The USMCA Is Now In Force. How Will it Impact North American Trade Policy?

The U.S.-Canada-Mexico Agreement (USMCA) entered into force on July 1, 2020, replacing the North American Free Trade Agreement (NAFTA) and establishing new rules of the road for trade and investment in the region. Along with including chapters on digital trade, environment, and labour, which did not feature in the original NAFTA, the new accord also features significant changes in relation to investor-state dispute settlement (ISDS). Parties have to a large extent abandoned this controversial mechanism.

The USMCA will govern a multi-trillion dollar market and is expected to face heavy scrutiny within the three countries, especially during a U.S. election year.  Known as CUSMA in Canada and T-MEC in Mexico, the new agreement has been mired in debate for both substantive and political reasons since the idea was first floated years ago.

Indeed, in the months leading up to Donald Trump’s 2016 election win and in the early years of his administration, the U.S. leader repeatedly threatened a NAFTA withdrawal unless he could obtain a “fairer” deal for American workers. This was part of a wider effort to negotiate or renegotiate trade agreements with any country that allegedly did not provide the U.S. with “free, fair, and reciprocal” terms, fuelling tensions with many trading partners, including Canada and Mexico.

Now that the USMCA has taken effect, we unpack some of the new features of the agreement below and explain why they matter.

Labor rights and enforcement with the new USMCA

NAFTA did not have a labor chapter, which was instead dealt with in a separate agreement on labor cooperation. Notably, the new USMCA labor chapter brings labor into the trade agreement, including a section on cooperation, and is subject to the trade agreement's dispute settlement chapter.

This means that if a dispute panel finds that one of the parties is not complying with the labor provisions, the party raising the issue can “suspend benefits” under the agreement if the issue is not resolved. However, the USMCA parties must first undertake consultations under the labor chapter before resorting to that option.

While the labor chapter was included from the start, the USMCA ratification process hit a snag last year, after Democrats in the U.S. Congress questioned whether its labor provisions were sufficiently stringent and threatened not to approve the deal. This prompted trade negotiators to develop a “Protocol of Amendment”, which involves select revisions to the environment, labor, intellectual property, and dispute settlement chapters.

The USMCA will govern a multi-trillion dollar market and is expected to face heavy scrutiny within the three countries, especially during a U.S. election year.

Notably, the protocol establishes a “Facility-Specific, Rapid Response Labor Mechanism”. This process allows one USMCA party to request consultations with another party  if they fear that a “facility” – such as a car manufacturing plant – is not complying with “the right of free association and collective bargaining” for its workers under the relevant labor laws . The complaining party can also ask for a review of conditions and even impose “remedies” as a result.

The complaining party can ask for a panel of labor experts to evaluate the claims, though remedies can be imposed before a panel has completed its work. The mechanism has raised questions, however, over the prospect of labor inspectors being sent into one country from another USMCA party to “verify” compliance, which led to U.S. officials clarifying to Mexico that these would solely involve technical experts, not tasked with enforcement action.

ISDS not applicable to Canada, US and Mexico agree to limited version

The USMCA’s investment chapter contains significant modifications from its NAFTA version, known colloquially as “Chapter 11”, which has been heavily used over the past 25 years. While some of the substantive standards have seen changes in the USMCA, due partly to the language in the U.S. Model Bilateral Investment Treaties of 2004 and 2012, the most notable difference is how this new tripartite trade and investment agreement will handle investor-state dispute settlement.

ISDS is the mechanism that allows foreign investors to file for arbitration against host states, i.e. those countries where they have undertaken those investments, in front of a three-person tribunal. The mechanism has been included in many international investment agreements, as well as trade agreements with investment chapters. However, ISDS has faced sharp scrutiny over the past several years, prompting a strong push for reforming the mechanism or doing away with it entirely.

For example, one of the primary concerns is what ISDS means for a government’s right to regulate in the public interest and concerns over whether the prospects of an ISDS claim can lead to governments experiencing “regulatory chill”. The hefty legal fees involved in investor-state arbitration, as well as the often massive damages awards that can result from a case, are among ISDS’ many other criticisms.

According to the United Nations Conference on Trade and Development (UNCTAD), at least 67 ISDS cases have been filed under NAFTA since it took effect 26 years ago. How USMCA might handle ISDS going forward was therefore a major issue for trade and investment watchers in the negotiation process.

In a landmark shift, ISDS will now no longer apply to Canada under USMCA, and its consent to ISDS for “legacy investment claims” under NAFTA will expire three years after NAFTA’s termination.

In a landmark shift, ISDS will now no longer apply to Canada under USMCA, and its consent to ISDS for “legacy investment claims” under NAFTA will expire three years after NAFTA’s termination.

Meanwhile, USMCA Chapter 14 allows for some ISDS but significantly limits the access to US and Mexican investors. Both parties are bound by an annex, which provides for investment arbitration only for claims alleging violations of direct expropriation and non-discrimination, and only in certain conditions and limitations.

A further annex, also applicable to the U.S. and Mexico, contains a special regime for “Covered Government Contracts” in sectors such as oil and natural gas, power generation, telecommunications, transportation, and infrastructure. Here, investors who are parties to such contracts can bring ISDS claims with respect to other types of violations, such as fair and equitable treatment (FET).

Looking ahead: the U.K. and Kenya

Aside from the geopolitical issues that the USMCA process brought to the fore, these substantive elements could give useful signals of how the U.S and the other USMCA parties will aim to address these in other trade negotiations, including in the forthcoming talks between the U.S. and United Kingdom, as well as a planned U.S.-Kenya trade deal.

The latter would be the U.S.’ first with an African partner, with negotiations due to begin next week. Trump officials have long said that this agreement could serve as a “model FTA” for agreements with other African countries, making that process one to watch closely going forward.

*The authors would like to thank Nathalie Bernasconi-Osterwalder for her valuable insights and feedback on this piece.