Focus

Rules of Origin: Highlights of the second WCO Conference

By the WCO Secretariat

The WCO Secretariat organized the second edition of its Global Origin Conference, held from 10 to 12 March 2021, with the objective of stimulating the exchange of knowledge on the management and implementation of rules of origin, both from a Customs and a trade operator perspective. Funded by the Korea Customs Service, the event was held online. Below are some of the key points made by the speakers[1].

 

Preferential treatment can be a game changer for regional economic integration as long as all the actors involved have access to the right information, a knowledge of the rules, and administrative and management capacities

Several Free Trade Agreements (FTAs) were discussed, starting with the African Continental Free Trade Area (AfCFTA). Annex 2 to the Agreement, which deals with rules of origin, is almost complete. Although some key requirements and Product Specific Rules are still under negotiation, trading under agreed rules of origin began on 1 January 2021.

For manufacturers, for those involved in trading goods and for governments to benefit from this Agreement (or any FTA), a sound knowledge of the rules of origin is needed, alongside information on the sourcing of the goods and manufacturing process, and management and administrative capacities (including access to efficient IT systems).

Putting to one side the difficulties generated by a lack of clarity in trade agreement provisions relating to rules of origin, there are other factors which can explain why preferential treatment is not utilized, including:

  • Information burden: distributors of goods generally do not have the needed information.
  • Sourcing burden: there will be higher costs to produce an originating good.
  • Compliance burden: paperwork increases transaction costs.
  • Compliance risk: if an importer is not sure whether a good is originating, the importer will not take the risk.

One speaker said that it was necessary to “leverage technology”, especially to ensure traceability of materials combined with origin documentation. Training was also seen as crucial: “Training all exporting SMEs will be difficult but what can be done is to focus on chambers of commerce, export promotion agencies, and certifying entities.”

A study on the use of FTAs by European importers[2] was presented during the Conference. It showed that company size and the preference margin do not matter, but that transaction values and the experience of the importer do.

In the case of the AfCFTA, manufacturers may need to restructure production, whilst importers and exporters may need to invest time and resources in training, and to secure proper documentation, as well as to adopt proper, verifiable accounting records which are accessible to authorities. Customs and certificate of origin issuing authorities need to digitalize processes, including those related to signatures, and ensure the seamless issuing and administration of certificates of origin and other documents. As is the case for economic operators, Customs need to build capacity in understanding rules of origin, as well as mechanisms for collecting feedback from users for continuous improvement.

One of the main challenges in implementing the AfCFTA is the lack of digital infrastructure in some countries. Some administrations are still paper-based, which translates into long procedures which will have a deterrent effect on the utilization of preferential treatment.

Other FTAs and their impact on regional integration were also discussed during the Conference, including the United States-Mexico-Canada Agreement (USMCA), the Comprehensive and Progressive Agreement for Trans-Pacific Partnership and the Regional Comprehensive Economic Partnership. Detailed presentations are available on the Conference website.

There is a lack of technical updates of product-specific rules of origin (PSR)

The classification of goods, and determination of the origin of goods according to the provisions of preferential schemes, are closely interlinked. Typically, the requirements for determining origin are specified for individual products or product categories which are identified according to their respective Harmonized System (HS) code. In many cases, the rules to be applied will refer to a change in tariff classification (CTC) at chapter, heading or subheading level, a criterion which requires correct classification of the final manufactured product and the input materials used in its production.

One speaker referred to fundamental changes to preferential rules of origin over the past two decades, stating, “Value-based rules are no longer the norm. Instead rules now are primarily based on HS classification and a tariff shift between the imports and the finished product.” He went on to add: “As a result, the knowledge and skills, as well as the evidential chain, needed to determine and verify origin has changed: accounting expertise has been largely replaced by a need for good classification skills.”

Every time the HS is updated – usually every five years – HS amendments are to be reproduced within the PSR of trade agreements. However, there are only rare examples of such transpositions being made, and the PSR agreed at a particular point in time remain fixed and unaltered from then onwards. In some cases, the text of the agreement does not even indicate which version of the Harmonized System is being used, and importers and exporters are left to infer this for themselves.

One speaker said that negotiators might be afraid to open a Pandora’s box (referring to the parties’ fear that technical updates of PSR would re-open discussions on the agreed rules themselves). The speaker suggested that this could be why the majority of today’s trade agreements do not offer a solution to this serious problem. There should be a clause in agreements to the effect that the rules have to be read dynamically, and that technical updates are not to be seen as new negotiations.

If updates of the RoO are not provided by the parties to the agreement, traders have to refer to different editions of the HS for the purposes of origin determination when intending to claim preferential treatment. The deeper the granularity or level of detail of the agreed rules of origin, the graver the issue. Cross-version correlation complexity is considered to lead to low preference utilization rates. The issue does not only impact traders, but also Customs, which face the same burdensome operations as operators when controlling the compliance of a preferential claim.

One specific software tool to deal with the situation was presented during the Conference, and interested readers can view the presentation on the Conference website to find out more.

Self-certification system offers multiple advantages

Recently concluded FTAs appear to prefer the self-certification of origin, particularly the fully exporter-based certification system and the importer-based certification system, with less – or no – involvement from the exporting country’s competent authority.

Under this arrangement, traders do not incur costs related to obtaining a certificate or delays in the procedure. Customs also see their administrative costs reduced, as they do not have to check the authenticity of the certificate and can instead concentrate on examining the goods and their claimed originating status. As a speaker explained, “By reducing documentary requirements, verification by default shift to the goods where it belongs.”

Automatic data exchange systems also enable Customs to focus controls on goods, rather than on the authenticity and validity of certificates

Some countries have developed IT systems to enable the automatic exchange of certificates of origin and subsequent electronic verification procedures. Importers and exporters do not need to submit and exchange certificates, but rather need only indicate the certificate number on the declaration. This enables Customs to focus controls more on the goods and less on the authenticity and validity of the certificates. However, one speaker said that it was worth noting that systems enabling self-certification and cutting paperwork do not solve all the issues faced by some economic operators, such as the lack of information on the sourcing and manufacturing process of the goods.

Convergence, not harmonization, is the way forward for preferential rules

A large number of Regional Trade Agreements (RTAs) have been signed in the last three decades, with provisions partly overlapping each other. Countries which have signed dozens of FTAs and RTAs are well aware that the rules they created are difficult for Customs officers and trade operators to apply. Each agreement defines differently the duties and import procedures, the way a product’s country of origin is identified, and the procedures on how this origin has to be documented.

Even though efforts are being made by some of them to standardize provisions across different agreements, all experts agree that this takes time, that a “one size fits all” approach is not always feasible, and that the product-specific rules of origin are adapted to the export supplies of the signatories.

Convergence is actually a reality

The outcome of the study Rules of Origin as Non-Tariff Measures: Towards Greater Regulatory Convergence[3] was presented during the Conference. It shows that, for some products, convergence has “naturally” happened between the rules of origin contained in different FTAs. Convergence has occurred in “non-sensitive” sectors, such as chemicals, though the rules continue to diverge in sectors that countries consider to be strategic (such as textiles and clothing for the US, and fisheries for the EU). The researchers are now working on developing a tool to show where there is convergence or divergence at a product-specific level, and to provide governments and businesses with options for drafting the rules.

Lack of clarity and consistency is what really determines whether an FTA achieves its objectives or not

As Customs administrations play a key role in the administration of rules of origin, they are well placed to address the inconsistencies and confusion attaching to procedures laid down in trade agreements.

A speaker explained that most problems stem from the negotiations and pre-implementation stages of FTAs: “One relates to the fact that FTAs are generally negotiated in English, often with English not being the primary language of one, some or all of the parties, and this does increase the likelihood of interpretation divergence resulting in unforeseen consequences when an agreement is up and running.”

Secondly, people interpret words in different ways. The same speaker went on to say: “When the agreement text is drafted into liable Customs regulations, the drafter may not be aware of the intent of the negotiators and focus on the words in front of them or, more accurately, the understanding of the words in front of them. As a result intent can be lost.” For example, it is crucial to distinguish between discretionary and mandatory language. When negotiators use the word “should”, they recognize that something is not always possible. “Should” refers to something recommended rather than required. Conversely, “shall” refers to something that is required. Regulations drafted in a way that does not convey this intent can lead to errors in assessments, unnecessary litigation and appeals.

The speaker also pointed to a lack of clear definitions of common trade terms, giving by way of example references to “third country invoicing”, “third Party invoicing” and “third party invoicing” in the same agreement and operation procedures. Whilst all agreements define “third Party invoicing” in the same way (generally with the third party as a signatory to the agreement), this cannot be said of the other two terms, thus opening the door to various interpretations.

One speaker said that it was necessary to harmonize the following elements of rules of origin:

  • Definitions
  • Procedures – direct shipment, time periods, appeal stages, etc.
  • Regional Value Content calculation methods
  • Documentation requirements

Avoid using concepts such as “direct consignment”, which give rise to misleading interpretations

Rules of origin have provisions relating to transport requirements for which different terminologies are used, creating confusion:

  • Direct consignment: in the ASEAN Trade in Goods Agreement, passing through non-ASEAN Member States is permitted for geographical reason, goods cannot enter commerce and some operations are permitted while in transit.
  • Transhipment: in the USMCA, no further operations are allowed other than loading and unloading while in transit.
  • Direct transport: in the Pan-Euro-Mediterranean (PEM) Convention, transport through other territories is permitted provided goods remain under Customs surveillance and undergo only certain operations.
  • Transit and transhipment: in the Trans-Pacific Strategic Economic Partnership Agreement.

One speaker pointed to the need for neutral terminology to reduce confusion, such as transhipment or transportation through third parties. He also explained that the concept of direct transport or direct consignment is neither in line with modern commercial practices, nor with Customs procedures: “International trade is a series of physical flows that may not necessarily use the most direct path but the least cost path. Transhipment or transportation through countries are a necessity and Customs have transit or transhipment procedures.”

Moreover, FTAs should clearly spell out the meaning attaching to requirements such as “Goods remain under Customs control” or “Goods remain under another authority”. Evidential requirements to verify that no manipulation or alteration has taken place must be limited to existing documents, such as bills of lading, export/import entries, commercial contracts, invoices, packing lists, storage documents, and reports from container seals and modern electronic devices.

Countries should not request a certificate of non-manipulation or any documentary evidence. One of the reasons is that the country where a consignment transited is normally not a party to the FTA. That country has no obligation to issue any documentary evidence and may not even issue such certificates for transhipped goods.

A review of RKC Specific Annex K is a significant opportunity to fix these issues

It is now 20 years since the adoption by the WCO Council in 1999 of the Revised Kyoto Convention, which provides standards and recommended practices to guide the development of predictable and transparent Customs procedures. WCO Members, recognizing the need to ensure that the RKC remains the blueprint for modern and efficient Customs procedures, approved in 2018 the establishment of a dedicated working group to carry out the instrument’s comprehensive review, including the review of Specific Annex K. The latter addresses rules of origin and origin procedures (documentary evidence and control), but fails to take into account a number of important aspects of today’s trade environment.

Key aspects of the content and structure of the proposal developed by the Specific Annex K review “Sponsoring Group” are discussed in a subsequent article. In the present article, we will simply say that the Group favours a “toolbox approach” which addresses all aspects of the management of preferential and non-preferential origin, and which provides clear up-to-date terms and concepts, using a common language and defining a common meaning. The tool would have an open architecture to allow new terms to be added and existing ones to be amended.

The idea is to assist trade negotiators who are not supply chain experts or familiar with the relevant terminology. By way of example, a speaker pointed to the difference between the ship on board date on a bill of lading, and the date of shipment on a certificate of origin: the speaker said that these were two different events which were often interpreted and enforced as being the same, with the expectation that the dates aligned and that preferential treatment was denied if this was not the case. The toolbox has the potential to eliminate this type of misunderstanding.

Non-preferential rules of origin – a “perfect storm”

Non-preferential rules of origin are used to apply trade policy measures such as antidumping or countervailing duties, safeguard measures, punitive tariffs, retaliatory tariffs, origin marking rules, quotas, or rules on government procurement. Over 40 countries apply such rules, and non-compliance can have heavy financial consequences. Antidumping duties, for example, are very high.

A key principle used to determine non-preferential origin is “substantial transformation”, i.e. the country in which the product was last substantially transformed, or made into a new and distinct product. Except for some goods for which a specific rule has been developed, these determinations are made on a case-by-case basis. One speaker noted that this makes it difficult for lawyers to advise companies and provide legal certainty. He also pointed out that during the development of the Union Customs Code, which entered into force on 1 May 2016 in countries of the European Union, there were some that proposed drafting non-preferential rules of origin for each product in the combined nomenclature, but a number of stakeholders thought it was not necessary.

Moreover, in many cases, businesses are uncertain as to the local country rules or to the position that a Customs authority will take. In explaining this “import versus export dilemma”, a speaker said that a company will often rely on the rules of the country where it is established, which are the ones it knows and that its chamber of commerce knows. However, the rules which are relevant are the rules of origin in the country of import.

Another issue is that regulations are not harmonized and there is no centralized repository to understand each country’s origin rules. Moreover, many lack the specificity of preferential product-specific rules and, in a world of global value networks, economic operators dealing with products not wholly obtained in a single country face the challenges of identifying the country in which the “last substantial transformation” occurred.

Within a company, the information and technical knowledge required to make a determination on origin are usually spread across various departments, including the department in charge of trade compliance (which knows the legal rules), and the department in charge of sourcing and manufacturing (which understands the transformation process).

Whilst non-preferential origin determination and reporting has always been a significant challenge for businesses to manage, in the past it has received less attention than other areas of trade compliance, due to its limited financial impact and the perception of lower-risk treatment from Customs Authorities. However, the recent use of origin in imposing punitive tariffs and taking action against countries has elevated non-preferential origin to new heights.

One speaker, having interviewed representatives of numerous companies from various industries while preparing his presentation, said that many were concerned regarding their capacity to apply these rules. One of them had told him that such rules were “one of the top three things in my trade compliance sphere that keeps me up at night”; another had said that they were “one of the biggest issues our trade compliance organization is charged with managing and fixing”; and a further representative had flagged that his company “expect increased enforcement from Customs in this area and is preparing more than ever before”. In addition, commenting on the introduction in the United States of punitive tariffs, a representative had said that his company “had to reprioritize non-preferential origin as a key part of its trade compliance efforts”.

Suggestions on possible approaches and options to minimize problems associated with non-preferential rules are discussed in detail in a subsequent article, and we will therefore not explore them here.

The examination of current practices and the utilization of preferences by LDCs shows that the rules in the Generalized System of Preferences need to be revised

Several World Trade Organization Members have implemented non-reciprocal schemes that offer preferential tariff treatment to least developed countries (LDCs), such as duty-free and quota-free treatment, or a generalized system of preferences. Rules of origin are not negotiated in such a scheme.

WTO members adopted several Decisions on preferential rules of origin for LDCs to ensure that preferential rules of origin established as part of such schemes are transparent and simple, and contribute to facilitating market access for exporters from LDCs:

  • 2005 Hong Kong Ministerial Declaration: commitment that preferential rules of origin applied to LDCs must be “simple and transparent”.
  • 2013 Bali Ministerial Decision: a set of multilaterally agreed guidelines and a recognition that LDCs have limited productive capacity to comply with more demanding rules. WTO Members should notify their preferential rules of origin for LDCs to the WTO to enhance transparency, and the WTO’s Committee on Rules of Origin (WTO CRO) shall also annually review these rules of origin. The Decision does not go as far as asking for the harmonization of the rules.
  • 2015 Nairobi Ministerial Decision: more detailed directions on specific issues, such as methods for determining when a product qualifies as “made in an LDC”; when inputs from other sources can be “cumulated” into the consideration of origin; details regarding direct consignment requirements; and simplified procedures for low value consignments. The role of the WTO CRO in examining current practices and the utilization of preferences, and in monitoring the implementation of the Decision, is strengthened.

Participants at the Conference were introduced to the work undertaken by the Committee to better understand current practices, match these practices against the benchmark of the Ministerial Decisions, and to hopefully identify best practices to encourage Members to reform their respective systems.

There was discussion of the complexity related to the calculation of “utilization rates” and the concept of “underutilization”. LDCs also have preferential agreements with some countries granting unilateral preferences, and monitoring the utilization of the latter requires an analysis of trade flows under all preferences. One of the identified challenges is access by analysts to trade transaction level data, which is useful in understanding how traders are using (or not using) preferential rules. Other challenges are finding experts with the right expertise, and engaging directly with private sector representatives in LDCs.

A speaker gave the following as some of the lessons learned at the WTO CRO:

  • All preferential schemes have some underutilization, which varies significantly from one sector to another, and from one LDC to another.
  • Underutilization is high in sectors subject to the wholly obtained product rule: 82% of all agricultural exports do not receive any tariff preference, despite being eligible for preferences under at least one scheme.
  • Strict direct consignment obligations have a direct impact on utilization: 52% of all exports from landlocked LDCs do not receive any preference (21% for LDCs with sea access).
  • The impact of RoO on utilization by LDCs is complex and requires more detailed investigations.

The points of view of LDCs, and the work undertaken by the LDC WTO Group to highlight the shortcomings of the current schemes, were also presented. In 2018 and 2019, the Group renewed efforts to bring new evidence that the rules of origin of preference-granting countries (PGCs) were not in conformity with the Nairobi Decision.

They focus on:

  • Examining each of the substantive components of the Nairobi Decision to show to PGCs how these deviate from their rules of origin, and the best practices that could be adopted.
  • Analysing the utilization rates to prove that the existing rules of origin adopted by PGCs are linked to low utilization of trade preferences.

The Group submitted around 18 documents from 2015 to 2020, in the form of substantive presentations or analytical documents. Some PGCs made some changes to their rules or undertook their own studies.

LDCs believe that it is necessary to revitalize the debate in the CRO and recognize that a new mandate involving all WTO Members, with a fresh work programme setting a time horizon, should be an outcome of the Twelfth WTO Ministerial Conference, which will take place from 30 November to 3 December 2021. The work undertaken at the WCO on the revision of Specific Annex K to the RKC should provide additional impetus to this process.

“Rules of origin are primarily used to limit trade, and hence represent an instrument for trade protection”

One representative from the private sector explained that rules of origin exist to avoid trade deflection, but that they distort global value chains and are costly to observe. The representative said that, in preferential trade agreements, trade deflection was unlikely to be profitable because tariffs were generally low; that countries in a common free trade agreement tended to have similar external tariff levels; that when tariff levels differ, deflection was profitable, at most, for one country in the pair; and that transportation costs created a natural counterforce: “It appears that rules of origin are primarily used to limit trade, and hence represent an instrument for trade protection.”

Conclusion

Participants were reminded that the International Trade Centre and the WCO Secretariat have developed an online tool called the “Rules of Origin Facilitator” (findrulesoforigin.org), which acts as a gateway to FTAs. The tool enables users to determine whether a specific product is covered by a preferential scheme and find the rules of origin that must be complied with in relation to a particular scheme. It targets both government and business.

One speaker said that it was not possible to change the nature of a multilateral system and stop the continuing expansion of FTAs, but that what could be done was to try to bring full transparency and operational clarity about rules of origin to the benefit of all: “We can try to reduce the gap in terms of information […], and bring intelligence and research insights to help policymakers take more informed data-driven decisions when designing new rules of origin.”

It is with this objective in mind that the WCO Secretariat organizes its Origin Conferences, and it hopes that this second edition enabled participants to get a better understanding of some critical aspects of rules of origin.

More information
origin@wcoomd.org

[1] This article reflects views held by various speakers and such views may not represent the views of the WCO or of other speakers in the event.

[2]The Use of the EU’s Free Trade Agreements, produced in collaboration between the National Board of Trade Sweden and the United Nations Conference on Trade and Development (UNCTAD), 2018.

[3] Bernard Hoekman, Stefano Inama, Rules of Origin as Non-Tariff Measures: Towards Greater Regulatory Convergence, Robert Schuman Centre for Advanced Studies Research Paper No. RSCAS 2017/45, 2017.