The 'rules of origin' are the biggest post-Brexit change for automotive trading. Oliver Bridge explains the impact of the new country of origin rules on the UK industry, including electric vehicles.
The rules of origin will have a substantial impact on the automotive industry. In the future, it will be essential for materials to meet the criteria before they can qualify for free trade. In the EU-UK Trade and Cooperation Agreement (TCA), material produced in both the UK and EU can qualify for it.
What are rules of origin?
A product's country of origin is its ‘economic nationality’, which is not necessarily the country that it was shipped from. For most products, 'origin' determines if a trade tariff, which would increase its cost, is applied. As with the TCA, materials qualify for free trade by meeting the rules of origin criteria.
The country of origin for a product changes when a suitable amount of processing has been completed. This is typically determined by either:
A change in tariff code (either the first two, four or six digits in the code)
A dilution of non-originating material has occurred to meet a threshold; this is often called maximum non-originating material (MaxNOM)
The rules of origin are in place to ensure preferential trade terms are not gained without adding value to the product; otherwise, products could take unfair advantage of free trade agreements where there is no diagonal cumulation.
How will rules of origin impact the automotive trade after Brexit?
The most obvious consequence of rules of origin is that it will increase costs for the automotive industry, eg, either through trade tariffs or extra administration. However, the rules of origin are likely to have impacts in three other areas as well.
12 month grace period
The automotive sector is complex; many vehicles have over 3,000 parts (component, sub-assembly or assembly). Historically, origin has been less important to EU and UK manufacturers because once the part is imported to the EU it can move around freely. Since agreeing the TCA, the rules of origin mean that parts imported to the EU or UK now cross a border, resulting in potential tariffs if the origin criteria are not met.
Luckily for the automotive sector, the EU has granted a 12-month grace period to identify origin. This means that parts can move around without the relevant origin documentation until the end of 2021. However, it is unclear if the EU will look to back-date tariffs if the origin is either unknown or not correct during this period. There is a risk that if origin is identified in December 2021, 12 months of back-dated tariffs may be due, which could range from 2% to 22% of the value of the part or vehicle.
Single tariff codes cover many products
Most automotive parts will fall into a single tariff heading (87.08). This includes bumper, plastics covers, gearbox assemblies, bearings, wheels, stabiliser bars, clutch parts, radiators etc. There are 136 individual codes in the 87.08 tariff heading. This is great, but consider a typical automotive part that crosses the EU / UK border multiple times.
A good example is the crankshaft used in the BMW Mini, which crosses the channel three times in a 2,000-mile journey before the finished car rolls off the production line.
Another example is brake assembly. The figure below shows the steps required to change raw metal into a brake calliper, then a sub-assembly, before finally becoming a brake assembly. In this example (figure 1), the assembly can remain of Chinese origin when it is placed in the car:
Brake calliper – Chinese raw material and processing defines the origin of the calliper as Chinese
Brake sub-assembly in the EU adds 40% local value. However, as the 87.08 MaxNOM rule is 50%, the origin remains Chinese
Brake assembly in the UK adds another 40% local value. Again, the 87.08 MaxNOM rule is 50%. Cumulatively, this adds up to 64% EU /UK material; however, because each step is calculated separately, the origin is still Chinese
The Society of Motor Manufacturers and Traders (SMMT) has estimated that today, 41% of the content of cars built in the UK is sourced from within the country, with between an additional 20% and 50% sourced from the EU. For some automotive companies, however, this proportion is even higher. The origin of electric vehicles (EV) is not known, but because of their high cost, it's likely to be determined by the battery.
We expect that the UK automotive industry will start to seek out parts that are less than 50% EU/UK material and look for options to reduce costs: eg, through changes in sourcing or the supply chain. This could be very concerning for tier 2 suppliers.
Figure 1: an example of tariff codes
The EV origin rules become more demanding, increasing the need for more UK/EU parts
Six years sounds a long way off, but manufacturers are already sourcing the parts for vehicles on sale in 2027.
Petrol and diesel cars and light vans will not be sold in the UK, and across much of Europe, by 2030. Hybrids have around five more years, until 2035, when only zero-emission tailpipe vehicles will be on sale. The same restrictions will follow for trucks and other vehicles later.
The TCA outlines the tightening tariff criteria for battery, hybrid and EVs. By 2024, the MaxNOM of these vehicles will reduce from 60% to 55%; however, this reduces further to 45% by the start of 2027.
If you combine the ban on petrol and diesel by 2030 and the tightening tariff rules by 2027, there may be an acceleration of change in the production supply chain.
For example, figure 2 shows:
If a petrol/diesel model is sold for, on average, seven years, then the last UK models to be produced are being sourced now
If hybrid models have a longer lifecycle, maybe up to eight years, they are being sourced until the end of 2021
Electric models tend to have a longer vehicle lifecycle due to the investment, maybe nine years. The models that will make up the bulk of the production volume will start to be sourced in 2022
If we assume that original equipment manufacturers (OEMs) do not want to re-source lots of parts because it is expensive, then the electric models being sourced in 2022 will meet the 45% MaxNOM criteria. This is a huge reduction in some parts of the industry.
In addition, with the cost of the battery being around 50% of a vehicle, advances in technology to reduce cost and changes to commodity pricing may determine the future of the UK vehicle industry. We believe British-based OEMs will want to manage this closely and be looking for more EU / UK parts in vehicles.
Figure 2: the timeline to electric vehicles impacted by TCA and emission rules
What can you do to prepare for rules of origin?
We all recognise that change is coming in the automotive industry as it moves to EVs or other propulsion methods. This change was always coming but has been accelerated by the TCA. We believe that:
EV production will continue to grow and add complexity to managing tariffs
The point at which the tariff heading changes may be important to optimisation
The cost of batteries as a percentage of a vehicle will become more important
As a parts or vehicle manufacturer, there are some things you can do to help manage this yourself:
Know the origin of your parts and see if there is an opportunity to consolidate the supply chain to maximise parts of EU / UK origin
Know the impact of tariffs and administration costs on your individual parts; some may now be making a loss
Talk to the OEM about origin; you may be able to incur some additional costs to reduce the overall non-originating content of the vehicle
Think about how your business will adapt to the EV market; it is much closer than many think
Our sector specialists have extensive experience in helping the automotive industry. If you would like to know more about how the rules of origin, or other aspects of the TCA, may affect you, contact Oliver Bridge.