On January 15, 2019, President Trump and Chinese Vice Premier Liu He signed the long-awaited “phase one” trade deal at the White House. The deal represents the first step towards a comprehensive agreement between the two nations and progress in the U.S.-China relationship. The deal will help ease trade tensions signaling a truce in the trade war, at least for a while.  The signing also marks the beginning of “phase two” negotiations, which will almost certainly be more contentious. “Phase two” will not be completed before the November election.

The Agreement

The agreement has eight chapters, including chapters on (1) intellectual property, (2) technology transfer, (3) agriculture, (4) financial services, (5) macroeconomic policies and exchange rate matters and transparency, (6) expanding trade, and (7) bilateral evaluation and dispute resolution.

As part of the agreement, the United States has already postponed a 15 percent tariff that was scheduled to be imposed December 15th on $160 billion of Chinese imports. The United States has also agreed to reduce tariffs on an additional $120 billion of Chinese imports from 15 percent to 7.5 percent. The reduction is set to take place February 14, 2020, according to a draft Federal Register notice from the United States Trade Representative. The agreement commits China to increase purchases of U.S. goods and services by $200 billion over 2017 levels. This includes $77 billion in manufactured goods, $32 billion in agricultural goods, $52 billion in energy, and $37 billion in services over the next two years. All purchases will be at market prices, and market conditions will dictate the timing of purchases.

The intellectual property chapter covers trade secrets, pharmaceuticals, patents, trademarks, geographical indications, and the enforcement of pirated and counterfeit goods. Specifically, it expands the scope of trade secret misappropriation liability, shifts the burden of proof requirements in civil cases, and adds criminal penalties for willful misappropriation. It also creates a mechanism to resolve pharmaceutical patent disputes early in the process and extends the effective patent term of patents experiencing delays in the Chinese approval process. The agreement requires that China increase its civil and criminal penalties to levels sufficient to deter intellectual property violations.

The technology transfer chapter covers various practices the United States determined to be unreasonable or discriminatory. China has agreed to end the practice of forcing foreign companies to transfer their technologies to Chinese firms as a condition for obtaining market access and administrative approvals. The chapter requires China to enforce its technology transfer laws in an impartial, fair, transparent, and non-discriminatory manner. China must publish the rules of procedure, provide parties adequate notice, allow parties to review evidence and respond, and allow parties to have legal counsel for the proceedings.

The agriculture chapter covers structural barriers to trade separate from China’s increased purchase obligations.  The provisions should increase U.S. food, agriculture, and seafood exports and market access. The provisions aim to increase American farm and fishery income and promote job growth nationwide. The deal removes barriers for U.S. beef, pork, poultry, processed meat, rice, seafood, and pet food, among others.

The financial services chapter allows U.S. financial service providers to compete fairly and expand in the Chinese market. The chapter covers a broad range of financial services including banking, insurance, securities, and credit rating services, easing restrictions U.S. firms currently face in China. The provisions of this chapter also require China to eliminate foreign equity limits for securities companies, fund management companies, and U.S. life, health, and pension insurance providers.

The macroeconomic policies and exchange rate matters and transparency (currency) chapter requires both parties to refrain from competitive devaluations and targeting exchange rates for competitive reasons. The chapter also reaffirms the parties’ commitments to disclose relevant data publicly and refers conflicts on these issues to the dispute resolution system. The United States removed China’s currency manipulator designation earlier this week.

The agreement also includes a chapter on dispute resolution. Enforcement has always been problematic in agreements between the United States and China.  The chapter creates a Trade Framework Group to discuss high-level implementation issues and a Bilateral Evaluation and Dispute Resolution Office in each country to deal with low-level implementation issues and settle disputes. The dispute resolution process begins with the complaining party launching an appeal.  Designated officials from the opposing party’s Bilateral Evaluation and Dispute Resolution Office then assess the appeal. If those officials cannot resolve the issue, the appeal escalates to the Deputy United States Trade Representative and the designated Vice Minister, and then to the United States Trade Representative and the designated Chinese Vice Premier. If they cannot resolve the dispute, the complaining party can suspend obligations under the agreement or adopt a proportionate remedial measure. If the suspension or remedial measure was made in good faith, retaliation is not allowed. The parties may withdraw from the agreement if they believe the action is taken in bad faith.

Next Steps

While the agreement is a step in the right direction, the trade war is far from over. According to President Trump, the “phase one” agreement only covers about half of the relevant issues both sides wish to see addressed.  Many of the “phase two” issues are more complex and controversial. These issues include Chinese government subsidies, intellectual property theft, state control of the Chinese market, and discrimination against foreign firms. In the meantime, U.S. tariffs will remain in place on approximately $370 billion of Chinese goods. Both sides will be extremely reluctant to give ground on many of these issues without gaining significant benefits.

“Phase two” negotiations are set to begin shortly now that “phase one” has concluded. The President noted, however, that the United States and China would not complete the agreement before the upcoming November election.

The success of “phase two” will depend in part on how the United States and China implement the “phase one” agreement. If both countries keep up their end of the bargain and the enforcement provisions effectively resolve any disputes, negotiations will likely continue in earnest. If the parties ignore their commitments and the dispute resolution process proves toothless, the chances of concluding a comprehensive “phase two” agreement will diminish significantly.

There are also concerns that some of China’s commitments are infeasible. The commitment to purchase an additional $32 billion in agricultural products, for example, represents a massive increase over the highest level of trade between the United States and China. China’s ability to purchase such a large amount of agricultural products is uncertain. To do so, China would likely have to divert imports from current sources, distorting trade worldwide. The language of the agreement seems to contemplate this. It notes that Chinese purchases are subject to market conditions and WTO rules. It also notes that the United States must ensure that it will make available enough goods and services to allow China to meet its purchase obligations. This suggests that parties may view these amounts as ambitious targets, not ironclad purchase commitments.

The other purchase requirements also raise questions about implementation including questions such as how much, to whom and when? Many details need to be addressed before progress on “phase two” can be expected.

With the “phase one” agreement complete, tensions should ease for now. This first step towards ending the trade war is an important one, but implementation will be the true judge of its success.

On October 18, 2019, the United States Trade Representative (USTR) announced an exclusion process for products included on China Section 301 List 4A, which covers approximately $120 billion of imports. Imported products on this list are presently subject to an additional 15 percent duty, which went into effect September 1, 2019 – that duty rate is scheduled to be reduced by half starting in mid-February.

Importers of products on List 4A must file exclusion requests with the agency by January 31, 2020. Once USTR posts a request, there is a 14-day comment period for interested stakeholders to oppose or support, followed by a 7-day rebuttal period for the requestor to respond. USTR will grant approvals and denials on a rolling basis.

If granted, any importer of a product may utilize an exclusion, which would apply retroactively to the September 1, 2019 effective date. Importers may use an exclusion going forward, and also may seek duty refunds through U.S. Customs and Border Protection. USTR has set a uniform expiration date of September 1, 2020 for List 4A exclusions, regardless of the date they are granted.

Pursuant to the U.S.-China Phase One trade deal signed January 15, tariffs on List 4A products will be reduced to 7.5 percent from 15 percent. According to a draft Federal Register Notice made available this week, the effective date of the roll back is February 14, 2020. The rate reduction is not retroactive from September 1, 2019.

The exclusion process does not cover products on List 4B, which were scheduled to be assessed an additional 15 percent duty effective December 15, 2019.  As a result of the Phase One negotiations and agreement, the President suspended indefinitely the application of additional 301 tariffs on List 4B products.

Today the president signed a new Executive Order (E.O.) announcing expanded primary and secondary sanctions on Iran, focused on the construction, mining, manufacturing, and textile industries.  OFAC also sanctioned a significant segment of the Iranian metals industry today, targeting the largest iron, steel, aluminum, and copper producers in Iran under an existing sanctions authority focused on the metals industry.  The actions are the latest move by the United States to expand sanctions on Iran and present new risks for global companies that conduct business in the metals, construction, mining, manufacturing, and textile industries in Iran, particularly given heightened tensions between Iran and the United States.

First, the new E.O. authorizes the Office of Foreign Assets Control (OFAC) to designate as an Specially Designated National (SDN) any person that operates in the construction, mining, manufacturing, or textiles sectors of the Iranian economy.  The E.O. also authorizes OFAC to sanction any person – including those outside of Iran – that that engages in a transaction for the sale, supply, or transfer of significant goods or services to or from Iran used in connection with the Iranian construction, mining, manufacturing, or textile industries.  In other words, non-U.S. companies that engage in significant transactions related to these sectors of the Iranian economy are at risk of being sanctioned by the United States.  U.S. persons, including other companies and U.S. banks, cannot do business with SDN’s.  Moreover, many global banks will not do business with SDN’s, even if U.S. sanctions jurisdiction does not apply to the particular transaction.  When a person or entity is designated as an SDN, bank accounts and other assets in the U.S. are blocked – essentially frozen.

Section 2 of the E.O. authorizes correspondent account and payable-through account restrictions on non-U.S. financial institutions that process or facilitate significant transactions related to these sectors. The E.O. also allows OFAC to expand the list of industries subject to sanctions under the E.O.

Second, OFAC designated the 13 largest steel and iron manufactures in Iran and the largest copper and aluminum manufacturers in Iran as SDNs today, a major step in imposing sanctions on the metals sector in Iran.  Under E.O. 13871, non-U.S. companies that conduct significant transactions with any of these new SDNs could be subject to sanctions from OFAC.

Today OFAC also sanctioned two Chinese entities for engaging in significant transactions related to the Iranian metals industry, including the purchase of substantial quantities of steel from Iran, the sale of carbon blocks, cathode blocks, and graphite electrodes to Iran for use in metals production, and the facilitation of sales of Iranian-origin copper to a customer in China.   The designation of the Chinese entities is an example of OFAC’s authority to sanction non-U.S. firms that conduct significant business involving Iran.

Please contact us with any questions on these developments.

 

 

Late last month, the Directorate of Defense Trade Controls issued a long-awaited interim final rule regarding what qualifies as the export, re-export, or transfer of technical data (a “controlled event”) under the International Traffic in Arms Regulations (“ITAR”). Specifically, in 2016, the Bureau of Industry and Security (“BIS”) issued a final rule clarifying that the transmission of technology outside of the U.S. using end-to-end encryption did not qualify as a controlled movement, provided that the technology is encrypted up to a specified standard. DDTC did not adopt an equivalent provision in its version of an overlapping final rule, creating significant compliance and logistical considerations for companies falling under the jurisdiction of both entities, especially those entities for which it was impractical to consolidate all IT infrastructure within the U.S.

In the interim final rule, DDTC is largely aligning its rules regarding “controlled events” with BIS’s rules, making DDTC’s treatment of technical data much more permissive than it is currently. Provided that all of the following are satisfied, sending/storing technical data will not qualify as an export: 1) the technical data is unclassified; 2) it is secured using end-to-end encryption; 3) it is secured using cryptographic modules compliant with FIPS 140-2 or equivalent standard; 4) it is not intentionally sent to a person or stored in a proscribed country (i.e., listed in ITAR 126.1) or the Russian Federation; 5) it is not sent from a proscribed country. These amendments are included in a new section of the ITAR, located at 22 C.F.R. 120.54.

Although this alignment does simplify companies’ responsibilities regarding the storage and transmission of technical data, compliance concerns remain that must be mitigated. First, if the technical data is decrypted by someone other than the sender, a U.S. person in the U.S., or a person otherwise authorized to receive the technical data, then the technical data is not secured using end-to-end encryption and the original transmission will be deemed a controlled event. Further, DDTC declined to create a safe harbor under which companies would only have to seek contractual assurance from cloud providers that technical data would not be stored in a 126.1 country or the Russian Federation to satisfy the ITAR provision. Instead, DDTC specifies in the rule that it will continue to evaluate potential violations related to technical data release under a totality of the circumstances framework.

As an interim final rule, DDTC is accepting public comments until January 27, 2020. The rule becomes effective on March 25, 2020.

Last week, the United States and China reached an agreement on the long-awaited “phase one” trade deal.  The deal, originally announced in October, will include tariff reductions by the United States and a $200 billion increase of U.S. good purchases by China. According to U.S. Trade Representative Robert Lighthizer, the 86-page agreement is currently being translated and undergoing legal review, but the terms are agreed to.  The parties expect to sign the deal in early January.

As part of the agreement, the United States indefinitely postponed a 15 percent tariff that was scheduled to be imposed December 15th on $160 billion of Chinese imports. The United States also expects to reduce tariffs on an additional $120 billion of Chinese imports from 15 percent to 7.5 percent.  Over the next two years, China has agreed to increase purchases of U.S. goods and services by $200 billion over 2017 levels, including $40 to $50 billion annually in agricultural products.

Additionally, the deal will cover intellectual property, technology transfer, agriculture (structural barriers), financial services, and dispute resolution, according to the Fact Sheet released by USTR.  The intellectual property chapter will address longstanding issues such as trade secrets and pharmaceutical intellectual property protections. The financial services chapter should allow U.S. financial service firms to compete more effectively in the Chinese market.

The technology transfer chapter will include “binding and enforceable obligations,” with China agreeing to end its controversial practice of forcing foreign companies to transfer their technologies to Chinese firms as a condition for obtaining market access. China has also commit to “provide transparency, fairness, and due process in administrative proceedings and to have technology transfer and licensing take place on market terms.” The technology transfer chapter is notable because earlier reports indicated that it would not be included in the deal.

The agreement also contains a dispute resolution chapter. Enforceability is a longstanding issue in previous agreements between the United States and China.  This chapter will provide both sides with a mechanism to ensure the implementation of and compliance with the agreement. It will also allow both sides to take “proportionate responsive actions” when deemed appropriate. While specific procedures have not been released, the inclusion of a dispute resolution chapter will go a long way towards quelling the fears of some that China will not follow through on its obligations.

On December 10, the U.S., Mexican, and Canadian governments signed an updated United States-Mexico-Canada Agreement (“USMCA”) in Mexico City.  The new agreement comes on the heels of months of additional negotiations between the three governments after an original deal was reached last year.  The terms of the new deal respond to criticism that the agreement needed stronger labor provisions to protect workers’ rights, better enforceability to ensure the parties live up to the commitments, improved monitoring mechanisms, stronger environmental provisions, and clarification on prescription drugs provisions.

With the revisions in these areas included in the updated USMCA, Democrats have expressed support for the agreement.  Indications are that it will be put up for a vote in Congress in the near future.  USMCA will replace the North American Free Trade Agreement (“NAFTA”) that was implemented by the three governments in 1994.

Check back here for updates on USMCA, including an analysis of the revised USMCA once the text is released.

In July, France signed into law a tax, which targets companies with high digital revenues such as Facebook, Google, and Amazon.  On Monday, the Office of the U.S. Trade Representative (“USTR”) announced the conclusion of an investigation into France’s digital tax under Section 301 of the Trade Act of 1974 (“Section 301”).  The USTR found that the French digital tax discriminates against U.S. digital companies and is inconsistent with prevailing tax principles.  The announcement added that the “USTR is exploring whether to open Section 301 investigations into the digital services taxes of Austria, Italy, and Turkey.”

Based on the report, Ambassador Lighthizer proposed tariffs up to 100% on $2.4 billion worth of French products including sparkling wine, handbags, makeup, and cheese.  A public hearing regarding the proposed tariffs will be held on January 7, 2020.  The public is invited to comment on the proposed tariffs before January 6, 2020 and to submit post-hearing rebuttal comments by January 14, 2020.

On Tuesday, French Finance Minister Bruno Le Maire called the proposed tariffs “unacceptable” and stated that the European Union would be ready with a response if the tariffs take effect.

On Tuesday, as “phase one” of the trade negotiations between the U.S. and China nears completion, the Wall Street Journal reported that the interim agreement would not only deter new tariffs, but lessen existing tariffs.  However, the “phase one” agreement reportedly will not include language regarding forced technology transfers.

China’s practice of forcing U.S. companies to transfer technology is one of the major reasons that the U.S. took action under Section 301 of the Trade Act of 1974 in March 2018.  The Section 301 Report called China’s forced technology practice “inequitable” and stated that it “significantly undermines the value of American technology (including IP), thereby distorting markets and compromising U.S. companies’ global competitiveness.”

As a “contentious” topic, Trump Administration officials may plan to address forced technology transfers in subsequent “phases” of trade negotiations.

“Phase one” of the deal between the U.S. and China may conclude as early as this week.  If no deal is reached by December 15, President Trump has announced that he may impose tariffs on an additional $156 billion worth of Chinese products.

Last week, Congress sent to the President’s desk a bill supporting pro-democracy activists in Hong Kong.  The Hong Kong Human Rights and Democracy Act of 2019, sponsored by Sen. Marco Rubio (R-FL), passed the Senate by unanimous consent and the House by a vote of 417-1 (last month, the House passed a similar measure authored by Rep. Chris Smith (R-NJ)).  It is unclear if President Trump will sign the bill into law. Given the implications it could have for the ongoing “phase one” trade deal negotiations with China, President Trump could veto it to save face with the Chinese.  Due to the bill’s bipartisan and near-unanimous support, Congress would likely override a veto.

The bill requires the Department of State to provide annual reports to Congress regarding whether Hong Kong retains enough autonomy to justify its unique treatment, which has especially important implications for trade between the United States and Hong Kong.  Ending Hong Kong’s special status would see its imports and exports subject to the tariffs that currently exist on trade between the United States and China.  The bill also requires that the Department of Commerce submit an annual report on the extent and nature of violations of U.S. export controls and sanctions law occurring in Hong Kong.

The bill provides for sanctions against persons responsible for the extrajudicial rendition, arbitrary detention, or torture of any person in Hong Kong, or gross violations of human rights within Hong Kong.  The bill authorizes the President to impose sanctions by blocking assets, blocking persons from receiving a visa, admission, or parole into the United States, and revoking existing visas or entry documents.

Chinese officials have urged the United States to reconsider, and claimed that Beijing would impose “strong countermeasures” if the bill becomes law.

The bill’s timing complicates the “phase one” trade deal.  While neither side has said that its passage into law will end negotiations, tensions have been rising since President Trump and President Jinping’s handshake agreement in October.  President Trump recently noted the deal was close, but as more time passes without a concrete agreement, there are signs the two sides are slowly drifting apart, again.

A related bill, which also awaits President Trump’s signature, prohibits the export of tear gas, pepper spray, rubber bullets, and other crowd control munitions to the Hong Kong Police Force.

 

The holiday season is nearly upon us, yet things in the trade world are not so jolly.  The United Kingdom (UK) eked out a slight gain in the third quarter to avoid a recession.  In the fourth quarter, the usual High Street hustle and bustle is expected to be dampened somewhat as Brexit uncertainty continues and voters prepare for the first December general election since 1923, when a similarly gloomy mood prevailed.  Retailers are already enduring reduced pre-holiday sales, and negative impacts on UK and European Union (EU) trade in a post-Brexit world are widely predicted, at least in the short term.  Adding insult to injury, fifteen countries have come together in the WTO to oppose the UK and EU’s proposed way forward.

In the many months of negotiations since March 2017, when the UK submitted its formal notice of intent to withdraw from the EU, the EU has steadfastly refused to engage in talks about the post-Brexit period until the terms of the so-called “divorce” were agreed and ratified – a goalpost yet to be reached.  The UK and EU did move forward, however, on a plan to divvy up existing preferential tariff rate quotas between the UK and the remaining bloc of 27 EU Member States.  Under the proposal agreed in August 2017, the UK would take over a portion of the EU quota commensurate to its average consumption over the most recent three-year period, thereby leaving WTO trading partners “no worse off” than before Brexit.  Argentina, Brazil, Canada, New Zealand, Thailand, Uruguay, and the United States (US) immediately complained that split quotas did not provide the same market opportunities as the current single EU market.  The countries claimed that such changes constitute more than a technical rectification, thus requiring consultation and consent from trading partners.

At last week’s WTO Goods Council, the number of countries expressing concerns about the proposed reallocation of the EU quotas rose to fifteen.  Australia, Canada, the US, and others claim that losses from Brexit uncertainty are already being felt.  As recompense for current commercial loss as well as future losses resulting from trade disruption and smaller markets, they seek concessions from the UK and the EU to provide improved access to both post-Brexit markets.  Calling the proposal “unjustifiable,” the US asserts that trading partners are at risk of being crowded out and would suffer market access losses in both markets.  The worry is that the EU will claim a large portion of the UK quota and vice versa.  The proposal could have particularly harsh results for US exports of pork and wine.

How the conflict is resolved in the near term may depend on whether an alternative dispute resolution system comes to fruition when the WTO’s Appellate Body ceases to function on December 10, 2019.  On that day, the Appellate Body will no longer have the three members necessary to review a case on appeal.  With the US holding fast to its position that blocking Appellate Body nominations is the only way to bring about WTO reform, something will have to give.  One alternative under consideration by the EU and Canada is an interim arbitration arrangement based closely on existing WTO rules.  Another possibility would entail Members agreeing to accept the Panel’s decision at the outset of a dispute.  With uncertainty piled on top of uncertainty, traders’ worries are not likely be lessened this holiday season.