Since the United States Trade Representative (“USTR”) formally initiated the Section 301 investigation against China in late August 2017, much has transpired in the trade relations between the United States and China. A so called “Phase One Agreement” was reached in late 2019, which brought hope of a possible stasis in the trade dispute if not a resolution. Current USTR Tsai among others have recognized that none of the commitment in that agreement has been met.
There was much anticipation of a reset in US China trade relationship under the Biden administration. We continue to wait. In the meantime, strategic decision making must be based on the trade landscape as it is and not as it was hoped to be. For China’s part, it has very recently taken steps to counter the US’s trade actions with regulatory controls of its own. From export controls on Chinese technology to potentially blocking certain unreliable entities and enacting national security laws in its Special Administrative Regions, China is leveraging its strengths to counter US trade regulatory measures. US law and Chinese law are now in some areas of trade regulation, in direct conflict. As a result, some companies perceive that they need to choose a side—either the US or China—in determining their near- and long-term strategies.
Such complexities present rare opportunities to gain significant competitive advantage for those organisations willing to take action. Successful companies will be considering strategic action on the following:
Opportunistic Acquisitions
The current political environment and global pandemic impact has created favourable valuation conditions for some business. Whether it is a technology company with larger exposure to politically sensitive jurisdictions or capital goods manufacturers suffering with a deeper than expected demand shock, valuable assets and opportunities may become available at favourable valuations.
Due diligence for trade and national security issues may be differentiating factor between success or failure in pursuing these opportunities. Understanding the factors that may lead to heightened scrutiny of foreign investments or acquisitions can help direct acquisition strategy. Understanding the trade regulatory landscape can help to ensure risks and uncertainties are baked into the valuation and are captured in the deal documentation.
Due diligence for trade and national security issues should be undertaken as early in the deal lifecycle as possible in order to identify possible roadblocks or develop planning strategies to give your organisation the best possible chance of success in such deals.
Supply Chain, Manufacturing, and Distribution Structuring
The existing tariff measures in the US against China as well as those announced against Vietnam are based upon the country of origin of the goods being imported into the US. Likewise, China’s retaliatory measures are based on similar rules of origin. Origin is not only a determining factor for punitive measures, however. Free trade agreements and other tariff preferences are also based upon the country of origin of imported merchandise.
It is therefore critical when planning commercial and production operations to understanding the rules of origin for each market, whether the operative rules are preferential or non-preferential such as in the case of free trade agreement planning or punitive tariff measure planning. Understanding when an item may not be entirely the product of a single origin but can nevertheless have its origin determined based upon certain substantial steps or value added in the production that can open up planning opportunities and drive competitive advantage.
Commercialising Compliance
Vetting customers, verifying end-use, maintaining records, ensuring appropriate licenses have been obtained, reporting accurate transaction values, and self-verifying these activities is now among the organisation’s “must do” actions rather items on a “nice to do” wish list.
Drafting, implementing and maintaining these compliance policies and procedures can realise great benefits from trade facilitation measures offered by regulators across several jurisdictions, they can be the difference between a successful bid for a large multinational supplier, and they will certainly protect shareholder value against fines, penalties, or even reputational damage. Finally, compliance policies that are well crafted and implemented can inform, facilitate, and enable distributed decision making across the organisation in real time, which supports the execution of the organisation’s commercial objectives.
Tax and Tariff Planning done right
When larger organisations operate across several markets, inefficiencies often result in the tax and duty liabilities incurred for such cross-border operations. It is therefore critical to understand the elements of value that are created in the organisation’s design, sourcing, manufacturing, distribution, sales, and servicing functions. Where these functions predominantly occur, which customers and markets predominantly benefit from such activities, and establishing transaction documents that adequately capture these activities and value add are essential in reducing costs of goods sold and maximising net profits.
Reviewing, amending, and negotiating agreements
The global pandemic, unreliable entities, denied parties and sanctions can all result in the shadow of uncertainty being cast over longstanding and pre-existing commercial agreements with suppliers and customers. Should the organisation need to make changes to such agreements, is there language incorporated that will enable such changes? Will there be punitive consequences? What will the financial impact to making business changes?
Well drafted commercial agreements should answer more questions that they raise. In the current environment, clauses and provisions of large and critical commercial agreements should contemplate and provide for such circumstances. Foresight in contracting can be a major competitive advantage for savvy organisations in times of great change and uncertainty.
Conclusion
Companies should take affirmative steps to adjust to the prevailing political and regulatory environment. Leveraging expert advisors can create value and help to gain or solidify competitive advantage. In fact, doing nothing must also be seen as an affirmative step and must itself also be the result of careful and intentional strategic decision-making.