In the light of the disputes in which the Mexican Government has been involved within the context of the United States-Mexico-Canada Agreement (USMCA), it seems essential to conduct a general analysis of such conflicts, as they must be addressed through the Dispute Settlement Mechanism, an instrument aiming to enable the three countries to find mutually satisfactory solutions to their trade disputes, in order to build a functional multilateralism, based on certainty for the region’s markets.

Author: Guillermo Sánchez Chao, Partner, Chevez Ruiz Zamarripa

Background

Since 2017, when negotiations for a new commercial treaty to replace the North American Free Trade Agreement (NAFTA) began, one of the fundamental subjects on which the discussion between the authorities of the three countries centered, was the modernization of the Dispute Settlement Mechanism, with the aim of finding improved institutional channels to deal with possible conflicts regarding the application and interpretation of the new trilateral commitments.

Since the USMCA  became  effective  on  July  1, 2020, the Dispute Settlement Mechanism provided for in Chapter 31 has been used on four occasions. Since then, (i) the United States initiated proceedings against Canada regarding the distribution of quotas in the dairy sector; (ii) Canada against the United States for alleged safeguard measures on photovoltaic cells; (iii) Mexico and Canada against the United States for the interpretation and application of rules of origin in the automotive sector; and most recently (iv) the United States and Canada against Mexico for its recent energy policies.

In recent months, U.S. authorities have raised concerns about several measures that the Mexican government is seeking to adopt in order to prevent the use of genetically modified corn and have suggested the possibility of initiating a procedure against Mexico in said regard.

The following is a general analysis of those disputes in which the Mexican State is involved, conflicts which might cause a major impact on the industries involved and their supply chains.

Automotive rules of origin

On August 20, 2021, the Mexican Government requested formal consultations with its U.S. counterpart, regarding what it considered to be an erroneous interpretation of various provisions of the Treaty and its Uniform Regulations, under which the U.S. authority applies a much stricter method than that agreed between the three countries to calculate the regional value content of vehicles manufactured within the region, thus restricting the number of cars and trucks with the possibility of accessing the benefits of being considered as originating in North America.

It should be noted that compared to NAFTA, which required 62.5% regional content for passenger vehicles and light trucks, the USMCA establishes a higher percentage that increases over the years, going from 66% required in 2020, to 69% in 2021, 72% in 2022 and finally, to a percentage of 75% applicable in 2023.

In the absence of  significant  results  from  the consultation procedure or the ministerial approaches between the countries to settle the dispute, on January 6, 2022, Mexico requested the establishment of an independent panel to solve the conflict, a proceeding to which Canada joined as a complainant.

Under such terms, the proceeding has been conducted in accordance with the terms and time frames established by the Agreement as, according to several sources, the report to be published by the independent panel would confirm the U.S. interpretation of the automotive rules of origin as incorrect and in violation of the USMCA, indicating a favorable resolution  for Mexico and Canada, as well as more flexible requirements for the entire industry.

Should the procedure result in the elimination of the controversial method, compliance within the rules of origin would be considerably easier for the companies in the sector, whose vehicles could reduce their prices as they would no longer be subject to the tariffs imposed by the U.S. authorities

Mexico’s Energy Policies

On July 20, 2022, the United States and Canada submitted formal requests to Mexico to initiate consultationsregardingtherecentenergypolicies adopted by its current administration in what they consider to be a generalized governmental effort to favor the Federal Electricity Commission (CFE) and Mexican Petroleum (PEMEX), both state-owned enterprises, to the detriment of Canadian and U.S. products and investments  in the sector, which they consider to be a direct violation of multiple commitments established by the USMCA.

Among the controversial measures is the 2021 reform to the Electricity Industry Law, which proposed to change the order of dispatch, that is, the hierarchy or priority in which generation plants must inject the energy they produce into the grid to be distributed and used, favoring the energy generated by CFE as the first to be employed, to the detriment of the domestic and foreign private sector.

In addition, there are claims regarding various government agencies such as the Ministry of Energy (SENER) and the Energy Regulatory Commission (CRE) hindering and diminishing the ability of private Canadian and U.S. companies to operate in the sector, by delaying, denying or simply ignoring applications for new permits, while revoking or suspending those existing in the matter.

Independently, the United States also claimed that Mexico has granted a special and exclusive five-year extension to PEMEX to reduce the sulfur content in the automotive diesel it sells (seen as an undue advantage to the detriment of its nationals), as well as a new “supply guarantee” strategy issued by SENER, by which new requirements would be demanded from the users of the natural gas transportation and infrastructure services, among them, to acquire such hydrocarbon only from PEMEX or CFE, which in fact, could be considered as a restriction to the exports of said product originating in the United States.

Even if to date, the three countries have not found a mutually satisfactory solution to the dispute, the consultation period to do so has been considerably extended,  and  according  to information from the Mexican Ministry of Economy, a third period of negotiations would take place between December 2022 and January 2023, far exceeding the approximate period of 75 days established by the Treaty.

Such an extension can only be explained on the basis of political will between the parties to find a favorable outcome with less damage to their economies, before requesting the launch of a contentious proceeding to be resolved before a panel, with all the implications this could entail.

Prohibition on genetically modified corn

By Decree of December 31, 2020, the Mexican Government established a transition  period  to achieve the total substitution of genetically modified corn grain within its national territory, which would culminate on a date no later than January 31, 2024. The above, by ordering the entire public administration to revoke and refrain from granting permits for the environmental release of such seeds, in what the authorities consider to be an effort to contribute to the country’s food security and sovereignty, as well as to protect public health.

As Mexico heads the list of buyers of yellow corn from the United States, the abrupt ban proposed by the Mexican government would imply a larger-scale disruption for U.S. exports, while at the same time, it is considered practically impossible to replace the product in its entirety during such a short period of time without direct damage to the Mexican economy, since the product serves as a primary input in various activities such as the production of animal feed, flour and starches.

The U.S. authorities have stated that if such measure is adopted by the Mexican Government, they could request the initiation of a procedure under the USMCA, for violations to the commitments agreed by the country in terms of biotechnology, which authorize the use of genetically modified products.

Thus, the authorities of both countries have already established a dialogue on the matter   in order to prevent the conflict from escalating, avoiding a disruption in U.S. corn exports, as well as a possible deficit of the product within Mexican territory. To date, Mexico claims that it is working on modifications to the controversial Decree, proposing to extend the transition period until 2025.

Steps to follow

As previously mentioned, the addressed controversies are subject to the Dispute Settlement Mechanism provided for in Chapter 31 of the Treaty, either solved by means of approaches between the Governments at a consultation level, or in accordance with the determinations made by the independent panels to be established in each matter.

Given this, paying attention to the behavior of the States in terms of compliance within the agreements reached to conclude such disputes is of the utmost importance, since failure to comply with them could lead to other countries imposing tariffs either on the industries involved or on any other industries, a circumstance which could affect the creation of employment, as well as the development of the sanctioned country economy.

On the other hand, it is imperative for industries to be aware of such procedures, not only to ensure their compliance with the standards to regulate them in Mexico, but also to recognize possible commercial opportunities, thus being able to maximize their operations both in the country and in the region.

Contact: Guillermo Sánchez Chao, Partner, Chevez Ruiz Zamarripa – chao@chevez.com.mx