Mercosur Trade Alert

Mercosur and European Union Struggle to Finalize FTA Negotiations

Chief negotiators from Mercosur and the European Union (EU) met in Brasilia, Brazil earlier this month to resume attempts to conclude an inter-regional free trade agreement (FTA) after new proposals from both sides tabled earlier this year created renewed momentum between the parties.

At the core of discussions are the EU's demands to strengthen sustainable trade commitments as a pre-condition to wrap up the agreement. The EU tabled a proposal in February 2023 that remained unanswered by Mercosur until September 2023. In addition, Brazil, with the support of Argentina, seeks to backtrack concessions on government procurement. Other outstanding issues are less controversial but also need to be resolved.

Both parties aim to reach a deal before the end of the year during Brazil's six-month presidency of Mercosur and Spain's six-monthly presidency of the EU. However, success is not a foregone conclusion. The absence of an agreement by year-end could mark the end of the negotiations as there has been growing tensions within the Mercosur and the EU over the trade deal being considered.

Background

Mercosur and the EU have been trying to put negotiations back on track in the last few months. Both parties have been negotiating an FTA since 2000 but negotiations have been suspended on a few occasions since their initiation. The "agreement in principle" for an Association Agreement, announced in June 2019, came under fire from certain EU Member States because of agricultural concessions granted to Mercosur and environmental concerns fueled by Brazil's stance over the protection of the Amazon rainforests and climate change under the former administration of President Jair Bolsonaro. In addition, Argentina's resistance to opening up its economy and moving forward with FTA negotiations has contributed to the paralysis.

In March 2023, chief negotiators from both blocs met in Buenos Aires for the first time in over three years. The change of government in Brazil in January 2023 and the international context – such as the war in Ukraine - created a new opportunity to relaunch the negotiating process. The joint communiqué issued at the end of the meeting stated that "facing the new global political and economic scene, and mindful of the strategic importance of the bi-regional relationship, both delegations agreed on the importance of intensifying the dialogue in order to finalize a mutually beneficial and balanced agreement."¹

There have been frequent calls in bilateral encounters by Brazil's President Luiz Inácio Lula da Silva, European Commission President Ursula von der Leyen, and other leaders from both sides to finalize the agreement as soon as possible. The EU's New Agenda for Relations between the EU and Latin America and the Caribbean, adopted in June 2023, has also made the Mercosur-EU FTA agreement a priority.²

Outstanding Issues

According to various sources, the main outstanding issues are as follows:³

• Sustainable trade: In February 2023, the EU proposed a "side letter" to strengthen commitments on environmental, human, and labor rights reached in 2019; Mercosur responded to this proposal on September 6, 2023, without addressing its substance.
• Government procurement: Brazil, supported by Argentina, has sought to backtrack on government procurement concessions as they would affect its new industrial development policy, particularly after the COVID-19 pandemic. Brazil seeks to negotiate the following changes: (i) exclude purchases made by the national health system (Sistema UNICCO de Saúde, SUS); (ii) increase the preference margin for small- and medium-sized enterprises in public procurement purchases; (iii) allow "offsets" in covered procurement indefinitely (the 2019 text provides for a 15-year phase-out period);⁴ and (iv) increase the applicable thresholds for public procurement expressed in value terms set out in the 2019 text (i.e., below which procurement contracts are excluded from the agreement). Brazil's request is consistent with its recent withdrawal from negotiations to accede to the WTO Government Procurement Agreement (GPA), started by the previous Bolsonaro Administration.⁵ The EU is not expected to make any concessions to the position that has been negotiated so far in this area, which is considered an important result by the EU.
• Geographical indications: The parties have been negotiating an annex with additional criteria to limit the "prior users" exception for the Mercosur countries regarding EU geographical indications (GIs). The EU fears that Mercosur's proposed implementation of the "prior users" exception would dilute the protection granted to EU GIs.
• Institutional and legal aspects: Foreseeing the potential deadlock for the ratification of the EU-Mercosur Association Agreement on the EU side, the European Commission has floated the possibility of reviewing the "architecture of the Association Agreement." This proposal entails splitting the agreement into two parts: one part covering solely trade issues, which would be subject to a fast-track ratification procedure involving the Council of the EU and the European Parliament so as to enter into force rapidly; and another part containing the non-trade provisions of the deal, which would require ratification by all EU Member States.

Sustainable Trade Discussions

According to a text leaked by EU civil society organizations, the EU has proposed a "joint instrument" (or "side-letter") to address EU public concerns about environment, labor, and human rights provisions in the Association Agreement.⁶

This side letter aims to provide a "shared interpretation" of different provisions in the Trade and Sustainable Chapter⁷ and other parts of the Association Agreement. This is designed to ensure that the contents of the side letter are taken into account in the interpretation of the agreement in the event of a dispute, in accordance with the general rule of treaty interpretation (i.e., Article 31 of the Vienna Convention on the Law of the Treaties).

This proposal has generated a strong reaction from Mercosur Member States, which have strongly criticized the new EU demands. They are concerned that the side letter would be more than a "non-binding agreement," despite EU claims. The leaked text provides a long list of commitments on matters governed by environmental, human rights, and labor multilateral agreements. In many cases, voluntary undertakings under those agreements would become mandatory under the Association Agreement, which could lead to eventual trade retaliation in case of non-compliance.

In addition, Mercosur Member States have expressed their concerns about the evolution of recent legislative initiatives in the EU that, inspired by a legitimate concern for the environment, could lead to restrictive measures of a unilateral, extraterritorial, and discriminatory nature, to the detriment of the Mercosur economies or that could undermine preferences granted to Mercosur under the agreement. This would especially be the case in relation to agricultural market access, which is key to Mercosur businesses (but sensitive to EU farmers). They have particularly criticized the recent adoption of two regulations that could compromise imports of key products from Mercosur countries, i.e., the Carbon Border Adjustment Mechanism⁸ and the Deforestation Regulation.⁹

The EU proposal, which is nine pages long, covers the following matters: (i) non-regression and high and effective levels of environmental and labor protection; (ii) climate change; (iii) biological diversity; (iv) forests; (v) labor rights; (vi) cooperation; (vii) human rights; (viii) civil society, and (ix) monitoring and review. An illustrative list of additional commitments sought by the EU is included in the table below.

Mercosur's response came after several months of internal deliberations. According to a text leaked by the Brazilian press,¹⁰ Mercosur is ready to work towards a rapid conclusion of the negotiation of the Association Agreement with the EU. It accepts to negotiate a joint trade and sustainable development instrument that builds on text negotiated in 2019, "in the context of the new circumstances of the global economy and the strategic value of this agreement."

The response does not comment or discuss the EU proposal but instead sets the framework of an eventual negotiation as follows:

• "The joint instrument must take into account the internal legislation of the parties and different national circumstances. Thus, Mercosur rejects any unilateral imposition of EU legislation."
• "There should be no sanctions (or even a hint of sanctions) incorporated into the document and parties should avoid using measures designed to achieve sustainable development as an unjustified or unnecessary obstacle to trade. The instrument needs to be based on a cooperative approach."
• "The Agreement should be equipped with a mechanism to rebalance trade concessions under the Agreement in the event that such concessions are suspended or nullified as a result of EU internal legislation."
• "The Agreement must safeguard the State's ability to implement public policies related, among others, to (i) public health; (ii) science, technology and innovation, (iii) sustainable, secure and resilient interregional value chains in the energy transition, sustainable mobility and digitalization, and (iv) climate action and food security."
• "The Agreement must provide for cooperation activities – including the necessary financing to (i) develop the capacity to allow vulnerable sectors to enjoy the benefits of the agreement; (ii) assist producers and exporters willing to comply with import requirements; and (iii) promote sustainable production initiatives, in accordance with national legislation. The Agreement should be a valuable tool to promote the integration of sustainable value chains."

Next Steps

Mercosur and the EU have now in effect reopened the negotiating process and will make every effort to reach a deal before December 6, 2023, when Brazil's six-month presidency of Mercosur ends. President Lula da Silva is scheduled to visit Germany on December 4, 2023, on his way back from the United Nations Conference of the Parties on Climate Change (COP28) in Dubai.

According to sources familiar with the negotiations, representatives from both blocs achieved "good progress" at their last meeting in Brasilia. They have reportedly agreed to intensify virtual and in-person meetings, both at technical and political levels, to try to reach an agreement before that deadline. A next meeting of chief negotiators from both sides is scheduled to take place on October 30, 2023, in Brasilia to take stock of the progress achieved. If an agreement is reached in December, the signing of the agreement should take place in the first half of 2024.

There is a perception on both sides of the Atlantic that momentum will be lost if an agreement is not reached by December 2023. Events such as the change of government in Argentina on December 10, 2023, or the upcoming elections for the European Parliament in June 2024, may disrupt the process. EU sources also indicate that the French position on the agreement is key (with some concern about expected agricultural market access for Mercosur farmers), with the result that any domestic political developments in France are likely to have an impact on the EU's ability to finalize the negotiations.

Paraguay's new President Santiago Peña put it bluntly last September when he told the Financial Times that if there is no deal by December, Mercosur countries will walk away and negotiate with Asian countries instead. Uruguay indicated that it could apply to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership and directly negotiate FTAs outside of the Mercosur framework, starting with China and Turkey. President Peña also said that "the time had come for European leaders to take a political decision on whether they want a deal with the four Mercosur Member States. This is no longer a technical issue." In reality, the EU and Mercosur countries both need this agreement to boost inter-regional trade, as China is becoming increasingly present in Latin America.

The bargain will now enter its final phase. If the parties are serious about finalizing the negotiations, they will have to be ready to scale back their demands. European Commission President Ursula von der Leyen, and the leaders of Germany and Spain, among others, will likely put pressure on Austria, France, and Ireland to break their resistance to the Association Agreement. On the other side, Brazil's regional leadership will be tested, as it will have to be ready to make concessions regarding its government procurement demands (a chapter that Paraguay and Uruguay do not want to reopen) and provide assurance to the Europeans on its multilateral commitments regarding climate change and the environment so that they can agree on a more balanced text on sustainable trade.

_{1 Click here to access the Joint Communiqué of the European Union and Mercosur.
2 Click here to access the EU press release and here to access the text of the Joint Communication.
3 As an example, click here to access Report No. 135 – 3/2023 (in Spanish) of Argentina's Minister Chief of Cabinet to the National Congress on the Mercosur-EU Agreement (Answer to Question No. 44).
4 In cases where a procurement involves goods not produced in the country, countries may provide for offset obligations. Typical approaches to implementing offsets involve mandating local processing, subcontracting to domestic enterprises, technology transfer, and purchasing goods and services from domestic sources.
5 Brazil's negotiations to accede to the GPA began in 2020. In July 2022, under Bolsonaro's administration, the country presented its final offer, detailing the procuring entities, goods, services, and thresholds to be covered by the agreement, as well as the intended exceptions. Brazil withdrew its offer on May 30, 2023. Click here to see official press release (in Portuguese).
6 Click here to access the EU's Joint Instrument proposal published by Friends of the Earth.
7 Click here to access the Trade and Sustainable Development Chapter agreed in 2019.
8 Regulation (EU) 2023/956 (published on May 15, 2023) establishes a carbon border adjustment mechanism (CBAM – carbon tax) applicable to imports of products from largest polluting industries, namely for cement, cast iron, iron and steel, aluminum, fertilizers, electricity, and hydrogen.
9 Regulation (EU) 2023/1115 (published on June 9, 2023) obliges companies to ensure that products sold in and exported from the EU have not led to deforestation and forestation degradation. The Regulation targets seven forest-risk commodities ("relevant commodities") – cattle, cocoa, coffee, palm oil, rubber, soybeans, and wood – as well as "relevant products," which are products that contain, have been fed with or have been made using the relevant commodities. The Regulation will be gradually implemented and become fully operational by January 2025.
10 Click here to access Mercosur's response (in Portuguese) to the EU proposal published by Brazilian newspaper Valor on September 9, 2023.}

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