Update: Who Is Winning The U.S.-China Trade War?

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Update: Who Is Winning The U.S.-China Trade War?

March 5th, 2022 Francois Moreau Leave a comment

In 2018, U.S. President Donald J. Trump initiated a trade war with China. The trade war, which has never officially ended, continues to this day. Neither side appears to be winning and many bystander countries are benefiting as a result of this international dispute.

In some cases, these countries are seeing a number of positive impacts, including an increase in trade exports. This article will take a look at where the U.S.-China trade war currently stands and what outcomes have occurred as a result.

An end to globalization?

One of the main concerns springing from the U.S.-China trade war was that it would damage the international economy and bring an end to globalization. Specifically, because the United States and China are the two largest global economies. However, even a global pandemic could not totally destroy the integrated economies of the world.

Recent research demonstrates that U.S. tariffs on Chinese goods resulted in higher import prices in the U.S. and the Chinese retaliatory measures ended up harming Chinese importers. In the end, two-way trade between the U.S. and China dried up. However, contrary to speculators’ fears, globalization has not disappeared and many bystander countries benefited from the trade war through increased exports.

Explaining Bystander Country Growth

It seems unsurprising that global participants would fill the void after China was axed from the U.S. trade pipeline. Countries like Mexico, Malaysia, and Vietnam benefited the most. However, more surprisingly is that global trade, in products affected by the trade war, increased 3% relative to products not impacted by tariffs. So, not only did imports from other countries increase, but overall global trade increased.

One possible theory is that countries saw the trade war as a chance to expand their global market presence. China, which utilized a zero-COVID policy over the past few years, saw lags in its trade activity as a result. These gaps in global trade gave countries the opportunity to invest in additional trade opportunities or the chance to mobilize larger portions of their workforce. These changes enabled countries to increase exports without increasing prices.

Another theory explaining the growth is how third countries were able to export more to the U.S. and China. This change shrank their per-unit costs of production and economies of scale thus allowing them to offer more products for lower prices. Countries, where global export prices are declining, are also those where the largest increases in global exports are occurring.

Country Trade Growth Factors

One might wonder, what more could be done to take advantage of these types of trade wars in the future? Some countries increased exports overall. Others reallocated their trade by shifting their exports from other countries to the U.S. Finally, in some cases countries saw an overall decrease because they sold less overall. Two primary factors emerged to explain these patterns.

Deep Trade Agreements

Deep trade agreements (agreements that go beyond just tariff regulation, but include other behind-the-border protections) were significant. In a “deep” trade agreement fundamental economic integration provisions, like tariff preferences, export taxes, investments, and intellectual property rights are combined with other provisions. The first layer of these provisions usually supports economic integration like rules of origin and anti-dumping and countervailing duties. Then, other provisions that promote social welfare, like environmental laws or labor market regulations are added in, on top.

Trade agreements beyond just tariff preferences and other fundamental provisions help minimize fixed costs of expanding into foreign markets. Countries with these types of agreements had the necessary security to expand trade as the U.S. and China vie for economic supremacy.

Accumulated Foreign Direct Investment

Deep trade agreements weren’t the only important factor though. Accumulated foreign direct investment was also significant. Foreign direct investment is different from other types of investment because FDI occurs when an investor based in a home country acquires an asset in a foreign nation with the intent to manage that asset. Many areas that are undergoing increased social, political, and economic connections to global markets also see increased direct foreign investment.

Foreign direct investment is significant because it helps manage the utilization of scarce global resources. Poor countries often lack the necessary capital to build the necessary economic infrastructure. By receiving these foreign funds, which are managed from abroad, countries can better develop their economies.

Supply chains interacted like dominoes

Analysts at the Peterson Institute for International Economics predicted as far back as 2016 that U.S. tariffs would cause widespread production shifts in a “daisy chain.” In essence, when U.S. tariffs hit China, companies moved production to a third country. This move then caused other activities in third countries to be shuffled.

Analysts have noted that the complexity of modern supply chains makes predicting these outcomes difficult to predict. However, countries that were more integrated into the global economy seemed more likely to land firm relocations.

No Reshoring of U.S. Jobs

Unfortunately, relocations did not occur in the United States. Supporters of the trade war often hoped that it would result in the reshoring of U.S. jobs. Others were supportive because it demonstrated a way to hold China accountable for its deleterious authoritarianism.

In any case, the trade war did not result in massive amounts of jobs returning to the United States as many had hoped – although admittedly this is something that’s difficult to measure. Overall, third countries were the main winners as they replaced Chinese imports with their own.

Bystander countries benefited the most, especially those with a high degree of trade integration. A good business plan can help a business navigate trying times. In the same sense, countries that adopted a strategy for global trade shakeups came out on top. Despite worries of an end to globalization, the trade war seems to have actually diversified trade and spread opportunities to other countries. In reality, the trade war has helped push us towards a world where trade is not monopolized by the U.S. and China.

Conclusion

Initially, we asked who was winning the U.S.-China trade war? The answer is clear: third countries with deep connections to international partners. This means countries that were able to take advantage of supply-chain shakeups and countries that already had existing trade agreements and large amounts of foreign investment.

For the United States, and China, it appears that the trade war did not result in any major gains. Some analysts believe that it does more harm than good. The U.S. did not see any increased reshoring of jobs and economic activities. Really, the U.S. replaced Chinese imports with imports from alternative countries

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U.S. and EU Impose Sanctions in Connection with the Crisis in Ukraine: A Detailed Look

February 27th, 2022 Hughes Hubbard & Reed LLP Leave a comment

On February 21, 2022, President Biden issued a new executive order targeting the breakaway regions known as the Donetsk People’s Republic (“DNR”) and Luhansk People’s Republic (“LPR”, and together with the DNR, the “Covered Regions”) in eastern Ukraine. On February 22, 2022, President Biden announced further sanctions, specifically designating two major Russian banks and three close associates of Russian President Vladimir Putin, and imposed increased restrictions on dealings in Russia’s sovereign debt. On February 23, 2022, the EU adopted, a set of new Regulations and Decisions implementing asset freezes and travel bans notably against senior Russian officials and close associates of President Putin, financial restrictions limiting Russia’s access to the EU’s capital and financial markets, and trade restrictions targeting economic relations with the Covered Regions. The actions follow President Putin’s formal recognition of the independence of those breakaway regions and react to the continued involvement of Russian military forces.

New U.S. Sanctions

February 21, 2022 Executive Order

The February 21 executive order largely extends the existing restrictions on the Crimea region of Ukraine and applies them to the Covered Regions. In particular, the executive order prohibits:

-New investment in the Covered Regions;

-Importation into the U.S. of any goods, services, or technology originating in the Covered Regions;

-Exportation, reexportation, sale or supply from the United States or by a U.S. persons of any good, services or technology to the Covered Regions; and

-Any approval, financing, facilitation, or guarantee by a U.S. person of prohibited transactions.

The executive order further authorizes the U.S. Department of the Treasury, Office of Foreign Assets Control (“OFAC”) to add to the Specially Designated Nationals (“SDN”) list any person determined by the Secretary of the Treasury, in consultation with the Secretary of State:

-To operate in the Covered Regions;

-To be a leader, official, senior executive officer, or member of the board of directors of an entity operating in the Covered Regions;

-To be owned or controlled or acting on behalf of any person blocked under the executive order; or

-To have materially assisted or supported any person blocked under the executive order.

However, although some individuals in the Covered Regions have been previously designated under the Crimea-related authorities, no person has been designated yet under the executive order as of the date of this alert.

Simultaneously with the issuance of the executive order, OFAC issued six general licenses to permit otherwise prohibited activity in the Covered Regions. Most significantly, General License 17 authorizes all transactions that are ordinarily incident and necessary to the winddown of transactions in the Covered Region until March 23, 2022. Note, however, that a specific license from OFAC would still be required for any transactions with an SDN designated under the executive order. The other five general licenses authorize the following activity:

–General License 18– authorizing the export or reexport to the Covered Regions of certain agricultural, medical, and COVID-19 related products and services;

–General License 19– authorizing transactions that are ordinarily incident and necessary to the receipt or transmission of telecommunications in the Covered Regions;

–General License 20– authorizing transactions by the United Nations and other specified non-governmental organizations;

–General License 21– authorizing transactions related to non-commercial, personal remittances to the Covered Regions; and

–General License 22– authorizing transactions related to the exportation of services or software from the United States or by U.S. persons that are incident to the exchange of personal communications over the internet, such as instant messaging, chat and email, social networking, sharing of photos and movies, web browsing, and blogging.

One key question following the issuance of the executive order is how the specific territories of the Covered Regions will be determined. This may be particularly challenging, given the shifting borders of the DNR and LPR throughout their prolonged conflict with the Ukrainian government. We anticipate that OFAC will seek to clarify this question through the guidance in the form of responses to “Frequently Asked Questions” in the coming days.

February 22, 2022 Actions

On February 22, 2022, in a speech in which President Biden stated that “Russia has now undeniably moved against Ukraine,” he announced “the first tranche of sanctions to impose costs on Russia,” promising to “continue to escalate sanctions if Russia escalates.” Subsequently, OFAC issued a press release detailing the specific actions, all of which were taken pursuant to the existing Executive Order 14024, which included the designation of two major Russian banks and three close associates of President Putin as SDNs as well as restrictions on transactions involving Russian sovereign debt.

Specifically, the two Russian banks targeted are the Corporation Bank for Development and Foreign Economic Affairs Vnesheconombank (“VEB”) and Promsvyazbank Public Joint Stock Company (“PSB”), along with 42 of their subsidiaries. The designations were made pursuant to a contemporaneous determination issued by Treasury Secretary Janet Yellen that Russian financial institutions are eligible for sanctions under Executive Order 14024 (previously, determinations had also been made on April 15, 2021, with respect to the technology sector and defense sectors). Both banks are state-owned institutions and play key roles in servicing Russia’s sovereign debt and defense contracts. Further, in connection with PSB’s designation, OFAC designated the following five Russian-flagged vessels in which PSB has an interest:

-Baltic Leader (IMO: 9220639), a cargo vessel;

-Linda (IMO: 9256858), a crude oil tanker;

-Pegas (IMO: 9256860), a crude oil tanker;

-Fesco Magadan (IMO: 9287699), a container ship; and

-Fesco Moneron (IMO: 9277412), a container ship.

In addition, three close associates to President Putin – including the Chairman and CEO of PSB and two sons of previously designated oligarchs – were added to the SDN list. As a result of these designations, U.S. persons are prohibited from virtually all transactions with the listed parties or entities of which they own fifty percent or more, directly or indirectly. In addition, “significant” transactions with these entities could create secondary sanctions liability under Section 228 of the Countering America’s Adversaries Through Sanctions Act (“CAATSA”).

OFAC also issued a new Directive 1A under Executive Order 14024, which replaces the prior Directive 1. The effect of the new Directive 1A is to expand existing sovereign debt prohibitions to cover participation in the secondary market for bonds issued after March 1, 2022 by the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation, or the Ministry of Finance of the Russian Federation. Specifically, Directive 1 previously prohibited U.S. financial institutions from, as of June 14, 2021, participating in the primary market for bonds issued by Russia’s Central Bank, National Wealth Fund or Ministry of Finance, or lending funds to those organizations. Directive 1A keeps those prohibitions in place, and additionally prohibits U.S. financial institutions – effective March 1, 2022 – from participating in the secondary market for bonds issued by the listed organizations. Note that OFAC clarified in FAQ guidance that the fifty percent rule does not apply to Directive 1A so that entities owned by the institutions identified in Directive 1A are not themselves automatically subject to the restrictions.

In conjunction with these restrictions, OFAC also issued General License 2, which authorizes transactions involving the servicing of bonds issued by VEB prior to March 1, 2022, and General License 3, which authorizes a winddown period with respect to VEB through March 24, 2022. No similar general license has been issued yet regarding transactions involving PSB.

Potential Further Action

The Biden Administration has also implied that additional multi-lateral sanctions could be forthcoming, indicating an incremental approach. A Fact Sheet issued in conjunction with the February 21, 2022 executive order explained that the executive order “is distinct from the swift and severe economic measures we are prepared to issue with Allies and partners in response to a further Russian invasion of Ukraine. We are continuing to closely consult with Ukraine and with Allies and partners on next steps and urge Russia to immediately deescalate.” As also noted above, President Biden characterized the February 22, 2022 actions as the “first tranche” of sanctions and kept open the possibility for “escalation” depending on how Russia responds. An embargo on semiconductors and advanced technology has reportedly been considered as part of a second tranche of actions if Russia escalates or continues its incursion further into Ukraine.

New EU Sanctions

February 21, 2022 Designations

On February 21, the Council of the European Union (“EU”) imposed travel bans and asset freezes (including a prohibition to make funds or economic resources available) on five new individuals “for actively supporting actions and implementing policies that undermine or threaten the territorial integrity, sovereignty and independence of Ukraine,” bringing the total number of designated parties to 193 individuals and 48 entities on the EU’s list of parties subject to Ukraine-related sanctions.

The new designations include members of the State Duma of the Russian Federation, who were elected to represent the annexed Crimean peninsula and the City of Sevastopol on 19 September 2021, as well as the head and deputy head of the Sevastopol electoral commission.

February 22-23, 2022 Actions

On February 22, the Presidents of the European Council and European Commission jointly announced that an additional package of restrictive measures will be swiftly adopted by the EU in reaction to Russia’s latest aggression against Ukraine, which the EU sees as “illegal and unacceptable” under the Minsk Agreements, which stipulate the full return of the Covered Regions to the control of the Ukrainian government.

The same day, Josep Borrell, the High Representative of the Union for Foreign Affairs and Security Policy, urged Russia “to reverse the recognition, uphold its commitments, abide by international law and return to the discussions within the Normandy format and the Trilateral Contact Group.” Borrell later announced in a joint press conference with French Minister for Europe and Foreign Affairs Jean-Yves Le Drian that the 27 Member States had unanimously agreed on a new package of sanctions.

The new package has been swiftly adopted and published in the Official Journal of the EU on February 23 through 4 Council Decisions and 5 Regulations amending EU’s current sanctions program targeting Russia progressively strengthened since 2014, which already included:

-Individual restrictive measures consisting of travel bans and assets freezes on designated individuals and entities;

-Comprehensive restrictions on economic relations with Crimea and Sevastopol, including (i) an import ban on goods from Crimea and Sevastopol, (ii) restrictions on trade and investment related to certain economic sectors and infrastructure projects, (iii) a prohibition to supply tourism services in Crimea or Sevastopol, and (iv) an export ban for certain goods and technologies;

-An import and export ban on trade in arms as well as an export ban for dual-use items for military end-users or end-use in Russia;

-Financial restrictions limiting access to EU primary and secondary capital markets for certain Russian banks and companies;

-Economic restrictions limiting Russia’s access to sensitive technologies and services that can be used for oil production and exploration.

As announced, the new package of sanctions is quite wide-ranging and intended to “hurt [Russia] a lot” in the words of High Representative Borrell.

First, the legal acts of February 23 (Council Implementing Regulation (EU) 2022/260 and 2022/261 ; Council Decision (CFSP) 2022/267) formally designate individuals and entities which will be subject to individual restrictive measures, namely a travel ban and an asset freeze, in the Union. The new designations target:

-336 members of the Russian State Duma who voted for the recognition of the two self-proclaimed republics; and

-22 decision-makers involved in the illegal decision in addition to 4 entities (Internet Research Agency, Bank Rossiya, PROMSVYAZBANK and VEB) financially and materially supporting, or benefiting from them, those operating in the Russian defense sector and having played a role in the invasion such as senior military officers, as well as individuals engaging in a “disinformation war” against Ukraine.

The legal acts (Council Implementing Regulation (EU) 2022/259 ; Council Decision (CFSP) 2022/265) also provided for a derogation from the application of the new restrictive measures targeting Bank Rossiya, PROMSVYAZBANK and VEB. The competent authorities of a Member State may authorize the release of certain frozen funds or economic resources belonging to these Russian banks, or the making available of certain funds or economic resources to those entities, under such conditions as the competent authorities deem appropriate and after having determined that such funds or economic resources are necessary for the termination by August 24, 2022, of operations, contracts, or other agreements, including correspondent banking relations, concluded with those entities before February 23, 2022.

Moreover, further financial restrictions limiting Russia’s access to the EU’s capital and financial markets will now apply (Council Implementing Regulation (EU) 2022/262 ; Council Decision (CFSP) 2022/264) including notably:

-A prohibition to directly or indirectly purchase, sell, provide investment services for or assistance in the issuance of, or otherwise deal with transferable securities and money-market instruments issued after March 9, 2022 by Russia and its government, the Central Bank of Russia or any person or entity acting on behalf or at the direction of the said Central Bank;

-A prohibition to directly or indirectly make or be part of any arrangement to make any new loans or credit to the above-mentioned persons and entities;

-The current prohibitions applicable to securities giving the right to acquire or sell such transferable securities are extended to the securities giving rise to a cash settlement determined by reference to transferable securities.

Finally, the legal acts (Council Implementing Regulation (EU) 2022/263 ; Council Decision (CFSP) 2022/266) introduce extensive trade restrictions targeting economic relations with the Covered Regions of Donetsk and Luhansk, on the model of those already targeting Crimea and Sevastopol including:

-A prohibition to import goods from the Covered Regions into the EU and to provide, directly or indirectly, financing or financial assistance as well as insurance and reinsurance related to such imports;

-A prohibition to (i) acquire any new, or extend any existing participation in ownership of, real estate in or located in the Covered Regions, including the acquisition in full of such an entity or the acquisition of shares therein, and other securities of a participating nature of such an entity; (ii) grant or be part of any arrangement to grant any loan or credit or otherwise provide financing, including equity capital, to an entity in the Covered Regions, or for the documented purpose of financing such an entity; (iii) create any joint venture in the Covered Regions or with an entity in the Covered Regions; and (iv) provide investment services directly related to these prohibited activities;

-A prohibition to sell, supply, transfer or export goods and technology listed in Annex II suited for use in the transport, telecommunications, energy, oil and gas and mineral sectors, to (i) any natural or legal person, entity or body in the Covered Regions, or (ii) for use in the Covered Regions;

-A prohibition to provide, directly or indirectly, technical assistance or brokering services related to the goods and technology listed in Annex II, or related to the provision, manufacture, maintenance and use of such items to any natural or legal person, entity or body in the Covered Regions or for use in the Covered Regions;

-A prohibition to provide, directly or indirectly, financing or financial assistance related to the goods and technology listed in Annex II to any natural or legal person, entity or body in the Covered Regions or for use in the Covered Regions.

-A prohibition to provide technical assistance, or brokering, construction or engineering services directly relating to infrastructure in the specified territories in the mentioned sectors, independently of the origin of the goods and technology; and

-A prohibition to provide services directly related to tourism activities in the Covered Regions.

The new restrictive measures entered into force on February 23, the date of their publication in the Official Journal of the EU.

Potential Further Action

In reaction to the latest events, Olaf Scholz, Germany’s Chancellor, announced that Germany will halt the certification of Nord Stream 2, a gas pipeline designed to bring natural gas from Russia directly to Europe, a decision welcomed by both High Representative Borrell and President Ursula von der Leyen.

On February 23, 2022, President Biden announced that he would direct OFAC to sanction Nord Stream 2 AG – a wholly owned subsidiary of Gazprom, which is already subject to U.S. sectoral sanctions – and its corporate officers.

The EU had warned it will leave the door open to the adoption of more wide-ranging political and economic sanctions at a later stage should Russia use “the newly signed pacts with the self-proclaimed “republics” as a pretext for taking further military steps against Ukraine.” As President Putin declared war against Ukraine and escalated military action on February 24, President Michel of the European Council urgently convened an extraordinary meeting of the European Council. EU leaders intend to meet later today to discuss further restrictive measures that “will impose massive and severe consequences on Russia for its action, in close coordination with our transatlantic partners.”

The Member States will also keep a close eye on Belarus, which is said to have “aided and supported the Russian actions” in Ukraine, and the EU is ready to enlarge the listing criteria “to target those who provide support or benefit from the Russian government – the oligarchs, in plain language,” if needed.

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Global Supply Chains Brace for Russia-Ukraine Conflict – Four Major Risks

February 11th, 2022 Jennifer Bisceglie, CEO and founder of Interos Leave a comment

As tens of thousands of Russian troops continue to mass along the Ukrainian border, and with diplomatic talks between the U.S. and Russia yet to bear fruit, the threat of a Russian invasion within the next few weeks appear to be growing.

A Russian invasion of Ukraine has the potential to cause extensive and debilitating disruption across global supply chains, resulting in rising input costs to a heightened threat of cyber attacks (see below).

Today thousands of U.S. and European companies do business with suppliers in Russia and Ukraine, which could be at risk during a prolonged military conflict. Analysis of global relationship data on the Interos platform reveals key findings:

-More than 1,100 U.S.-based firms and 1,300 European firms have at least one direct (tier-1) supplier in Russia.

-More than 400 firms in both the U.S. and Europe have tier-1 suppliers in Ukraine.

-Software and IT services account for around 12% of supplier relationships between U.S. and Russian/Ukrainian companies, compared with 9% for trading and distribution services, and 6% for oil and gas. Steel and metal products are other common items purchased from the two countries.

While the proportion of U.S. and European supply chains that include tier-1 Russian or Ukrainian suppliers is relatively low, at around 0.75%, this figure increases significantly when indirect relationships with suppliers at tier 2 and tier 3 are included.

-More than 5,000 firms in both the U.S. and Europe have Russian or Ukrainian suppliers at tier 3 (representing 2.76% and 2.37% of their respective supply chains).

-More than 1,000 firms in both the U.S. and Europe have tier-2 suppliers based in Ukraine, with around 1,200 dependent on suppliers at tier 3.

Supply chain and information security leaders in U.S. and European organizations should review their dependence on Russian and Ukrainian suppliers at multiple tiers as a key first step in their efforts to assess risk exposure in the region and ensure operational resilience.

Four Major Risks for Global Supply Chains

In the event of a Russian invasion of Ukraine, there are four major areas where global supply chains could be negatively impacted:

1. Commodity prices and supply availability

2. Firm-level export controls and sanctions

3. Cyber security collateral damage

4. Wider geopolitical instability

1. Commodity price increases. Energy, raw material and agricultural markets all face uncertainty as tensions escalate. Russia provides over a third of the European Union’s (E.U.) natural gas, and threats to this supply could force up prices at a time when companies and consumers are already facing higher energy bills. Natural gas supply pressures likely would spike volatility in other energy markets too. By one estimate, an invasion could send oil prices spiraling to $150 a barrel, lowering global GDP growth by close to 1% and doubling inflation. Even lower estimates of $100 a barrel would cause input costs and consumer prices to soar.

Food inflation is another risk, with Ukraine on track to being the world’s third largest exporter of corn, and Russia the world’s top wheat exporter. Ukraine is also a top exporter of barley and rye. Rising food prices would only be exacerbated with additional price shocks, especially if core agricultural areas in Ukraine are seized by Russian loyalists.

Metal markets may also continue to be squeezed. Russia controls roughly 10% of global copper reserves, and is also a major producer of nickel and platinum. Nickel has been trading at an 11-year high, and further price increases for aluminum are likely with any disruption in supply caused by the conflict.

2. Firm-level Export controls and sanctions. Commodity cost pressures could be exacerbated by targeted U.S. and European export controls. The use of such controls to restrict certain companies or products from supply chains has soared over the last few years. While many have been aimed at Chinese companies, a growing number of Russian firms have been earmarked for export controls for “acting contrary to the national security or foreign policy interests of the United States”.

Prominent Russian companies already on a U.S. restrictions list include Rosneft and subsidiaries and Gazprom. Extending export controls and sanctions to Gazprom’s subsidiaries, other energy producers, and key mining and steel market firms could further impact supply availability and input costs. Not surprisingly, U.S. companies and business groups are urging the government to be cautious in how it applies any new rules.

U.S. and E.U. export controls would also likely target the Russian financial sector – including state-owned banks – if an invasion takes place, and may be a tactic for deterrence as well. U.S. officials have noted that any sanctions would be aimed at the Russian financial sector for “high impact, quick action response”.

3. Cyber security collateral damage. Entities linked to malicious cyber activity may also face further repercussions from the U.S. and its partners. Ukraine is certainly no stranger to Russian cyber aggression. Russia has twice disrupted the Ukrainian electric grid, first in December 2015 leaving hundreds of thousands of Ukrainians in the cold, and then again the following year. But destructive attacks on the country’s infrastructure could also spark significant collateral damage in global supply chains.

In 2017, the NotPetya attack on Ukrainian tax reporting software spread across the world in a matter of hours, disrupting ports, shutting down manufacturing plants and hindering the work of government agencies. The Federal Reserve Bank of New York estimated that victims of the attack, which included companies such as Maersk, Merck and FedEx, lost a combined $7.3 billion.

This figure could pale in comparison to the global supply chain impact of a Russia-Ukraine military conflict, which would inevitably include a cyber element. Whether Russia would target its cyberwar playbook at U.S. or E.U. targets in retaliation for any support to Ukraine remains hotly debated. But the Cybersecurity Infrastructure and Security Agency (CISA) has been urging U.S. organizations to prepare for potential Russian cyber attacks, including data-wiping malware, illustrating how the private sector risks becoming collateral damage from geopolitical hostilities.

4. Geopolitical instability. Just as cyber warfare would be unlikely to remain within Ukraine’s borders, so the destabilizing effect of a Russian invasion could have wider geopolitical ramifications. In Europe, a refugee crisis could emerge, with three to five million refugees seeking safety from the conflict. In Africa and Asia, rising food prices could fuel popular uprisings. Of the 14 countries that rely on Ukraine for more than 10% of their wheat imports, the majority already face food insecurity and political instability.

China is watching closely to see how the world responds if Russia invades Ukraine. The superpower has its own aspirations of seizing territory and extending its sphere of influence. Taiwan’s defense minister has remarked that tensions over Taiwan are the worst in 40 years. A Russian invasion could further embolden China to enlist military tactics against Taiwan – something that, as well as its far-reaching geopolitical implications, would have a significant impact on electronics and other global supply chains.

***

Although many of these risks may not materialize, and represent a worst-case scenario, executives should be thinking now about the potential impact of a Russia-Ukraine military conflict on their operations over the coming months. These same leaders need to ensure that appropriate contingency plans are in place for their most critical supply chains and riskiest suppliers in the region.

Risk mitigation strategies include:

-evaluating required levels of inventory and labor in the short to medium term;

-discussing business continuity plans with key suppliers; and

-preparing to switch to, or qualify, alternative sources for essential products and services.

With proper analysis, planning and execution, it is possible to mitigate significant risk and ensure operational resilience.

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Xinjiang US Import Sanctions Looming Over Global Supply Chains

February 4th, 2022 Vedia Biton Eidelman Leave a comment

On December 23, 2021, President Biden signed into law the Uyghur Forced Labor Prevention Act (the “UFLPA”), which passed Congress with strong bipartisan support. With the UFLPA, the US has targeted imports of goods sourced from or produced in the Xinjiang region of China in an effort to address allegations of forced labor. Until now, similar orders had focused only on certain products – computer parts, cotton and cotton products, silica-based products, apparel, and hair products – from Xinjiang or from certain Xinjiang producers. The new measures will affect a wide range of industries and supply chains around the world. Companies are obliged to apply heightened diligence and transparency requirements in Chinese-based supply chains, and anticipate extended shipment delays for US imports and possible shifts in global apparel, food, solar, electronics, and automotive sectors, among others.

Background

The UFLPA was a bipartisan effort following on the heels of congressional action dating to 2019 in reaction to alleged human rights abuses against ethnic minorities in Xinjiang. It was enacted as part of a whole-of-government effort to combat alleged forced labor abuses in Xinjiang:

-US Customs and Border Patrol (“CBP”) has issued Withhold Release Orders (“WROs”) applying to cotton, tomato, apparel, hair products, silica-based products, and computer parts from Xinjiang.

-The Bureau of Industry and Security (“BIS”) of the Department of Commerce added more than 50 Chinese entities on the Entity List.

-The Office of Foreign Assets Control (“OFAC”) of the US Department of the Treasury designated more than a dozen persons on the Specially Designated Nationals and Blocked Persons List (“SDN List”) under the Global Magnitsky Human Rights Accountability Act.

-The US Department of State imposed visa restrictions against China Communist Party officials “believed to be responsible for, or complicit in, the unjust detention or abuse of Uyghurs, ethnic Kazakhs, and members of other minority groups in Xinjiang” as well as their family members.[1]

The UFLPA calls for a ban on the import of “all goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part in the Xinjiang Uyghur Autonomous Region of China, or by persons working with the Xinjiang Uyghur Autonomous Region government for purposes of the ‘poverty alleviation’ program or the ‘pairing-assistance’ program.” These programs, per the UFLPA, subsidize the establishment and operation of manufacturing facilities in the Xinjiang Region.

In fact, CBP’s authority to withhold release of imports suspected of involving forced labor already has existed for almost 100 years under Section 307 of the Tariff Act of 1930, which prohibits importing into the US any product that was “mined, produced, or manufactured wholly or in part by forced labor, including forced or indentured child labor.” CBP enforces the prohibition through the issuance of WROs.

CBP first began issuing WROs relating to Xinjiang in 2016. Most recently, in 2020 and 2021, CBP issued a series of WROs. Some apply to listed companies and their subsidiaries while others apply to the entire Xinjiang region:

In one of its first major actions under the Biden Administration, on June 24, 2021, CBP issued a WRO instructing ports of entry to detain shipments containing “silica-based materials” that are “derived from or produced using” products manufactured by Hoshine Silicon Industry Co. (“Hoshine”). Hoshine is one of the largest global producers of metallurgical-grade silicon, the raw material needed to produce solar-grade polysilicon that is used to create solar cells. In addition, BIS added Hoshine and four other Chinese companies to the “Entity List,” banning exports, re-exports, or transfers of US goods and technology to the listed entities. When the new order under the UFLPA goes into effect, the 2021 restrictions will be viewed merely as a preview to a much more pervasive region-wide and not sector-specific import ban that will reverberate through a wider variety of supply chains.

The US government has identified the following industries as involving heightened risk due to potential forced labor in Xinjiang:

Where there is suspicion that the goods contain materials originating in Xinjiang, these industries’ products will likely be held at customs as banned from imports into the US on suspicion of being sourced with forced labor.

What does the Uyghur Forced Labor Prevention Act do?

Pursuant to the UFLPA, 180 days after enactment of the Act, on June 21, 2022, CBP will apply a “rebuttable presumption” that applies to any goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part in the Xinjiang Region or produced by the entities listed by the Task Force. This “rebuttable presumption” will apply except when the CBP determines that the importer has:

(a) fully complied with the guidance described in the China forced labor strategy and any regulations issued to implement that guidance;

(b) completely and substantively responded to all inquiries for information submitted by the CBP to ascertain whether the goods were mined, produced, or manufactured wholly or in part with forced labor; and

(c) shown, by clear and convincing evidence, that the good, ware, article, or merchandise was not mined, produced, or manufactured wholly or in part by forced labor.

CBP advises that the importer may be required to submit time cards, wage payment receipts, and daily process reports that demonstrate the employment status of the employees in order to meet the burden of proving the lack of forced labor. In fact, textile companies whose cargoes got held up at US ports pursuant to Section 307 have needed to prove such evidence to CBP to get the goods released.

Finally, the UFLPA calls for increased enforcement of WROs. Within 30 days of making its determination, CBP will submit a public report to congressional committees identifying the good and evidence it has considered. The UFLPA provides for the Forced Labor Enforcement Task Force (the “Task Force”), in consultation with the Secretary of Commerce and Director of National Intelligence, to develop a strategy for supporting enforcement of CBP WROs.

What does this mean for companies?

The UFLPA is distinguished from a CBP WRO, which subjects to detention at US ports of entry products produced by listed entities or, in many cases, any products derived from or incorporating such products because the UFLPA’s rebuttable presumption will subject any and all goods sourced from or produced in XUAR to the import ban. The release process under the UFLPA will be what it has been for WROs.

To release the goods from detention, the importer must either re-export them from the US or provide evidence demonstrating that the goods were not manufactured with forced labor. In practice, goods subject to a CBP WRO are banned from entering the US until and unless the importer can convince CBP that it should not be withheld.

For example, in January 2021, CBP stopped a UNIQLO shipment of men’s cotton shirts that had arrived at the Port of Los Angeles / Long Beach pursuant to the XPCC cotton WRO. UNIQLO was required to provide various detailed records of the production chain (including timecards, salary records, and transportation records) from the raw cotton grower to the bulk trader to the yarn maker to the finished product. While UNIQLO argued that the shirts were not produced by XPCC, the burden is on the importer to prove the negative; even if UNIQLO eventually succeeds in convincing CBP, the shipment will have been delayed for months. Thus, the new WRO will also trigger shifting of supply chains by companies that do not want to take that risk.

In addition to customs consequences, a variety of measures may be applied to Xinjiang-affiliated entities. For example, an Entity List designation prohibits exports and reexports of all US goods, software and technology to those entities absent a license from BIS. Even more, those listed on the SDN List are prohibited from dealing, directly or indirectly, with US persons and are likely blocked from the global financial system altogether.

1. Shifting of Supply chains

When the rebuttable presumption under the UFLPA becomes effective on June 21, 2022, all goods sourced from or produced in XUAR – including any goods incorporating or derived from such goods in any amount – will essentially be banned from entering the US pending a favorable determination by Customs. In other words, there is no de minimis requirement for the import ban. Therefore, companies should expect and plan for global supply chain pricing and sourcing issues.

For instance, as 40-45 percent of the world’s solar-grade polysilicon comes from Xinjiang, the US solar projects industry will start to suffer even greater supply chain headaches. Currently, the WRO only applies to silica-based materials if the silicon was produced by Hoshine. Under the rebuttable presumption, it will extend to any products containing either silicon or polysilicon produced in China. This is expected to impact the supply and pricing of polysilicon worldwide. China produces more than 65% of the world’s silicon and around 89% of the world’s polysilicon. Most of the polysilicon production is believed to be outside of Xinjiang. Since Xinjiang is not a transparent place at present, it is hard to say exactly how much. US importers will likely encounter third-country suppliers who are reluctant to dig as deeply as the UFLPA demands.

In order to avoid import delays, component and product manufacturers in third countries (for example, Germany and South Korea) will seek to shift their supply chains to products that are not sourced from or produced in XUAR, if possible. Those efforts are beginning now in anticipation of the June effective date.

2. Heightened Supply Chain Transparency and Recordkeeping Obligations in Affected Sectors

Companies – especially those in industries listed above as identified by the US government to be higher risk – need to establish heightened supply chain transparency obligations. Supply chain transparency will help companies in the uphill battle of meeting the burden to prove the absence of forced labor. Up to now, transparency in Chinese in-country supply chain has been lacking, which makes it difficult to forecast the future impacts of the UFLPA. Without such transparency, it will be nearly impossible for companies to convince the CBP, “by clear and convincing evidence, that the good, ware, article, or merchandise was not mined, produced, or manufactured wholly or in part by forced labor.”

Transparency and recordkeeping will go hand-in-hand, and both will be necessary to navigate the UFLPA waters. In addition to requiring transparency on all levels of the supply chain, companies also need to keep records of the entire supply chain to be able to quickly and easily provide such records to CBP as evidence of lack of forced labor, if and when necessary.

3. Reputational and Banking risks

Aside from US sanctions enforcement risks, reliance on Xinjiang suppliers in any aspect of a supply chain presents significant dual-sided reputational risks. For example, due to reputational concerns, major brands, such as Calvin Klein, Gap, H&M, IKEA, Patagonia, and Tommy Hilfiger, stopped purchasing or committed to stop purchasing cotton sourced from Xinjiang.

There is also reportedly backlash from Chinese authorities and consumers. Brands that issued statements against sourcing cotton from Xinjiang, such as Burberry, thereafter faced a public backlash from Chinese consumers. Intel issued an apology to its Chinese customers after facing backlash for telling its suppliers that it would not be using forced labor or goods sourced from XUAR.

Banks in particular are highly attuned to OFAC primary and secondary sanctions-enforcement risks, as well as the above-mentioned reputational risks. In view of the 9- and 10-figure sanctions-related settlements, even non-US financial institutions are generally conservative in their sanctions compliance and risk appetite. Sanctions pose an existential risk to some banks that rely on access to US correspondent banking accounts in order to deal in US dollars. Thus, aside from the CBP order, banks and companies continuing to engage in transactions directly or indirectly with sanctioned Chinese producers risk having their transactions rejected or blocked by the US and global financial systems.

__________________________________________________________________

Vedia Biton Eidelman is an associate in Eversheds Sutherland’s International Trade Practice. She advises clients on a wide range of regulatory matters, including sanctions (OFAC) and antiboycott matters; antidumping, countervailing duty and safeguard actions before the US International Trade Commission (ITC) and the US Department of Commerce (DOC); export controls (ITAR and EAR); national security controls on investment in US entities (CFIUS); trade policy issues such as free trade agreement negotiations; customs matters; and transactional due diligence.

[1] M. Pompeo, “The United States Imposes Sanctions and Visa Restrictions in Response to the Ongoing Human Rights Violations and Abuses in Xinjiang,” (July 9, 2020), https://2017-2021.state.gov/the-united-states-imposes-sanctions-and-visa-restrictions-in-response-to-the-ongoing-human-rights-violations-and-abuses-in-xinjiang/index.html.

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US Fed: A fata morgana hiking cycle?

February 4th, 2022 Alexis Garrati and Patrick Krizan Leave a comment

In early January, the US Federal Reserve’s communications pointing to more hikes and an earlier balance sheet run-off, together with CPI reaching a yearly rate of 7% in December, have triggered a surge in long-term US yields. Over a short span of two weeks, US 10y Treasuries yields rose 24bp from 1.5% to 1.75% and temporarily reached 1.9% (Figure 1).

Figure 1: Evolution of US 10y Treasury yield (last 2 months).

In total return, this was the largest decline of 10Y US Treasuries over the last four decades. Only in February 1980, when Chairman Volcker raised the Fed Funds rate to 21% did long-term US Treasuries have a worst two-week performance, and this was against the background of much lower growth than today. For some, this is enough to (once again) claim the switch to a new regime, where “low for longer” is replaced by rising yields, driven by higher inflation uncertainty and growing interest rate risk. For us this view reflects mostly tactical noise rather than the underlying dynamics of recent yield movements. Over the recent days, US 10y Treasury yields have consolidated again at 1.74%.

Bonds markets seem have become more confident about the near-term US recovery rather than worry about incipient stagflation. The components of US nominal yields show that the recent increase was not caused by the risk component (term premium) but by a higher expected nominal short-term rate. The inflation expectations embedded in this rate remain stable, but the implied expectations for the real rate have risen (real short-term rate). The real short-term rate is closely linked to the economic outlook. In other words, the recent yield movement can be explained by increasing confidence among market participants that the upcoming Fed rate hikes (four hikes are currently priced in for this year) are appropriate and will not derail real growth. However, residual skepticism remains. The risk premium associated with the real short-term rate (real term premium) remains negative indicating limited potential for higher longer-term rates in a sustained growth cycle. Thus, we are not dealing with a risk surge, but with a re-rating of the growth scenario (Figure 2).

Figure 2: Decomposition of US 10y Treasury yield*

Don’t be fooled by real yields based on breakeven rates. From this growth story one could hastily derive a considerable upside potential for nominal yields especially in view of still clearly negative real yields (nominal yield – breakeven). But this is a flawed reading. The breakeven rate (derived from TIPS ) is not pure measure of inflation expectations and is subject to substantial market distortions. The US 10y breakeven rates – untypically – trade 50bp above their fair value due to a combination of lack of liquidity, high demand, and limited supply (Fed holding around 20% of the outstanding TIPS volume). Using the fair breakeven value (liquidity-adjusted) to calculate real yields, we see they are almost come back to pre-crisis levels (which is nearly the same as the sum of the real rate expectation and the real term premium in Figure 2 above). The US growth story is thus already priced in and provides very little upside for nominal yields (Figure 3).

Figure 3: Real yields back pre-crisis when adjusted for liquidity distortions*

However, changes in the duration of US Treasuries might provide some small upward pressure on the yield curve. Markets are also repricing the declining dampening stock effect of the Fed’s bond holdings on the US curve. With the upcoming quantitative tightening (QT), the share of duration-bearing securities in the private sector’s balance sheet is going to increase while short-term reserves are becoming scarcer. The additional duration supply translates into upwards pressure on yields. Currently, the QE-induced duration extraction is still dampening 10y US Treasuries by 130bp. With quantitative tightening we expect this effect to diminish by 20bps by the end of the year. However, a lower fiscal impulse than expected (e.g., if the Build-Back-Better framework does not pass) could also result in lower financing need by the US government and reduce the net supply of Treasuries, which could put downward pressure on yields and partly balance the effect from quantitative tightening.

The Fed might break the hiking cycle earlier than markets expect. The US monetary stance has undeniably become more hawkish. Given the tightening labor market, the expanded balance sheet and political pressure to fight inflation the risk reward of not tightening has indeed become too high. Cautious tightening can avoid overshooting inflation becoming embedded in expectations. However, the Fed also knows that tightening will not fight supply-side constraint-driven inflation. From this side, the pressure is going to ease over the year as we expect the inflationary pressure to abate. Our inflation tracker is already pointing at peak in Q1 2022 (Figure 4).

Figure 4: Inflation in the U.S. may peak in Q1 2022*

Sources: Refinitiv, Allianz Research

*US Inflation Tracker: equally weighted and normalized composite measure comprising 15 sub-segments (underlying trends (modified/trimmed measures), forecasts, market-based inflation measures, expected inflation implied by term structure models, monetary aggregates, consumer and producer price components, labor market indicators, commodity prices, corporate margin & profitability, and proxies for price effect from supply chain disruptions). Official measures: equally weighted and normalized composite measure comprising headline and core inflation reported by national authorities.

The normalization of the liquidity premium in the TIPS market, which should bring down breakeven rates, should also help to reduce the risk of de-anchoring inflation expectations. Instead of CPI and FOMC minutes, the focus of fixed income investors should lie on economic activity and monetary and financial conditions (MFC).

Figure 5: US Financial Conditions and ISM Manufacturing Index

Our baseline is still a cycle with three rate hikes this year and eight in total. This remains a very moderate normalization path by historical standards. On average, nominal tightening in the hiking cycles of the last 50 years reached 3.9pp and real tightening 2.8pp. For the upcoming cycle, we see tightening at only 2.0pp in nominal terms and 2.1pp in real terms. But if the growth momentum slows down further (e.g. ISM falling below 50, persistently weak retail sales as in December etc.) and if we see a noticeable tightening of MFC, then the Fed could break the tightening cycle after only two or three hikes. From today’s standpoint, 3-4 hikes would then have to be priced out. The market would switch from bear-flattening to bull-steepening (Figure 5).

Financial markets signal a shortened cycle. The 2y10y steepness of the US curve is already very flat compared to earlier lift-off phases (75 bps vs an average of 120bps in the 2 months prior to lift-off). Looking at the swap forward curve, we can already see inversion patterns that previously only appeared in late phases of hiking cycles, usually 2 to 3 hikes before the peak (Figure 6). These signals are somewhat at odds with the aggressive pricing on the money market, where currently 6-7 hikes are priced for the next two years.

Figure 6: Forwards at inversion point even before the hiking cycle started

Equity market developments seem to confirm a shortened cycle. Over the last 50 years, 85% of the Fed rate hikes have taken place at a moment when the S&P 500 has experienced a 12-months drawdown of less than 10%. Today we are already at -8.3%. So, we are approaching an area where rate hikes are very rare (16% of all hikes). When they took place, it was mostly in the very late phase of the cycle (Figure 7). One can, of course, emphasize the uniqueness of this post-pandemic cycle and argue that the Fed should not care about equity markets. However, the past has shown that the suppression of risky asset volatility and preservation of the wealth effect feed into the reaction function. For us, behind the tactical noise signals are piling up that the biggest risk in the U.S. bond market might thus not come from the Fed falling behind the curve, but from many market participants positioning themselves too far ahead of the curve. Like the real economy went through a full cycle in less than 2 years, markets might go through monetary cycle without substantial hiking ever happening.

Figure 7: Fed rate hikes and S&P 500 12 Drawdown

Even in the long run US yields will remain subdued. It is difficult to imagine long-term rates reestablishing clearly above 3% on a sustained basis. We currently see the long-term (5 years ahead) nominal equilibrium interest rate in the U.S. at 2.6% of which 0.6% are attributable to the real neutral rate. This equilibrium rate could only shift substantially above 3% if we experience extreme monetary tightening or if massive government spending creates a permanent boost to potential GDP. For some, President Biden’s infrastructure plan could trigger such a GDP boost. However, to double the neutral rate relative to our baseline scenario, trend growth would have to reach around 3.5% (against currently 1.8%) without triggering a permanent surge in inflation. But the equilibrium rate could also reach 3% in a negative stagflation scenario.

Figure 8: US equilibrium rate scenarios for a 5-year horizon*

In that case, the driver would be permanently de-anchored inflation expectation (over 3%) while the neutral interest rate would decline as the growth potential is impaired. On a fundamental basis it is therefore hard to justify the regime shift narrative. It is much more likely that, behind all the current market noise, the low for longer regime will prevail (Figures 8 and 9)

Figure 9: Scenarios for US real neutral rate (r*) for a 5-year horizon

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U.S. Government Signals that Increased Sanctions and Export Controls Will Likely Follow if Russia Invades Ukraine

February 3rd, 2022 Grant Leach, Cortney O'Toole Morgan, and Tony Busch Leave a comment

Russia has amassed more than 100,000 troops at the Ukrainian border, leading the White House to issue a warning on January 25 that the U.S. is “prepared to implement sanctions with massive consequences that were not considered in 2014 [when Russia invaded and annexed the Crimea region of Ukraine]” if Russia “further invades Ukraine”. President Biden conducted a telephone call with Ukrainian President Volodymyr Zelenskyy on January 27 in order to reaffirm his administration’s support for Ukraine. The White House has proposed a strategic response which could hurt Russia with measures calculated to exact immediate and sustained harm to the Russian economy. A senior administration official stated that “[i]n addition to financial sanctions, which have immediate and visible effect on the day they’re implemented, we’re also prepared to impose novel export controls that would deal Putin a weak strategic hand over the medium term.” Congress is also considering taking action, with a bipartisan group of Senators currently negotiating provisions of S. 3488 titled the “Defending Ukraine Sovereignty Act of 2022” and a companion bill introduced in the House (H.R. 6470).

However, for the avoidance of doubt, the U.S. has not yet responded systematically to the Russia-Ukraine border situation through new sanctions or export controls (though OFAC did designate four (4) Ukrainian officials on January 20, 2022 for acting on Russia’s behalf).

The Biden Administration has indicated that any retaliatory sanctions and export controls will likely be closely aligned with an expected European response. According to media reporting, potential responsive U.S. sanctions and export controls measures could include:

Office of Foreign Assets Control (“OFAC”) Specially Designated National and Blocked Persons List (“SDN List”). President Biden said he would consider personally sanctioning Russian President Vladimir Putin, which would most likely mean placing Putin on the SDN List. The U.S. would likely place many other Russian individuals and entities on the SDN List, such as “oligarchs” perceived to be close to the Russian regime. S. persons are prohibited from dealing with SDN List designees, whether directly or indirectly, and the OFAC 50 Percent Rule extends such “blocking” sanctions to entities owned, directly or indirectly, 50 percent or more by one or more SDN List designees.

Exclusion from the Society for Worldwide Interbank Financial Telecommunication (“SWIFT”) System. This measure was implemented against Iran in 2012 and would be harmful to the Russian economy.

U.S. Dollar Clearing Sanctions. While certain designees under OFAC sanctions are already prohibited from clearing transactions through U.S. correspondent banks, a more widescale ban on such transactions for even non-designated entities could be far more impactful.

Secondary Market Russian Sovereign Debt. Effective June 14^th, 2021, OFAC Directive 1 under Executive Order 14024 prohibits U.S. financial institutions from engaging in activities with the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation and the Ministry of Finance of the Russian Federation which involve either participation in the primary market for ruble or non-ruble denominated bonds issued by those institutions or lending ruble or non-ruble denominated funds to those institutions. The U.S. could expand these sanctions to also prohibit the secondary market from conducting transactions tied to Russian sovereign debt.

Widescale Blocking of Transactions with Russian Banks and Other SSI List Designees. Many Russian banks and other entities are currently designated on the OFAC Sectoral Sanctions Identifications List (“SSI List”), which prohibits certain limited activities such as dealings in debt issued by SSI List designees, but which otherwise allows U.S. persons to generally transact with SSI List designees. OFAC could upgrade these SSI List designations to SDN List designations which would then fully block any dealings with these entities by U.S. persons and the U.S. financial system.

Increased Sanctions and Export Controls Targeting Russian Energy Exports. Currently, Directive 4 of the SSI List imposes sanctions on various Russian deepwater, Arctic offshore and shale projects for the exploration for or production of oil or gas and the Protecting Europe’s Energy Security Act imposes additional sanctions on Russia’s Nord Stream 2 natural gas export pipeline. The U.S. could significantly enhance these sanctions in response to Russian military action against Ukraine. For example, in a January 26 interview with NPR, U.S. State Department spokesman Ned Price stated that “if Russia invades Ukraine, one way or another, Nord Stream 2 will not move forward, and we want to be very clear about that.”

Export Administration Regulations (“EAR”) Foreign-Produced Direct Product Rule (“FPDPR”). The U.S. previously imposed a modified version of the EAR’s FPDPR against Huawei, which prevents persons and companies abroad from supplying Huawei with foreign-origin items manufactured from certain types of U.S. software or technology. Many media reports have speculated that the U.S. could use a version of the FPDPR to restrict the supply of certain items to Russia generally or to certain sectors of the Russian economy.

Bureau of Industry and Security (“BIS”) Entity List Designations. The EAR generally prohibits any exports, reexports, or transfers of items “subject to the EAR” to persons named on the BIS Entity List. BIS has used this tool to significant effect in recent years, especially in regards to China. BIS could also use the Entity List to deprive Russian companies of their access to U.S.-origin goods and software.

Any new sanctions and export controls would affect many countries and industries around the world. However, nothing has happened yet and everything discussed above is currently speculative.

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Grant Leach is an Omaha-based partner with the law firm Husch Blackwell LLP focusing on international trade, export controls, trade sanctions and anti-corruption compliance.

Cortney O’Toole Morgan is a Washington D.C.-based partner with the law firm Husch Blackwell LLP. She leads the firm’s International Trade & Supply Chain group.

Tony Busch is an attorney in Husch Blackwell LLP’s Washington, D.C. office and is a member of the firm’s International Trade & Supply Chain practice team.

Archives, EU Trade, Global Trade Daily, International Trade

Navigating Trade & Business 1 Year Post-Brexit

January 30th, 2022 David O'Sullivan, Senior Counsel at Steptoe & Johnson LLP and Co-Authors Leave a comment

It is just over five and a half years since the Brexit referendum delivered a surprise 52/48 verdict in favor of the UK departing the European Union.

It has been a period of intense political upheaval in the UK resulting in the departure of two successive Prime Ministers and two general elections, all against the backdrop of fraught negotiations to agree with the EU a Withdrawal Agreement (WA), setting out the terms of the departure, and a new Trade and Cooperation Agreement (TCA), designed to frame the new relationship.

The WA was concluded in December 2019. The UK exited the EU on January 31, 2020, but nothing changed until the expiry of a transition phase at the end of that year, by which point the TCA was also agreed.

The dust has still not fully settled on the definitive shape of EU-UK relations as there are several as yet unresolved issues due to certain grace periods (the UK is only this year beginning fully to implement checks on EU imports) and some unfinished business (defining the modalities of the vexed arrangements for Northern Ireland). However, the general direction of travel is clear. The UK has opted for the most severe form of exit, seeking to cut most ties with the EU and aiming to achieve the maximum degree of regulatory independence.

The economic and social dislocation caused by the pandemic has made it difficult sometimes to distinguish between the impact of Brexit only versus that of COVID 19. However, this article seeks to describe, as far as possible, how Brexit has affected the business and regulatory environment across the full range of areas covered by Steptoe and Johnson practices so far, and to identify issues of potential future concern for companies.

Trade, Customs, and the Level Playing Field

Customs and Supply Chain Issues

2021 was a year characterized by supply chain issues. Not just in the EU or the UK, but globally. While trade was down in the first half of 2020 due to the global pandemic, 2021 saw a complete reversal with global ports being highly congested. This issue was felt differently in the EU as compared to the UK, however. Euro-area exports of goods in October 2021 were close to pre-pandemic levels, being only 2,34% down from October 2019.[1] In the UK, on the other hand, exports of goods were 9,6% lower in October 2021 than in October 2018, the “most recent ‘stable’ period” in the UK.[2]

A key reason why customs and supply chain issues were more acute in the UK as compared to the EU appears to be Brexit. UK companies have so far experienced more difficulties in trading under the new customs arrangements following Brexit than EU companies.[3] Indeed, the EU has been applying full customs checks to imports from the UK since January 1, 2021, while the UK has repeatedly delayed similar checks on imports from the EU. However, as of January 1, 2022, the UK has introduced full customs checks on goods imported from the EU to Great Britain, with exceptions regarding Ireland and Northern Ireland.[4] UK importers are likely to face significant disruptions, at least in the short term, as they get used to the additional red tape due to the application of full customs checks. This could have an important impact on EU export volumes to the UK, similar to the disruptions caused to UK exports to the EU when the EU started applying full customs checks on imports from the UK.

The Level Playing Field

Ensuring a post-Brexit “level playing field” was a key issue during the Brexit negotiations. A key fear of Brussels was that having left the strict rules of the EU, the UK would turn into an economy with limited regulations and uncontrolled subsidies while retaining duty free access to the Single Market. The TCA ended up including a number of components related to the level playing field, with key parts being related to subsidies and state-aid. The outcome of this on the UK side has been the UK Subsidy Control Bill 2021,[5] which seeks to strike a balance between the UK’s obligations under the TCA, while at the same time allowing the UK with sufficient flexibility to provide subsidies where it deems fit. In its current form, its principles regarding subsidy control largely mirror those of the TCA, although there does seem to be room for interpretation and it remains to be seen whether the EU will consider the implementation thereof to be in line with the TCA.

In parallel, the EU is in the process of adopting a new regime to address distortions caused in the EU market by foreign subsidies.[6] This would give the European Commission the power to investigate foreign subsidies granted to any company active in the EU and impose regressive measures to counteract any distortive effects (see our blog post describing this proposed regime here). While this proposed legislation is not specifically related to Brexit, it could have implications for UK companies active in the EU which have received UK subsidies.

The Northern Ireland Protocol

While Brexit happened on February 1, 2020, and the Brexit transition period ended on January 1, 2021, there are still many unresolved issues under negotiation. Throughout 2021 the EU and the UK have been engaged by intense negotiations regarding the Northern Ireland Protocol, which has in effect resulted in Northern Ireland remaining in the EU Single market for goods. This has, however, resulted in several disruptions in trade between the rest of the UK and Northern Ireland, with several customs checks on goods, and severe disruptions on agri-food products, due to the absence of a veterinary agreement.

These disruptions are despite the fact that all the checks under the Protocol have not yet been fully implemented, while the UK has continued to extend the “grace period” during which lesser checks apply.

Towards the end of 2021, the situation got very tense, with the UK threatening to unilaterally suspend part of the Protocol over continued trade disruptions caused by the Protocol. Although at the time of writing the situation seems to have somewhat settled down, UK red lines remain, and the UK remains prepared to suspend part of the Protocol should the parties not come to an agreement.[7]

Should the UK suspend (part of) the Protocol, the EU has indicated that it may initiate dispute settlement proceedings and/or take retaliatory measures. There is even the potential that the EU may renounce the TCA in its entirety if the UK suspends the Protocol, although this appears less likely. It is clear, however, that a UK suspension of the Protocol would have significant consequences for EU-UK relations; not only in terms of trade but also other issues dealt with in the agreement.

Regulatory landscape

Competition

Since the end of the transition period, EU competition law ceased to apply to the UK and EU competition law is no longer applied by UK enforcement authorities. Although they must have regard to EU guidance and future EU case law, they are not bound by future EU law and may depart where appropriate.

The UK’s competition authority, the Competition and Markets Authority (CMA) is no longer party to the EEA’s cooperation network, nor does it benefit from the 60+ cooperation agreements between the EU and third countries. The TCA envisaged such an agreement and under discussion are provisions to share information, attend each other’s interviews (M&A and infringements), and request the other to conduct raids. However, it has yet to be concluded.

EU block exemptions (which define certain types of agreements that are allowed under the EU’s competition rules) have been retained as part of the UK’s domestic law. The EU has been conducting public consultations on some Block Exemptions which will expire soon, including those concerning vertical agreements. The CMA is in the process of preparing its own version. The two are likely to diverge, not least because the EU’s Single Market imperative is not relevant in the UK context, save as between the UK nations (where the UK now has its own UK Internal Markets Act).

As regards merger control, the UK regime is voluntary and the thresholds are unchanged. It is envisaged that mandatory notification may be introduced in the digital markets. The UK has now also adopted, in line with other major jurisdictions, a foreign direct investment (FDI) screening regime – the National Security and Investment Act (NSIA). Under the NSIA, there is currently mandatory notification of transactions required in 17 key “sensitive” sectors, including notably telecommunication, technology, and defense. The CMA has issued new Market Assessment Guidelines which, for example, broaden the CMA’s approach to when it will claim jurisdiction over a transaction. The CMA closely monitors the market and has significantly increased the review of transactions and called in completed transactions for investigation.

Sanctions

During Brexit negotiations, the EU and UK stated their desire to coordinate as much as possible on sanctions policy post-Brexit without agreeing on a formal framework to do so. The past year has seen several examples of continuing cooperation when EU and UK political priorities align, including announcing coordinated measures under their respective Belarus, Global Human Rights and Myanmar sanctions regimes. Yet, the decoupling brought about by Brexit has resulted in a degree of divergence between EU and UK sanctions priorities, designations and implementation.

The UK’s establishment of an autonomous Global Anti-Corruption sanctions regime in April 2021 underlines the UK’s efforts to develop a more agile autonomous sanctions regime that is capable of swift action. The move brought the UK more into line with the scope of the “Magnitsky” regimes adopted in the US and Canada, which unlike the EU’s Global Human Rights Sanctions Regime also apply to corruption offenses. It also emphasized the UK’s commitment to expanding the roster of like-minded international partners with which it will collaborate post-Brexit.

The decision to not directly transpose existing EU sanctions regimes into the UK’s new legal framework for sanctions already has resulted in divergence in designations and the implementation of sanctions policy, bringing with it the potential to create sanctions compliance difficulties for companies that are subject to both regimes. For example, the legal tests for designation are different in the EU and UK, which has resulted in disparities between EU and UK sanctions lists. It is likely that, over time, these differences will expand further in response to the refinement of designation thresholds and shifting political priorities. The UK also has introduced new tools, such as general licenses, to enable companies that meet certain conditions to undertake otherwise prohibited activities under specified sanctions regimes. Such tools are absent from the EU’s sanctions architecture. This could potentially complicate the navigation of sanctions exemptions and licensing derogations for companies operating across Europe.

Insurance

In preparation for Brexit, many insurers rationalized their business so that UK business was handled by entities in the UK and EU business was handled by entities in the EU. Numerous books of business were transferred using portfolio transfers (almost half of those from the UK were to Ireland or Luxembourg). In other cases, insurers simply discontinued their UK or EU business.

The TCA, concluded at the last moment, largely excluded financial services.

Following Brexit, the right under EU law for insurers to passport from the UK into the EU, and vice versa, ended. However, the UK permitted EU insurers to carry on business as usual in the UK for a limited period, under a temporary permissions regime (“TPR”), the intention being to allow such insurers to become UK-authorised if they wished to do so. Fewer insurers than expected opted into the TPR. The EU did not offer any comparable arrangement, and most EU Member States now prohibit UK insurers from conducting new business and have stringent rules concerning the run-off of existing business.

During the Brexit negotiations, the possibility of the EU recognizing the UK as an equivalent regime under the EU’s insurance legislation was a key topic. Although the UK has granted equivalence to the EU, the EU has not done so with the UK’s regime. The EU and the UK regimes concerning solvency may diverge in the near future due to the ongoing reviews of an applicable framework on both sides of the Channel, which further reduces the likelihood of the EU recognizing the UK as equivalent.

UK and EU re-insurers have adjusted their operations to reflect the restricted market access rights, including by establishing local licensed entities and setting up appropriate outsourcing arrangements for the most efficient allocation of group resources.

Chemicals

Those campaigning for Brexit often cited the benefits of a more flexible, targeted, UK-centric approach to environmental regulation as one of the prizes, and in 2021 the UK government wasted no time in seeking reform. However, of all the environmental issues, the regulation of chemicals stands out as creating some of the biggest Brexit challenges.

The issue stems from the European approach of ‘no data, no market’, which requires companies to submit data on hazard properties through a registration process to obtain market access. The UK failed to reach an agreement with the EU on the existing database, so the independent regimes for the UK market require companies to populate new databases, at a cost estimated at over a billion euros.

In response to industry concerns about timescales and costs, in December 2021 the UK announced a review to explore a ‘new model’ for data packages, with longer timescales for submitting data and a greater focus on use and exposure, allowing ‘more targeted’ regulatory action. Also, in December 2021, the UK announced its approach to identifying ‘substances of very high concern’, setting a different process to the EU list. The moves generated an immediate reaction from NGOs who claim the UK is not upholding the terms of the TCA on ensuring a ‘level playing field’, and urging the EU to step in.

The arguments are likely to intensify in 2022, when the EU pushes forward with its legislative agenda to deliver the Chemicals Strategy for Sustainability, with some significant changes predicted. In 2022 we also anticipate the UK’s own chemicals strategy, first promised in its 25 Year Environment Plan back in January 2018. With chemicals underpinning so much of the economy, this is an agenda with implications far beyond the chemicals sector itself, and international companies should monitor this closely. You can read more in our briefing.

Data protection

Brexit left a question mark over the flow of personal data between the UK and the EEA. That question was not resolved until June 2021 when the European Commission issued its decision confirming that the UK does ensure an adequate level of protection. While that outcome was highly political, it was difficult for the Commission to come to any other decision given that the UK had implemented the EU’s data protection legislation into national law and, to date, applied the case law of the European Court of Justice. However, the adequacy decision is not permanent. It may be revoked by the Commission if the UK no longer provides that requisite protection and will be reviewed in 2024. If that review does not result in an extension, the decision will expire on June 27, 2025.

Notwithstanding the above, the UK has flagged its intention to deviate from the EU’s privacy strategy by adopting a supposedly more business-friendly approach. In particular, the UK is likely to adopt its own set of adequacy decisions, develop domestic data transfer mechanisms and has stated its intention to overhaul the regulation of website cookies. In addition, the UK will not be a party to the upcoming changes in the EU to the regulation of cybersecurity, AI, and more.

How quickly and how far the UK deviates from the EU’s data protection legislation is yet to be seen. Whatever the possible deviations, the key question will be how far the EU is prepared to tolerate such divergence and still grant adequacy.

Criminal Investigations

The WA and the TCA have significant implications for cross-border cooperation in criminal matters in the UK and EU.

In relation to financial crime enforcement, the key provisions in the WA are contained in Title V on ‘Ongoing Police and Judicial Cooperation in Criminal Matters.’ In relation to investigations and proceedings commenced before the end of the implementation period, requests or judicial orders received by the appropriate authority in the UK or EU prior to the end of the implementation period remain enforceable. For requests or orders issued after that time (including European Investigation Orders (“EIOs”)) mutual legal assistance arrangements will need to be relied upon instead. These arrangements can be administratively burdensome and time-consuming. There are also exceptions that allow members states to refuse to comply with a request, including where a matter has already been adjudicated on in another state, that state may refuse to comply with a request.

Part 3 of the TA concerns ‘Law Enforcement and Judicial Cooperation in Criminal Matters,’ and covers a number of areas including exchanges of operational information, cooperation with Europol and Eurojust, surrender, mutual legal assistance, anti-money laundering and counter-terrorism financing, and freezing and confiscation orders. Most significantly, the UK ceased being a member of Europol and Eurojust, with its influence and involvement being significantly reduced as a result. The availability of the European Arrest Warrant (“EAW”) in the UK also came to an end, and was replaced by a new regime known as ‘surrender’. In essence, surrender is based on the mutual recognition of arrest warrants issued by another state. In contrast to an EAW, states can elect to refuse to comply with a request for surrender on the basis that the underlying offense is ‘political’, and may also elect to refuse to surrender their own nationals or attach conditions to the surrender of their own nationals.

The TCA also expressly provides for Joint Investigation Teams (“JITs”) between UK and EU member state investigating authorities, although it is largely silent on the detail. It is envisaged that changing political moods and relationships have the potential to affect the willingness and ability of authorities to cooperate with each other.

Conclusion

While some of the impacts of the UK’s departure from the EU are becoming increasingly clear, much of the detail remains to be defined. The politics of Brexit are likely to remain fraught, both around the Northern Ireland Protocol and other areas such as fisheries, data privacy, chemicals, and financial services. Companies will need to follow very closely both the fine-tuning of existing arrangements as well as the way potential new arrangements will evolve. Steptoe and Johnson can offer detailed and informed commentary and advice on all the areas covered in this article.

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*Co-authors: Renato Antonini, Eva Monard, Byron Maniatis, Charles Whiddington, Alexandra Melia, Guy Soussan, Angus Rodger, Simon Tilling, Ruxandra Cana, Leigh Mallon, Charles-Albert Helleputte, Diletta De Cicco, Zoe Osborne

[1] See https://ec.europa.eu/eurostat/documents/2995521/11563419/6-16122021-%20AP-EN.pdf/fe1315b6-a0c5-56b3-3de3-13468db7becd, and https://ec.europa.eu/eurostat/documents/2995521/10662401/6-16122020-BP-EN.pdf/083d8003-af99-e3c6-0294-6b5df4e68156.

[2] See https://www.ons.gov.uk/economy/nationalaccounts/balanceofpayments/bulletins/uktrade/october2021#total-trade-three-monthly-and-annual-movements. After October 2018 disruptions caused by Brexit started to kick in, further exacerbated by the pandemic starting in 2020.

[3] In December, the British Chamber of Commerce reported that 45% of UK companies have had difficulties in trading under the new customs arrangements put in place by the TCA. See https://www.britishchambers.org.uk/news/2021/12/almost-half-of-firms-facing-difficulties-trading-with-eu-under-post-brexit-trade-agreement.

[4] See https://www.gov.uk/government/news/less-than-a-month-until-full-customs-controls-are-introduced.

[5] See https://bills.parliament.uk/bills/3015.

[6] See https://ec.europa.eu/commission/presscorner/detail/en/ip_21_198.

[7] See https://www.politico.eu/article/uk-to-eu-british-position-on-northern-ireland-remains-unchanged/.

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BIS Delays Implementation of New Cybersecurity Items Interim Final Rule

January 26th, 2022 Tony Busch, Cortney O'Toole, and Grant Leach Leave a comment

In an October 21, 2021 interim final rule (“IFR”), the Bureau of Industry and Security (“BIS”) published long-awaited “cybersecurity items” controls in Categories 4 (Computers) and 5, Pt. 1 (Telecommunications) of the Commerce Control List (“CCL”) and followed the IFR up on November 12, 2021 with relevant FAQs. The IFR will impose new export controls on certain “cybersecurity items” that relate to “intrusion software” or “IP network communications surveillance.” The IFR, originally scheduled to become effective on January 19, 2022, will now become effective on March 7, 2022. In the January 12, 2022 notice announcing the delay, BIS stated it “may consider some modifications for the final rule” and indicated it would “provide the public with additional guidance.” Below we describe the IFR as it currently stands. We will update readers when BIS implements any additional edits to the IFR and/or updates its guidance.

The IFR establishes two (2) new export control classification numbers (“ECCNs”) and expands the control text of several additional ECCNs within the CCL. The IFR collectively defines the items falling under these CCL modifications as the “cybersecurity items.” Each “cybersecurity item” covered in the IFR will be destination-controlled for National Security (“NS”) and Anti-Terrorism (“AT”) reasons. The modifications fall under two (2) broad topics: (i) expanded control text in Category 4 for hardware, software, and technology providing the infrastructure for managing “intrusion software”; and (ii) expanded control text in Category 5, Pt. 1 related to “IP network communications surveillance” items. The IFR also includes notes which clarify that, in the event any commodities or software which qualify as “cybersecurity items” also incorporate “information security” functionality described in any Category 5, Pt. 2 ECCNs (which will often involve encryption or cryptanalysis), then those Category 5, Pt. 2 ECCN classifications will prevail. However, those notes do not cover technology (which has a special definition under the EAR). The notes also specifically state that elements of source code implementing functionality not controlled by Category 5, Pt. 2 may still be subject to the “cybersecurity item” controls implemented by the IFR. “Cybersecurity items” controlled for Surreptitious Listening (“SL”) reasons under pre-existing ECCNs will also remain under those ECCNs.

The new “intrusion software”-related parameters will control hardware and software specially designed or modified for the generation, command and control, or delivery of “intrusion software,” as well as technology for the “development” or “production” of that hardware or software. The EAR’s pre-existing definition of “intrusion software,” will remain. It is primarily designed to describe exploits or payloads that do not involve encryption but that are nonetheless specially designed or modified to avoid detection by ‘monitoring tools’ or to defeat ‘protective countermeasures’ for the purpose of extracting data or modifying a standard software program execution to allow the execution of externally provided instructions. Importantly, the IFR does not impose export controls on the “intrusion software” itself. “Intrusion software,” when designed for military offensive cyberspace operations, would more appropriately be considered for classification purposes under the International Traffic in Arms Regulations (“ITAR”) as clarified by BIS FAQ #5.

The new “IP network communications surveillance” parameters will control telecommunications equipment capable of servicing a carrier class Internet Protocol (“IP”) network, performing application layer analysis, indexing extracted data, and being “specially designed” to execute searches based on “hard selectors” (i.e., personal data) and mapping relational networks of individuals or groups of people (hereafter referred to in this post as the “Telecommunications Surveillance Equipment”). The new and expanded control text will also control the software equivalents of the Telecommunications Surveillance Equipment as well as the test equipment, software, and technology specially designed or modified for the “development,” “production,” or “use” of the Telecommunications Surveillance Equipment.

The IFR also creates a new License Exception Authorized Cybersecurity Exports (“License Exception ACE”). Although LE ACE is similar to the EAR’s existing License Exception Encryption Commodities, Software, and Technology (“License Exception ENC”), there are some key differences between License Exceptions ACE and ENC. Exporters hoping to use the new License Exception ACE’s authorizations will need to consider the full range of U.S. export controls represented in its terms and conditions: destination, end-user, and end-use. For instance, License Exception ACE lays out a multi-layered approach where the nature of the end-user (e.g., “U.S. subsidiary,” “non-government end user,” “government end user,” and/or “favorable treatment cybersecurity end user”) must be considered alongside the destination and any knowledge or “reason to know” of an illegitimate end-use (which, without citing the EAR definition, is what is commonly understood as black hat and/or state-sponsored “hacking”). “Deemed” exports to Country Group D foreign nationals of any Country Group D destination are presumptively not authorized under LE ACE. However, when an exporter can determine the end-user of the export or “deemed” export is a “non-government end user,” then License Exception ACE will provide authorization to certain Country Group D destinations for (i) exports to “favorable treatment cybersecurity end users”; (ii) exports for “vulnerability disclosure” or “cyber incident response”; and (iii) “deemed” exports to foreign nationals.

A final note on License Exception ACE, especially for those proficient in License Exception ENC, is that License Exception ACE’s definition of “government end user” is far broader than the parallel definition in License Exception ENC.

Some heightened areas of risk under the IFR will include exports and reexports to non-U.S. subsidiaries in Country Group D countries and proper due diligence to meet BIS’ “reason to know” standard for end-use restrictions in License Exception ACE.

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Tony Busch is an attorney in Husch Blackwell LLP’s Washington, D.C. office and is a member of the firm’s International Trade & Supply Chain practice team.

Cortney O’Toole Morgan is a Washington D.C.-based partner with the law firm Husch Blackwell LLP. She leads the firm’s International Trade & Supply Chain group.

Grant Leach is an Omaha-based partner with the law firm Husch Blackwell LLP focusing on international trade, export controls, trade sanctions and anti-corruption compliance.

Archives, Global Trade Daily, News

DHS Requests Comments to Inform Implementation of the Uyghur Forced Labor Prevention Act

January 24th, 2022 Tony Busch and Robert Stang Leave a comment

Today, the U.S. Department of Homeland Security (“DHS”) issued a request for comments to assist the Forced Labor Enforcement Task Force (“FLETF”) with implementation of the Uyghur Forced Labor Prevention Act (“UFLPA”). The UFLPA, signed by President Biden on December 23, 2021, creates a rebuttable presumption that goods manufactured wholly or in part in the Xinjiang Uyghur Autonomous Region (“Xinjiang”) or produced by an entity on a number of lists to be produced, will be denied entry into the U.S. under section 307 of the Tariff Act of 1930 (19 U.S.C. 1307). The UFLPA was passed in response to the alleged use of forced labor of Uyghurs, Kazakhs, Kyrgyz, Tibetans, and other persecuted groups in China. Readers can learn more about the UFLPA and the rebuttable presumption, which goes into effect on June 21, 2022, in our previous post following the UFLPA’s enactment.

While the UFLPA will almost certainly result in additional withhold release orders (“WROs”) on goods manufactured wholly or in part by entities in China, DHS’ request for comments does not provide the public with new details about investigations and enforcement practices or procedures that DHS has utilized in the Xinjiang-related WROs issued on certain silica-based products as well as certain cotton and tomato products. Instead, the request for comments poses eighteen (18) open-ended questions.

U.S. importers potentially affected by WROs are encouraged to submit comments to ensure a balanced and fully accurate record. Some questions of particular importance include:

-What due diligence, effective supply chain tracing, and supply chain management measures can importers leverage to ensure that they do not import any goods mined, produced, or manufactured wholly or in part with forced labor from the People’s Republic of China, especially from the Xinjiang Uyghur Autonomous Region?

-What type, nature, and extent of evidence can companies provide to reasonably demonstrate that goods originating in the People’s Republic of China were not mined, produced, or manufactured wholly or in part with forced labor in the Xinjiang Uyghur Autonomous Region?

-To what extent is there a need for a common set of supply chain traceability and verification standards, through a widely endorsed protocol, and what current government or private sector infrastructure exists to support such a protocol?

-What measures can be taken to trace the origin of goods, offer greater supply chain transparency, and identify third-country supply chain routes for goods mined, produced, or manufactured wholly or in part with forced labor in the People’s Republic of China?

Comments are due on March 10, 2022 at 11:59 PM. Husch Blackwell will continue to monitor UFLPA developments including the anticipated reports, lists, and implementing regulations.

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Tony Busch is an attorney in Husch Blackwell LLP’s Washington, D.C. office and is a member of the firm’s International Trade & Supply Chain practice team.

Robert Stang is a Washington, D.C.-based partner with the law firm Husch Blackwell LLP. He leads the firm’s Customs group.

3pls, Archives, Global Logistics, Global Trade Daily

Planning for Survival in the New Normal

January 4th, 2022 Jerry Peck Leave a comment

With so much having already been written on supply chain disruption over the past eighteen months – beginning with the initial shut-down of production in China, to fascinating tales of toilet paper hoarding, and now to the current inability to get backlogged demand through our ports of entry — I was initially reluctant to add yet another article to the stack. So what changed my mind? There are actually two reasons, which I’ll explain.

First, the problems and lessons learned from the COVID-19 pandemic are now forcing companies to become more agile, reassessing every element of their existing supply chains in preparation for the “new/next normal”. It’s now blank sheet of paper time as previous playbooks regarding sourcing, inventory levels, placement and risk mitigation plans (if they even had one) – together with any supporting infrastructure of people, processes and enabling technology – are being tossed out the window.

And while COVID-19 can be credited as the catalyst for forcing companies to perform these assessments, it doesn’t take a pandemic to bring a supply chain to its knees. In addition to the exposure contributed by single-sourcing key goods or from maintaining lean inventory levels (i.e., “Just-in-Time” versus “Just-in-Case”), designing a more resilient, risk-averse global supply-chain will require the inclusion of a broader list of potential risks to consider particularly when selecting foreign suppliers. These should include geopolitical conflicts, socio-economic factors including labor, crime and corruption, limited port capacity/infrastructure, weather-related disruptions, and even natural disasters (recall the 2011 earthquake and tsunami in Japan).

Take geopolitical risk, for example. The US’s over-dependency on China for products ranging from personal protective equipment (PPU) to rare-earth minerals has made it a growing concern from both a business and a national security perspective. A sobering report by the Hinrich Foundation (“Strategic US-China Decoupling in the Tech Sector”), states that “the China-US geopolitical competition has reached a competitive tipping point and morphed into a new ‘cold war’”, citing an increase in China’s bold hegemonic policies. The report further highlights China’s years of intellectual property theft, growing labor costs, and the more recent special tariffs levied by the Trump administration, as key reasons for an increase in US supply-chains decoupling from China and either moving into more risk-averse areas in Southeast China, near-shoring to Mexico, or even re-shoring to the US.

In an actual side-by-side near-shoring exercise which compared China with Mexico, the advantages quickly fell to Mexico citing a shorter supply chain with fewer physical touchpoints (damage/theft/service fees), lower freight costs, and eligibility for duty-free entry under the USMCA Free Trade Agreement, as well as side benefits that included ease of communication with vendors and the convenience of traveling to vendor sites.

Risk Management Meets Industry 4.0

The second reason for my writing is that there’s another movement afoot that aligns with supply-chain risk initiatives from the position of enabling technology capable of producing even greater resiliency. Labeled as “Industry 4.0”, this next industrial revolution is the result of the substantial transformation that is occurring through the digitization of manufacturing. For context, the first industrial revolution was through the introduction of water and steam power. Steam would give way to electrical power as the second industrial revolution, with the third being born out of the introduction of computers and their ability to automate previously manual tasks. Fast forward to today where the fourth revolution is now further optimizing that automation by connecting computers with smart machines and “disruptive technologies” such as Artificial Intelligence (AI), Machine Learning, Advanced Business Intelligence, Predictive Analytics and Data Lakes, capable of removing humans from decision-making processes, including applications capable of identifying and even predicting risk.

Where Industry 4.0 supports supply-chain risk initiatives is that the 4.0 movement includes the digitization of global supply-chains. This will translate into unprecedented transparency and connectivity across the entire end-to-end order and shipment process where supporting business functions such as Product Engineering, Procurement, Sales & Marketing, Transportation, Trade & Customs and Accounts Payable traditionally operate in respective silos.

For example, take Trade & Customs operations. Its typical placement near the end of the supply chain process, together with a lack of early visibility to international order, has served for years as a recipe for reactive firefighting as shipments become “stuck in customs” upon arrival until data/documentation issues are resolved. Under a digitized model, silos are replaced with connected supply-chain visibility that would allow Trade & Customs’ participation to move upstream to the earliest stages of new product build/buy decisions. As a result, they’re now in a position to proactively contribute critical advice on regulatory issues, import admissibility requirements, duty/tax minimization strategies such as Tariff Engineering, Foreign Trade Zones, Free Trade Agreements or changes in source countries (e.g., avoiding a 25 percent special tariff on Chinese goods by switching the sourcing to Mexico) – all key factors capable of removing cost, risk and time from their supply-chain.

If you’re currently building a business case to launch your own risk initiative, an interesting report from McKinsey & Company (“Resetting Supply Chains for the Next Normal”), might give you some additional support. For instance, in their survey of 60 senior supply-chain executives across industries and geographies, 85 percent responded that they struggled with insufficient digital technologies, 93 percent plan to increase resilience across the supply chain, and 90 percent plan to increase digital supply-chain talent in-house needed to support that new technology. In short, you’re not alone.

Whether your current project is to address the exposure from disruptions to your supply chain or to digitize the entire enterprise as a result of the increasing disruption caused by technology-driven innovation, what’s becoming clear is that companies will be forced to become agile and adaptive — able to change business models at unprecedented rates of speed in order to survive and thrive in the “new/next normal.”

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Jerry Peck is the Vice President of Product Strategy at QAD Precision, with over 30 years of experience in Global Trade Management. His career has uniquely encompassed nearly every facet of GTM, including third-party logistics, trade operations within Fortune 300 multinationals, and professional services consulting firms.

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