TPP Automotive Origin Rules: The New “Rules of the Road”

Mr. Froman has gone on to say that the TPP is having a “magnetic” effect on countries outside the TPP block who want “in” on the agreement, as they realize the TPP has set the “rules of the road” for years to come. Therefore, in advance of the likely release of the TPP text later this month, it may be helpful for North American automotive executives to start thinking about how to approach and analyze the TPP rules of origin issues in the context of other competitive issues currently on their plate.

The Underlying Environment – Existing and Prospective Cost Challenges

North American automotive parts producers have been facing new costs pressures due to more stringent fuel-economy standards that these components and systems have been designed to meet.  Other cost increases are due to increases in the costs of regional inputs such as steel, rubber, petroleum and plastic prices and more expensive labor. Presumably these materials costs will keep rising, leading to similar increases in component costs. In addition, recent events will likely lead to more federal regulations requiring certain safety features, which will add to these costs. The purpose of this alert is to focus on the TPP automotive rules and how they can be used by readers to help make critical cost decisions in the months ahead.

Rather than increasing the price of the automotive components, North American parts suppliers will likely be seeking solutions to reduce the costs of these components. This could include looking for cheaper imported materials and components. Lower costs of these imports, however, must be balanced against global sourcing costs, such as transportation and logistics costs, tariffs, and currency fluctuations, and other variables.

These trends underlie the importance for automotive suppliers to conduct reviews of the economic, competitive, regulatory, and technological factors affecting input costs and the prices of automotive components and systems. This review should include the identification and assessment of the risks and opportunities for each strategic option and priority. Included in this analysis, automotive suppliers should be assessing their current utilization of the NAFTA and how this might be affected, undermined or enhanced by the TPP.

The Potential Risks and Opportunities Presented by the TPP Origin Rules 

For NAFTA automotive parts suppliers, the TPP will present particular risks in the potential increase in competition as similar parts sourced from producers located outside of North America could be eligible for preferential duty treatment for which these parts currently do not benefit under the NAFTA. At the same time, NAFTA automotive suppliers should benefit from duty free access to additional markets in the Pacific Rim, which could be in the form of increased exports to or investment in these countries. What will drive these decisions is the push/pull of achieving the lowest possible costs irrespective of benefits conferred by the TPP and ensuring that the TPP content requirements are satisfied so that parts produced can be exported to any TPP country without the imposition of tariffs or related fees.

However, as the NAFTA automotive origin rules proved, the issue is more than the regional content value, but the detailed rules governing how the origin is counted.  Moreover, individual North American automotive parts producers face varying risks and will pursue their own unique opportunities according to their respective risk appetite and strategic objectives, based in part on the TPP origin rules.

How Origin is Counted

The TPP rules of origin, like other free trade agreements, will determine how much of an automotive part must be made within a TPP country in order to receive preferential tariff treatment under the agreement. The details will not be actually known or confirmed until the actual TPP text is released and implementing regulations or guidance is issued, but here are a few issues to note and monitor:

• Goodbye to the automotive tracing rules. Most familiar with the complex automotive rules were glad to hear reports that similar rules are not in the TPP mainly because of the administrative burden these rules created. Oddly, however, the tracing rules often serve to raise the NAFTA origin content of an automotive vehicle or part. US officials have noted that the 62.5 percent NAFTA rule for light vehicles can actually represent as little as 53 percent – and one of the reasons a lower regional value content in the TPP was accepted by many automotive assemblers. The effect on automotive parts producers will certainly vary by company.
• All costs are not created equal. In determining what costs are included in the originating content of an automotive vehicle or part, current reports indicate that the “net cost” method will be used. This is good news for those who remember the “direct cost” requirements under the old Canada-US Free Trade Agreement, and how the US and Canadian customs officials had differing opinions on what these costs included. While the NAFTA “net cost” rules were subject to less interpretation, any type of cost determination under the TPP will be subject to scrutiny when origin claims are audited, in some cases years after the duty benefit is realized by the TPP claimant.
• One for all and all for one – accumulation. Similar to the NAFTA accumulation rules, TPP automotive parts manufacturers will be able to treat as originating value the cost of inputs produced in TPP-member countries according to summaries prepared by the TPP governments. This will be important for many NAFTA automotive parts companies that benefit today under NAFTA from sourcing parts from all three NAFTA countries. However, this also will significantly reward Japanese automotive part producers that depend on plants located in Malaysia and Vietnam for cheap inputs.
• The Great Unknown. While predictions on ratification of the TPP by the US Congress and the legislatures of other countries vary in degree by the number of individuals to whom this question is posed, there are other uncertainties that automotive executives should factor into their risk analysis.
  • Effective Date – If the TPP is implemented in time frames similar to NAFTA, companies will not have a lot of time to prepare. The US ratified the NAFTA on December 8, 1993 and NAFTA was fully implemented 3 weeks later on January 1, 1994 – including the uniform regulations that provide the detailed rules governing the origin determination of products.
  • NAFTA or TPP – A few commentators have suggested that US, Canadian and Mexican companies will have a choice between the NAFTA and TPP rules regarding the rule of origin to be used for a specific product. This option would be a surprise to most TPP observers as there is nothing in any official government announcements that describe this flexibility.
  • TPP Transition – Presuming that TPP provision will control all origin determinations, it remains to be seen whether there will be a transition period for origin determinations for NAFTA countries beyond the TPP effective date. But until the TPP text is released and any related bilateral or multilateral agreements are made public, the interplay between the NAFTA and the TPP origin rules will only be conjecture.  

What Automotive Companies Can Do Now

Despite some uncertainties, automotive parts companies can start planning now to address possible scenarios which present specific risks and opportunities.

1. For automotive parts, because the regional value content is reported to be reduced from 60 percent under the NAFTA to 45 or 40 percent (and 35 percent in some cases) under TPP, there may be parts produced by NAFTA automotive suppliers that today do not qualify for NAFTA duty free treatment, but would qualify for TPP duty free treatment under these new content levels.
2. Because the regional value content requirements are lower under the TPP, a NAFTA parts supplier may be able to qualify its products using cheaper (or preferred supplier), non-qualifying inputs from non-TPP countries.
3. Conversely, if an automotive supplier’s current NAFTA products benefit from the automotive “tracing rules,” some of these products may not qualify under TPP even if they qualify for NAFTA today.
4. For North American producers of automotive parts that have existing plants in Pacific Rim countries, these plants could create new market opportunities instead of serving just the local market, which was sometimes the driving force behind theses plant locations.
5. Conversely, North American parts producers may have located plants in some TPP countries to avoid the extremely high duties (Vietnam and Malaysia, as much as 70 percent). Following the prescribed TPP phase out period, duties will be zero, which might lead to rethinking whether these plants make strategic sense (especially if plant consolidation is an objective of the company).
6. There will be new investor-state protection rules in the TPP that will modify or replace NAFTA’s Chapter 11 provisions designed to protect cross-border investors and facilitate the settlement of investment disputes. These provisions will be important risk points for companies to understand that wish to establish or enhance their foot print in TPP countries.

How the TPP automotive rules will affect the North American automotive parts industry will vary from company to company. For larger automotive parts companies located in North America, the TPP presents significant market expansion opportunities both within and outside of the NAFTA countries, although a watchful eye should be kept on the competition with respect to its current business in North America. Small and medium sized automotive parts companies that primarily source from the NAFTA countries are likely not to face severe origin challenges. At the same time, these companies may face pressure to find cheaper inputs from other TPP countries as well as non-TPP countries to counter competition from non-NAFTA automotive parts producers located in other TPP countries.

***

Related Posts:

Travels in Canada — Part Seven: Chatham, Ontario — The TPP: Nuts and Bolts

The Signing of the TPP- What You Need to Know and What Lies Ahead for the North American Automotive Sector

Travels in Canada — Part 6: Washington, DC — The TPP Takes Shape

The TPP and the Auto Industry: Now is Not the Time to Wait