Don't underestimate USMCA changes

As if the coronavirus shutdown wasn't enough of a seismic shock for U.S. companies, they'll face another earthquake in just over a month, when the United States-Mexico-Canada Agreement takes effect.

The good news about the replacement for the North American Free Trade Agreement is that it finally gives us certainty around trade in the region after more than three years spent hanging on the next round of talks or tweet. It will bring investment back and provide needed stability.

The bad news is that companies' level of awareness about the deal and their preparedness for its implementation July 1 is worryingly low. A surprising number of companies are thinking about the deal as "NAFTA 2.0," little more than a spruced-up version of the old agreement.

But it should be clear by now that USMCA is a very different, more demanding beast.

Among 113 corporate respondents to a Plante Moran survey in late April, 49 percent said they had a limited understanding of USMCA and believed there was more they didn't know about it than what they did.

In addition, 19 percent thought the new deal was "just NAFTA 2.0 with some minor changes," while not a single respondent said they knew all the relevant provisions and had taken steps to address them.

If this is any guide, many companies are in for a rude awakening after July 1.

USMCA, whose central goal is to bring manufacturing back to the region through higher local content requirements, has a lot more teeth than NAFTA did. Under NAFTA's relatively simple rules, the determination of a product's content was often made at a warehouse by whoever was shipping the product. Often, it would be identified as NAFTA-compliant, even if it had just arrived from China and changed boxes. But penalties were rare.

By contrast, USMCA carries many more penalties and puts a lot more requirements on companies to provide data showing their compliance. The methodology for determining qualification of a product is significantly changing and requires companies to research and understand the harmonized tariff system.

No longer may a company solely rely on country of origin and transformation without first determining which methodology will apply for compliance.

The agreement implements a very specific procedure utilizing the harmonized tariff system to determine that method. This means the accuracy of a product's declared harmonized tariff code is critically important.

Using the wrong code could mean the methodology used to qualify your product for treaty benefits is invalid, making your product noncompliant with USMCA. Falsely declaring an item as USMCA-compliant is subject to hefty penalties with interest, additional duties and possible fraud charges.

The stakes are very high for automakers. They will have to certify that 75 percent of their components are made in the region, up from NAFTA's 62.5 percent. Additionally, they'll need to meet new labor value content requirements, with 40 percent of the labor needing to be paid at $16 or more per hour. Regional content requirements will also apply for steel and aluminum.

Demonstrating that they meet those requirements is the difference between being able to bring a light truck made in Mexico into the U.S. duty-free and being subject to a 25 percent tariff.

As a result, automakers are likely to start unilaterally putting provisions in their purchase orders requiring suppliers to comply with the new content rules. If those suppliers eventually come under audit and can't certify the content, they could be in legal jeopardy on a scale that could wipe out their business.

The impact is going to be felt hardest by the many smaller suppliers that don't have the technical ability to track and report country of origin and labor-rate information.

Their enterprise resource planning systems often aren't set up to properly track every aspect of their supply chain, leaving gaps at the lower levels that are crucial for accurate reporting under USMCA. Many companies have been reporting the country of origin of their supplies in a very loose way that simply isn't going to pass muster after July 1.

The complexity ramps up even further for the automotive industry, which is subject to very specific requirements that will demand detailed reporting and information exchange with carmakers.

In light of the coronavirus crisis, it's quite possible that automakers will request and secure an extension of the July 1 deadline. Still, the complexity and weighty implications of the deal mean that every company likely to be affected needs to start taking it seriously right now.