Free Trade Agreements.
Canada continues to face off against its trading partners in disputes arising under its free trade agreements (“FTA”). At the conclusion of 2022, Canada successfully resolved an ongoing dispute concerning the calculation of regional value content (“RVC”) under the USMCA’s automotive rules of origin. Canada remains the target of two dairy disputes, one filed by the United States and one filed by New Zealand, concerning its allocation of tariff rate quotas for dairy imports. Canada has also partnered with the United States in a developing dispute concerning Mexico’s treatment of foreign energy businesses. Finally, Canada looks to expand its FTA partners by announcing consultations on a proposed bilateral FTA with Ecuador.
USMCA – Automotive Rules of Origin Dispute
Claimant: Mexico and Canada
Respondent: United States
In August 2021, Mexico requested consultations with the US regarding its interpretation and application of the relevant provisions of Chapter 4 of the USMCA regarding the determination of the country of origin of passenger vehicles, light trucks and parts thereof. Canada notified its intention to participate in the consultations shortly thereafter.
In particular, the dispute focused on the approval letters issued by the United States to importers for individual “alternative staging regimes” (“ASR”), which provide an alternative set of import requirements for passenger vehicles or light trucks until January 1, 2025, stated that the calculation of core parts for all vehicles must “not count otherwise non-originating simply because the same part or component was used as part of the calculation to meet the core parts requirement.”
In January 2022, Mexico requested the establishment of a panel and Canada joined as a complaining party. In December 2022, the panel ruled in favour of Mexico’s and Canada’s interpretation of the Chapter 4 requirements. The Panel Report, released in January 2023, stated that producers must determine if a “core part” meets the 75% RVC (relying on Articles 3.8 and 3.9), and if it does, these core parts can be “rolled-up” to 100% RVC when calculating the RVC of an entire vehicle (pursuant to Article 4.5.4). In other words, the “result of the methodologies set forth in Articles 3.8 and 3.9 can be relied upon to calculate the core parts RVC used as an input for calculating the vehicles RVC”. Additionally, the panel found that the U.S. practice of issuing ASRs contingent on calculating the RVC based on the U.S. interpretation of same was outside the scope of the parties’ intentions and therefore a breach of the USMCA.
Looking ahead to 2023, automotive manufacturers now have certainty on how to calculate the RVC under Chapter 4. Canada’s success in this dispute will positively affect Canadian auto manufacturers in sourcing auto parts and their manufacture of USMCA eligible vehicles.
USMCA – Dairy TRQ Dispute
Claimant: Mexico and Canada
Respondent: United States
In 2021, the United States successfully challenged Canada’s dairy TRQ allocation measures. Pursuant to the USMCA, Canada may distribute the TRQs using an allocation mechanism defined as “any system…other than first come first served”. The vast majority of the TRQ was reserved for Canadian processors and further processors, while the remainder could be allocated amongst other applicants. While downstream Canadian processers were benefiting from imports of lower value products, downstream US processors were failing to obtain TRQ allocations to export processed dairy products at preferential duty rates to Canadian purchasers. The December 2021 Panel Report found that Canada’s decision to set aside a TRQ percentage for Canadian processors was inconsistent with its obligations under the USMCA not to “limit access to an allocation to processors”.
Following the Panel Report, Global Affairs Canada amended its dairy TRQ allocation measures, only to be met with yet another request for consultations from the United States. In December 2022, the United States requested consultations to challenge Canada’s market share approach to TRQ allocations. In December 2022 the United States made a panel request, which alleges that Canada’s allocation measures remain offside the USMCA. Specifically, the Unites States is challenging Canada’s decisions to:
- Exclude retailers and food service operators are eligible for TRQ allocations (only processors, further processors, or distributors are eligible);
- Calculates allocations on a market share basis using unique criteria for each market;
- Require applicant to have been “regularly active” in a prior 12 month period; and
- Fail to properly return and reallocate unused TRQs.
This challenge, in addition to the challenge by New Zealand outlined below, adds mounting pressure on Canada’s dairy supply management system, and Canada’s discretion to administer domestic policies that are consistent with its obligations under its FTAs.
The outcome of the most recent challenge, if successful, will likely result in further policy changes to Canada’s existing TRQ allocation measures. We expect the next Panel Report on this issue may opine as to how the allocation measures taken by Canada fail to comply with its obligations under the USMCA. Whether the Panel Report will circumscribe Canada’s significant discretion to design and implement allocation measures under Article 3.A.2., remains to be seen. The December 2021 Panel Report failed to express any opinion on the different methods and substantive result of the allocation measures. A successful challenge may increase competition between Canadian dairy processors and their U.S. counterparts, who may face less TRQ allocation hurdles to import consumer-ready dairy products.
USMCA – Energy Dispute
Claimants: United States and Canada
In July 2022, the United States and Canada requested consultations with Mexico regarding policies that purport to favour Mexico’s stated owned electrical utility, the Comisión Federal de Electricidad (CFE), and the state-owned oil and gas company, Petróleos Mexicanos (Pemex).
The United States’ and Canada’s requests for consultations generally raise four issues:
- Amendments to the Electric Power Industry Law (“EPIL”) permits Mexico’s national grid operator to prioritize CFE over private competitors when dispatching electricity into Mexico’s grid, allows the Energy Regulatory Commission (“ERC”) to revoke privately held self-supply contracts and to review all Power Purchase Agreements made with private producers, and reduces the value of Clean Energy Certificates held by private producers.
- The EPIL provides less favourable treatment to imported energy products and foreign energy enterprises than the treatment applied to CFE. Mexico is alleged to have blocked private companies’ ability to operate renewable energy facilities, import and export electricity and fuel, store or transload fuel, and build or operate retail fuel stations by delaying or denying permit applications and suspending and revoking permits.
- An extension granted to Pemex to comply with regulatory requirements for Mexico’s automotive diesel fuel standards.
- An energy policy and supply guarantee that incentivizes or requires current or future users of Mexico’s natural gas transportation service to source natural gas from CFE or Pemex and imposes restrictions on natural gas imports.
The parties allege that these measures breach the USMCA by providing treatment to imports that is less favourable than like products of national origin, by failing to accord national treatment to non-Mexican goods, by restricting imports and exports, and by the government failing to impartially exercise its discretion or administer its laws in a consistent, impartial and reasonable manner.
Canada and the U.S. agreed to extend their consultations beyond the mandated 75-day window. To date, there has not yet been a request to establish a panel. In January 2023, the President of Mexico was reported to have met with several Canadian energy companies to informally resolve their disputes. There is no indication that the dispute proceedings have been suspended or terminated. Accordingly, Canadian energy companies should continue to follow this dispute to determine what steps may be necessary to protect their existing investments or what energy-related opportunities may be present in Mexico if the resolution of these disputes creates a favourable investment environment.
CPTPP – New Zealand Initiates Consultations on Canada’s Dairy TRQs
Claimant: New Zealand
In May 2022, New Zealand initiated dispute settlement proceedings against Canada under the Comprehensive and Progressive Trans-Pacific Partnership (“CPTPP”) regarding Canada’s administration of dairy TRQs. In November 2022, New Zealand requested the establishment of a panel to hear the dispute. The challenge is the first dispute under the CPTPP. New Zealand alleges that Canada’s measures for administering TRQs are inconsistent with the CPTPP specifically, they are: not “fair and equitable”; do not allow importer to use TRQs quantities fully; limit the use of TRQs; limit all persons eligible from consideration for TRQ allocation; limit allocation to processors; allocate TRQs in non-commercially viable shipping quantities; and TRQ allocation is not conducted in an equitable and transparency method where applicant requested exceed quota size.
On their face, the arguments raised by New Zealand are similar to those raised by the Unites States USMCA challenge. Given the similarity of the drafting outlining Canada’s obligations under the USMCA and the CPTPP, which was relied on as evidence by Canada of common intent in the first UMSCA challenge, the likelihood of a successful challenge to Canada’s TRQs by New Zealand is high.
Canada Initiates Ecuador FTA Consultations
Canada launched consultations on future bilateral free trade agreement negotiations with Ecuador. Currently, imports from Ecuador are subject to MFN preferential tariff treatment pursuant to its World Trade Organization membership status. Currently, bilateral merchandize trade between Canada and Ecuador is approximately $1 billion CAD. Ecuador’s top exports include crude oil, bananas, seafood, coffee, and cut flowers and its major trading partners include the United States, Peru, and Chile.
Any eventual FTA arising from the consultations will join the growing list of Central and South American countries that have entered into FTAs with Canada (Peru, Panama, Honduras, Costa Rica, Colombia, and Chile). A Canada-Ecuador FTA will create new opportunities for Canadians to import goods originating in Ecuador under a new preferential tariff treatment. An FTA would also create a new export market for Canada-originating goods that would be subject to preferential treatment in Ecuador.