FTAs a Panacea or Placebo



We are seeing and hearing a lot about how the way forward post-Brexit is to ensure the UK has good Free Trade Agreements (FTAs).  We are even talking about having a FTA with the remaining 27-members of the EU.   But is having lots of FTAs the panacea that certain government ministers and spokespersons would like us to think or simply a placebo to pacify the unwary?  Speaking as someone who has worked in international trade trying to put FTAs into practice for 32 years, FTAs are a pain in the “articles”!

Let’s get one thing straight, FTAs are all about money. The customers in the receiving country pay less import duty if the goods are moved under FTA terms.  But companies have to prove the goods meet the Rules of Origin (ROO) and this is a cost to business.  At a recent Compliance Conference held in Brussels a negotiator for EU FTAs asked an audience of around 200 representatives from big/ medium-sized businesses and related service providers how many used FTAs at export.  About 6 people put their hands up.  She was taken aback and asked again.  Same response so she asked why and the answer was that it is too expensive and too difficult and time consuming to obtain, maintain and supply the required evidence of origin.  And, it can be.

Free Trade Agreements require negotiation and within the negotiations “rules of origin” (ROO) are established for the goods covered by the agreement (not all goods have to be covered in an agreement).  These rules are presented in the FTA as List Rules.  List Rules are written to ensure that the FTA only benefits the trading parties signing up to the agreement, though addition supply markets can be included if the contracting parties agree – this tends to be under cumulation rules. 

As an annex there are two examples of FTA lists rules, same description of goods 3 different EU-FTAs, varying qualification rules.  The EU and the World Trade Organisation (WTO) are aiming to standardise Rule of Origin for preference but, to be pragmatic, each country has their own agenda when it comes to trade and protecting domestic products so variants are to be expected.

You will notice that each of the ROO start with the word “manufacture” – this is because the goods must be manufactured in a signatory country of the FTA.  In other words, it must have undergone more than a “simple process”.  Simple processes are defined as simple assembly, re-packing, re-labelling etc, etc.  The definition of “simple processes” is outlined in the Articles to the FTA which come before the List Rules in the agreement, and they can differ per agreement.   Final point here, the ROO will often state a limit on non-originating materials/items used in the manufacturing process – this is called either a requirement to establish a Regional Content level or Non-Originating Material content.

Now this is important.  Currently the UK is one of 28 countries, which means, for UK exports, manufacture can take place in any one of the 28 countries to meet the qualification rules.  It also means we can source materials/ items from 27 other countries for goods produced in the UK and these EU materials/ items are seen as “regional content” that “originates”.  If we have a UK FTA with another country, such as the USA or India, would all materials have to be UK origin?  Is that possible taken our supply chain has been closely linked across the EU for 40 years?

Turn this around and look at the UK companies that currently sell materials, parts, assemblies into the other 27 EU member states.  Their EU customers can use what is made in the UK as a percentage of the qualifying content.  So, if the UK is no longer an EU member and does not have a link into EU FTAs, why would some EU companies continue to buy UK origin goods if they want to establish EU preference origin for their exports overseas?  If UK origin goods are now non-originating it may mean that the goods our customers make in Germany, France, Poland, etc will no longer qualify under the EU-FTA and that will have a negative effect on their sales prices.  Oh, a good negotiation point I hear some of you saying, perhaps but isn’t it just simpler to buy the parts, materials from one of the other EU-27 countries and retain the qualifying status?  How much of what we provide is unique?

But to go back to an earlier point, EU businesses are not using FTAs as much as trade negotiators believe.  It is actually easier and cheaper for larger exporters to give their customer a discount to make up the differential between standard customs duty and preference duty rates.  You have to have detailed Bill of Materials, or ingredient lists so you can establish the manufacturing make-up of the product.  You then need to know the tariff heading of everything you buy from outside the EU and the percentage value impact it has on your finished item.  Much worse though is that even if you do buy material, goods, components from a UK or EU supplier you have to get them to certify that the goods meet the rules of origin for each FTA you are working with and update this statement annually (though the statement can be valid from 1 month to 2 years).  This has to be maintained because companies are constantly adapting and adjusting their source supply chains – maybe moving away from buying within the EU to low-cost source markets, which for preference purposes means we now have more non-originating content and have to start with the calculations all over again (and sometimes means our goods no longer qualify for preference – whoops!).  The Long Term Supplier Declaration (LTSD), as it is termed, is important because though we may buy something from an EU member country it doesn’t mean it was made there, they could have imported it from China or USA for example.

There are software companies that provide systems that will do the preference calculations – great! But we still have to obtain, check and maintain the required data.  I believe the USA did a survey on compliance levels on exports made to Canada and Mexico under NAFTA and they found that many of the exports declared as qualifying under the agreement actually did not meet the ROO when audited.  This led to fines and penalties on the exporter and the importing company, as well as a potential fine for not checking the NAFTA certificate was correct before using it, had to pay the customs duty they thought they had saved (back 3 years) to the authorities.

The nice thing is that it isn’t mandatory to use FTAs currently, but if you do use them you have to be compliant with the regulations.  But with all the press and government statements appearing to see Free Trade Agreements as our way through to the other side of being an EU member I’m concerned the cost and practical implications of using FTAs is being overlooked.  Has anyone surveyed businesses to see who uses FTAs currently and how they manage and staff the administration?  Has anyone asked HMRC about the amount of audits and checks needed at import and export to ensure compliance?  Or maybe no one really cares about what has to happen as long as it makes good headlines – the placebo with nasty side-effects.

Annex 1: Example Cucumber drink

Annex 2: Example pump for liquids

Article written by Sandra Strong Managing Partner of Strong & Herd LLP

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Understanding Origin and Preference Rules

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