The pandemic has ushered in numerous pressures that are slowing the way OEMs are fulfilling vehicle manufacturing needs. 63% of OEMs recently surveyed by McKinsey anticipated their manufacturing costs had increased between 5% and 20% year-over-year in 2020, while 58% experienced warehousing cost increases. These pressures have resulted in reduced inventory, rising prices for prospective customers, and delayed repairs. Such disruptions are not helpful for automakers, which have led to parts shortages and heightened Lemon Law liability issues due to the number of days vehicles have been in repair.
Aggravating these problems, however, is the new United-States-Mexico-Canada Agreement (USMCA). The USMCA, which replaced NAFTA, implemented new regulations and protections addressing intellectual property, cross-border trade, and labor issues between the United States and its immediate neighbors. The law, which took effect in July 2020, has also implemented new rules and requirements that will impact OEMs and their supply chain activities for years to come.
Based on voluntary data from U.S. automakers, the USMCA is projected to create 76,000 U.S.-based auto industry jobs and generate $34 billion in new U.S. automotive investments.
The law is also expected to attract $23 billion in new auto part purchases from U.S. manufacturing partners. For OEMs, this progress will come at a cost. Substantial changes to rule of origin (ROO), labor value content (LVC), and regional value content (RVC) standards will dictate how OEMs will be managing their supply chains. Non-compliance, after all, will prove costly for OEMs. While vehicles that meet the law’s new sourcing and labor requirements will be considered duty-free, non-compliant cars will be subject to a 2.5% duty in the North American market. Here is how the USMCA is currently impacting the auto sector and what GCs must consider when weighing various avenues for compliance.
How the USMCA Impacts the Auto Sector
One way that the USMCA is disrupting manufacturing activities is through its new ROO requirements. Under NAFTA, OEMs were allowed to use parts not explicitly identified as originating from North America so long as they manufactured affected vehicles on North American soil. OEMs were therefore allowed to incorporate parts manufactured outside of North America into their cars and trucks for shipping into the United States, as they were “deemed” originating under NAFTA. The USMCA closes this loophole to encourage the creation of more jobs domestically and encourage investment and partnerships with North American factories. The law also added a ROO requirement that now requires manufacturers to source their battery cells and advanced batteries from North American suppliers. Given the Biden administration’s push to have EV vehicles make up half of all new vehicle sales by 2030, this ROO modification will weigh heavily on supply chain strategies for EV-focused OEMs.
The USMCA also increased regional value content (RVC) requirements for manufactured vehicles. Previously, vehicles were required to meet a 62.5% RVC threshold for vehicle parts overall, with lower specific RVC requirements for core parts like engines and transmission, principal parts like tires and brakes, and complementary parts such as interior panels and catalytic converters. The USMCA now requires OEMs to source 70% of their vehicle parts from North American manufacturers while increasing content requirements for specific part types. The AV vehicle sector, which is highly reliant on key sensing and computing parts, will likely feel a significant impact from this mandate. While OEMs could still incorporate non-North-American parts into their vehicles, they must ensure that 75% of their core parts, 70% of their principal parts, and 65% of their complementary parts contain North-American-derived materials. On top of these requirements, 70% of an OEM’s steel and aluminum purchases must originate from North America. That being said, the USMCA increases the de minimis threshold of non-originating materials allowed in vehicles to 10%, up from 7% under NAFTA.
Finally, the USMCA introduced a new labor-focused content requirement that will impact supply chain activities. Under NAFTA, OEMs did not need to consider wage requirements and labor sourcing when developing their fleets, encouraging the offshoring strategies that underpin today’s supply chain models. The USMCA’s Labor Value Content (LVC) requirement, however, represents a significant game-changer. To satisfy the law’s LVC requirement, manufacturers must ensure they produce at least 40% of the value of passenger vehicles and 45% of the value of light trucks must be in North American facilities where workers earn $16/hour on average or more. The USTR anticipates that the USMCA’s job sourcing requirements will lead to 76,000 additional jobs in the United States alone over the next five years, representing a 7.6% increase over pre-USMCA levels.
Cross-Border Supply Chain Considerations for OEMs Post-USMCA
Despite pleas from automakers to delay its implementation, the USMCA took effect on July 1, 2020. The USTDR did invite automakers in April 2020 to submit alternative staging plans detailing how they were planning to adjust to the USMCA’s content requirements over the next five years, but has already finished considering OEM proposals. Additionally, U.S. Customs and Border Protection (CBP) will still enforce NAFTA rules for vehicles entered into commerce on or before June 30, 2020.
As its member nations work out the USMCA’s finer details, OEMs can start taking substantial steps to ensure compliance, especially now that the CBP has concluded its Phase I implementation of the law. For one, GCs must coordinate with supply chain stakeholders to bring their supply chain contracts into full compliance with USMCA provisions. As part of this process, GCs should ensure their partners are required to disclose complete country-of-origin information for all materials they supply. Alternatively, in-house counsel can instead mandate sufficient information that allows the OEM to ascertain the value content of the parts they purchase. OEM GCs may also want to consider reshoring to localize their supply chain to manage the unpredictability of cross-border pandemic restrictions and find North American partners who can accommodate the law’s LVC requirements.
The USMCA will change the way OEMs mold their supply chains. With Legal’s help, OEMs can leverage strategic contract management to ensure their vehicles continue to receive duty-free treatment.
