EU-Mercosur trade deal in peril over sustainability standards

Europe’s demand for stricter sustainability requirements in a stalled trade agreement with South American countries shows the difficulty in imposing a global baseline, as governments navigate different economic trajectories in the green transition

Confidence in finalising a free trade agreement between the EU and a bloc of South American countries formed by Brazil, Argentina, Uruguay and Paraguay is waning, as negotiating factions disagree over the enforcement of sustainability safeguards. Upcoming elections across both groupings are complicating talks further.

Although a political agreement between the parties was announced in 2019, the final texts of the EU-Mercosur deal were never signed or ratified. If completed, the deal could generate the largest free trade zone the EU has ever established, covering more than 780mn people and removing customs duties on 91 per cent of EU goods exported to the Mercosur trade bloc, according to estimates by investment bank Jefferies.

Earlier this year, the EU sent an additional document requiring further assurances from the South American group on biodiversity, forests, labour rights and climate change.

The EU’s demands follow the 2022 release by the European Commission of a more stringent trade policy approach with regards to sustainability matters. The revised policy focuses on toughening the trade and sustainable development chapters of trade deals, which include increased monitoring and enforcement, with the option of imposing trade sanctions as a measure of last resort.

By doing so, the EU aims to deter parties from backtracking on any climate initiatives, as was the case during Brazil’s previous government led by Jair Bolsonaro. However, Mercosur countries consider the additional requirements as a step too far, resulting in interference with their domestic policy agenda.

Diplomatic challenges

Employing trade negotiations to raise sustainability standards in less-developed economies, with widely different social and judicial structures, carries the risk of creating diplomatic tensions.

The EU’s adoption of higher environmental standards and increased consumer preferences in this area would motivate Brazilian agribusinesses interested in exporting to the bloc to invest in higher standards as well, says Vera Kanas Grytz, who leads Brazilian law firm TozziniFreire Advogados' international trade practice group.

However, Grytz considers the threat of restricting trade based on EU standards as a protectionist move as it would result in closing the EU market for Brazilian goods, instead of providing co-operation and training measures towards the adoption of similar standards in Brazil.

Eline Blot, policy analyst at the Institute for European Environmental Policy, a think-tank based in Brussels, says that to avoid a widening gap in levels of standards and subsequent market exclusion, the EU should mobilise technical and financial assistance to developing countries to ensure they can both elevate their standards and continue to benefit from international trade.

“The EU must leverage its attractive single market to [promote the international adoption of] sustainability standards,” she notes.

A joint Mercosur response to the EU’s further sustainability requests is reportedly still in the making, although European Commission president Ursula von der Leyen said in her latest State of the European Union speech that the bloc should aim to complete the deal by the end of this year.

In fact, time might be an important factor for all parties involved. The EU leadership might change as the next European parliament elections are soon approaching, scheduled for June 2024. Whereas Argentina is holding elections in October, with one of the main contestants — Javier Milei — openly stating his opposition to the trade deal.

“If [Milei] wins the election, and implements this promise, certainly Mercosur will be impaired, including trade discussions,” argues Grytz. 

Still, in July, the EU and Argentina signed a memorandum of understanding to increase co-operation on energy security, hydrogen and methane emissions abatement.

Deforestation threat

Following political change in Brazil last year, much attention has been given to the degree of deforestation in the Amazon rainforest. Brazilian president Luiz Inácio Lula da Silva pledged in his election campaign to end deforestation in the region, reversing the tone of his predecessor, Bolsonaro, who infamously declared it open to business and defied critics stating that “the Amazon is ours”.

Blot notes that the originally agreed draft of the EU-Mercosur agreement does not include sufficient safeguards to prevent deforestation in the Amazon driven by trade pressures. It does, however, contain measures to combat illegal logging and related trade in forestry products, but these commitments do not tackle commodity-driven deforestation, from beef or soya, she says.

However, Vladimir Miranda Abreu, partner and coordinator of TozziniFreire Advogados' agribusiness practice, says that the impact of the trade deal on deforestation is exaggerated. He argues that Brazil already has strong legal frameworks that protect the environment and regulate agricultural activities, and that the sector is responding to sustainability demands pushed by consumers. He also suggests that Brazil can increase its plant-based capacity without deforesting by, for instance, converting cattle-raising areas into agricultural production fields.

Aside from the additional forest criteria requested in the Mercosur trade deal, the EU is also set to impose higher standards through its anti-deforestation regulation, which was approved earlier this year.

The law aims to block imports and exports of commodity products derived from forest degradation, such as palm oil, cattle, wood, coffee, cocoa, rubber and soya, as well as derived products such as chocolate, furniture and printed paper. It imposes due diligence requirements, regular checks and inspections, penalties and a benchmarking system, which will see operators and countries being assigned different risk categories.

Mercosur countries, especially Brazil, are taking into account the EU anti-deforestation act when analysing the costs and benefits of the Mercosur trade deal, according to Renê Medrado, partner at Brazilian law firm Pinheiro Neto Advogados. He says this discussion is at an early stage, but it may have an impact on the ratification of the agreement.

The anti-deforestation regulation will still apply to imports from Mercosur countries regardless of the outcome of the trade deal and despite concerns raised by the South American bloc that it could be in breach of World Trade Organization rules. Similar concerns have been raised regarding the EU’s carbon border adjustment mechanism, which sets a price on carbon emissions from certain industries when their products enter the bloc.

Blot argues it is likely that Mercosur’s counterproposal to the EU’s additional sustainability safeguards could include some measures aimed at watering down the requirements under the anti-deforestation regulation.

The impact of the EU’s law could be far-reaching in the commodities space. In a research note, Jefferies highlights that the regulation is likely to shift trade flows, with EU-based companies aiming to establish supply chains within the bloc. It is also expected to cause disruption, with the prices of certain commodities set to increase, while diplomatic ties with “higher” risk countries could be compromised.

A lack of co-ordinated action among countries bordering the Amazon rainforest is also not helping to abate deforestation concerns. Last month, a summit held in Brazil and attended by countries sharing the Amazon area failed to agree on a common deforestation policy.

Still, under its new presidency, Brazil is pushing forward its green agenda, with the recent announcement of a new ecological transition plan.

Brazil’s ecological plan

The plan mentions the formation of a regulated carbon market, the issuance of sustainable sovereign bonds, a sustainable taxonomy, and the reformulation of the country’s climate fund to finance activities that involve technological innovation and sustainability.

Although the announcement did not include a fiscal impact nor precise timeline, “all indications from the government and congress are to have the regulated carbon market bill to be passed into law still this year”, says Natalia Azevedo de Carvalho, senior associate at Pinheiro Neto Advogados. 

The government’s approach so far is to allow for the voluntary and regulated carbon markets to run independently, according to de Carvalho. The ecological transition plan also aims to adopt rules on sustainable aviation fuel, green diesel, ethanol, and carbon capture and storage. The establishment of a legal framework for offshore wind projects is also under discussion.

“Many [measures] will still require detailed follow-up regulation by other legal instruments (such as decrees, normative instructions, resolutions), to be fully implemented, but the idea is that providing the larger regulatory framework for these areas is a good indication to investors that the country will proceed on this path with legal safety,” says Paula Susanna Amaral Mello, partner at Pinheiro Neto Advogados.

Given Brazil’s leading role in Mercosur negotiations, the country’s major policy change on sustainability should be seen by other countries as a positive outcome in the direction of the entire bloc, adds Abreu.

Medrado agrees that Mercosur trade negotiations should benefit as Brazil sets new environmental goals and standards.

“The Brazilian ecological transition plan may be instrumental in helping Brazil and other Mercosur members increasing the chances of addressing [the] EU’s concerns expressed on the side-letter proposal,” he says. 

New sustainability clauses

Since releasing its new sustainability trade policy in 2022, the EU has agreed free trade agreements with New Zealand and Chile.

The IEEP’s Blot notes that the EU-New Zealand deal includes, for the first time, the possibility of sanctions as a last resort for actions that are not compliant with the Paris agreement. This element was not introduced in the EU-Chile agreement, but although its sustainability provisions don't go as far as those in the deal with New Zealand, they go further than what has been so far designed for the EU's trade relations with Mercosur.

“We recommend that the level of ambition of the EU-New Zealand agreement be considered as a new standard approach for EU trade agreements going forward, with room for progressive improvement,” she says.

Blot adds that sustainability discussions with New Zealand and Chile have been aided by the fact that the former was a progressive negotiator when it came to sustainability provisions, and the latter has been a longstanding trade partner of the EU.

With Mercosur negotiations, on the other hand, the main sticking point is the persistent issue of deforestation.

Although both New Zealand and Chile have seen some degree of deforestation, this stems mostly from forestry activities, Blot notes, while some Mercosur countries are among those with the greatest rates of deforestation globally, largely driven by agricultural expansion.

“The production and export of goods and commodities that are at the heart of deforestation in the Mercosur region, such as beef or soy, are considered crucial for the economies of these countries, making any sort of concessions on the topic quite difficult,” she says.

In its additional document to the Mercosur countries, the EU proposes to set an interim target of reducing deforestation of at least 50 per cent of current levels by 2025. 

Although Mercosur’s counterproposal is expected to be communicated to the EU shortly, Blot expects that the gap between countries regarding the EU’s anti-deforestation regulation is likely to determine whether the trade agreement can be finalised before the end of the year, as the EU hopes.