TRALAC - Trade Law Centre

Preferential market access: why rules of origin matter

Wednesday, 05 March 2008

Source: Business Day (South Africa)

In the intricate world of trade negotiations, little tops the complexity of rules of origin, writes Mathabo le Roux

African, Pacific and Caribbean (ACP) countries were offered duty free quota free access to European markets last year as part of the economic partnership agreements (EPAs) the regions were negotiating with the European Union (EU).

However, this preferential market access is subject to exporters meeting the rules of origin that form a key component of the new agreement.

These rules set the requirements under which a product may be considered to be of local origin, which would qualify it for duty-free quota free access. Different methodologies can underlie the rules, with the EU employing a range of tests to determine origin. For example, products may have to undergo certain local processing operations before they are considered to be of local origin, or alternatively a minimum “value-added” is imposed to qualify. If the product does not meet these conditions (which are often very specific to a particular product), a product’s duty-free status is lost and normal import duties will be applicable.

The extent of these obscure, sometimes bizarre rules, is amply illustrated by the example of fish. To the layman fish caught in local waters would qualify as local fish. Not necessarily, says Eckart Naumann, an associate of the Trade Law Centre of Southern Africa (Tralac - see www.tralac.org), speaking at a recent conference of the Stellenbosch-based think tank.

In terms of EU Rules of Origin, only inland fish (rivers, lakes) and fish caught within the 20km territorial zone off a country’s coast is considered local. Beyond the 20km zone — where most commercial fishing activity takes place — a host of additional requirements apply to determine the “origin” of the fish. This is notwithstanding the fact that a country has exclusive economic rights to its coastline extending 322km out to sea. EU rules of origin base the origin of fish on the ownership of the vessel, registration, the flag under which it sails and a host of other conditions.

Take the hypothetical example of hake caught 80km off the coast of Walvis Bay by local fishing enterprise Eros Fishing Company. Eros would run into all sorts of rules of origin difficulties if it wanted to export its product to the EU duty-free and the vessel that caught the fish was not registered locally (even if licensed to fish in Namibian waters), or if foreign nationals owned more than 50% of the company. Under the previous dispensation — prior to the revised requirements under the free trade agreement — even the captain and crew had to be at least 50% nationals of the exporting country.

Unavailability of locally owned fishing vessels is also a virtual impossibility under the rules. The EU stipulates that any leasing agreement must be authorised by the EU subject to strict criteria, and that the country must have first offered the EU the opportunity to negotiate a fisheries agreement (giving it special access rights) prior to the notion of third country leasing arrangements being considered.

“The sobering thing about rules of origin is that without them, there would not be trade agreements,” says Naumann. It is important for firms considering EU exports to familiarise themselves with the requirements, as they affect production and sourcing dynamics, costing and ultimately impact on investment decisions. Investment is less likely to take place if rules of origin are too strict, because any restrictions on business’ ability to conduct their affairs in the most efficient manner will have an impact on profit and price.

Notorious for its restrictive rules of origin, the rules the EU applied under the Cotonou agreement, which previously governed ACP countries’ trade with the EU, were in effect imposed, rather than negotiated conditions, notes Naumann. This is because Cotonou was a preferential trade agreement unilaterally extended to ACP countries by the EU. These so-called non-reciprocal trade preferences were ultimately why the Cotonou agreement ran foul of World Trade Organisation (WTO) disciplines, and had to end last year.

The EPA negotiations presented the first opportunity for a negotiated outcome on rules of origin. Naumann says the process was hamstrung for various reasons. On the one hand, the EU did not have clear policies and was itself adjusting its negotiating prerogatives and product sensitivities. On the other, ACP countries were unable to articulate a clear vision and problems were compounded by widely divergent interests in the various ACP negotiating blocs.

Despite a haphazard process, the EU eventually extended “Cotonou-plus” rules of origin, using the previous rules as a template and as part of the negotiations effecting modifications here and there. These pertain mostly to a few processed agricultural products and fish, while clothing and textiles was the only industrial sector that saw notable changes in the rules.

Naumann says the benchmark for ACP region was mainly clothing and textiles and fishing.

“There was almost an abnormal fixation with getting better rules of origin for these sectors and to some extent the EU used this as a carrot to get countries to sign. This fixation rather clouded the outcome in other areas,” he says.

Even so, the EU’s concessions on clothing and textiles are significant and essentially bring them on par with those under the African Growth and Opportunity Act (Agoa), under which African countries get preferential access to the US market. The key difference with Agoa is that a negotiated trade agreement provides far greater long-term certainty to producers and consumers, unlike Agoa which forms a piece of US legislation and can therefore be amended unilaterally.

Under the EU’s original rules of origin the requirement was for two “stages of conversion”, which effectively required clothing manufacturers to make up apparel locally from local fabric.

Naumann says these requirements ignored the fact that large international buyers — brand owners, large retailers and sourcing agents — hold the reigns in this sector, in effect determining pricing, setting fabric sourcing parameters and stipulating everything from lead times to design.

“Such industry behaviour is often referred to as a buyer-driven value chain and unless rules of origin are complementary to these dynamics, producers will be severely compromised with regard to export competitiveness,” he remarks.

The new rules demand a single transformation, which broadly, and significantly, means fabric can now be sourced from abroad while local fabric mills can also source yarn from foreign manufacturers and still qualify for local origin status.

On fishing the EU was far less openhanded. With its large, established fishing industry the EU obviously has a vested interest and opted to keep protecting its industry.

Despite intense lobbying, the EU agreed to drop only the crew component, with strict local conditions remaining for registration, ownership and flag (the nationality of the vessel). The EU further agreed to exempt 15% of processed fish from the local requirement.

But the latter concession is “really rather meaningless”, says Naumann, with a general across-the-board concession of 15% “value tolerance” available for all products except textiles and clothing, which was also available under the original rules of origin.

On the whole, however, the more relaxed rules of origin for clothing and textiles are a major victory, especially for Swaziland and Lesotho, whose secondary economies are to a large degree concentrated in clothing manufacturing.

But Naumann cautions that SA’s refusal to initial the interim EPA will complicate matters.

First, it essentially nullifies SA’s participation in the concept of cumulation. Cumulation allows more than one country to jointly comply with the applicable rules of origin of a product and is facilitated by the fact that the rules of origin and tariff treatment into a given market — for example for entry into the EU — are alike. With SA not party to the EPA, manufacturers that have joint operations in, for instance Lesotho and SA, now cannot cumulate anymore without complying with the rules of origin separately.

But SA’s non-participation in the EPA also means that it now cannot readily consider itself a supplier to the region any more for goods to be further processed into EU exports because of limitation of cumulation.