The investor-to-state dispute settlement system (ISDS) has been the focal point of most discussions on trade agreements currently negotiated. Whilst the discussion is mostly directed at the mega-regional agreements,[1] the critics’ cause for concern in fact derives from older Bilateral Investment Treaties (BITs) signed and ratified in the 1960-80s.
So also Simon Lester’s critical essay. Whereas Lester’s title speaks of the need to reform, the underlying argument in his essay is that ISDS is superfluous. I am concerned that Lester chooses to ignore the need for judicial review in a more globalized and more political environment, where protecting foreign investments from arbitrary or discriminatory behaviour of states is essential for the respect of property rights.
Today’s foreign investment climate did not come about by chance.
Lester starts off by arguing that foreign investment is treated well, thus questioning the need for investment protection clauses. He makes his criticism of investment protection by citing Hajzler’s figures showing how expropriation of foreign investors in developing countries has decreased from 423 instances in the 1970s to 27 instances during the period between 2000 to 2006.[2] Although I share the enthusiasm for a world in which expropriation is less common, Lester fails to give credit to what has brought about the decrease in expropriation. Interestingly, Hajzler himself concludes that the decline in expropriation is likely to correlate with the increased number of investment treaties signed.[3] In that sense, the success of including investment protection in BITs is the exact reason to include it in future investment chapters and treaties.[4]
Furthermore, Lester argues that the “fair and equitable” treatment obligation is a catch-all provision opening the door for potential frivolous claims by investors. Looking at the data, there are few successful frivolous claims to be found. Thus, his criticism of the concept is unsubstantiated, but interestingly enough it also carries another hypothesis: Perhaps even the most “flawed” investment protection chapters are drafted in such a way as to prevent frivolous claims from being ruled in favor of the investor. UNCTAD statistics show that investors are far less successful in winning cases than states, meaning the theoretical fear of frivolousness is just that, theoretical.
Does a more democratic world equate to better treatment of foreign investment?
Direct expropriation might be in decline in the developing world, but that does not cover the full range of discrimination against foreign investors in the developed world. In fact, most ISDS cases do not deal with expropriation at all, but rather with broken contracts or arbitrarily withdrawn licenses.[5] Moreover, 40 percent of the claims in 2014 were brought against developed states, showing that even here investors see the need for ISDS.[6] Whilst Lester is correct in stating that more people than ever live in democratic states,[7] I question whether this is a reason to keep ISDS out of future agreements.
One of the main reasons why foreign investment must continue to be protected even in democratic countries is politics, and the lack of effective separation of powers between the executive branch and the judicial system. The fact that two of the EU Member States that will be a party to TTIP are ranked below Russia and Zimbabwe in judicial independence shows that investors seeking redress in domestic courts face potential discrimination even in EU Member States.[8] Furthermore, Lester asks if it is not better to fix domestic courts when found biased and corrupt instead of including ISDS, but he offers little guidance on how to do so. Perhaps this is too obvious to mention, but the two approaches are also not mutually exclusive.
Unfortunately, there are a number of recent cases where developed states have discriminated against foreign investors by arbitrarily terminating contracts and licenses, but also by expropriating assets. One of them is AbitibiBowater v Canada, where Newfoundland and Labrador expropriated the assets of the company without compensation.[9] Another is Vattenfall v Germany, where the city of Hamburg due to a public and political uproar decided to terminate Vattenfall’s permits to build a power plant,despite the city’s previous approval.[10]
Lester’s argument implies that treaties upholding fundamental rights are not needed where these rights are already seen to. There is a danger in taking both the respect for human rights and property rights for granted in an environment affected by politics and political whims. Therefore, as a libertarian, one ought to welcome investment protection clauses that put a “regulatory chill” on political whims, thus safeguarding property rights.
Globalization as a normative tool
One of the problems that Lester explores is the globalized nature of investment, blurring the lines between domestic and foreign investments, insinuating that foreign investors are not treated worse than domestic investors. Perhaps he is right, but he makes another very important point without acknowledging it. The fact that it is harder to distinguish between foreign and domestic investments could have a normative effect on investment protection, creating interdependence and making it more costly to discriminate against any investor. Moreover, blurring this line gives domestic investors access to ISDS, if needed.
This can be seen in Yukos v Russia, where the Russian nationals associated with Mikhail Khodorkovsky could file a claim against Russia for expropriating the company’s assets, since the company was listed on the Isle of Man.[11] Furthermore, this is also salient in the claims filed by the minority shareholders from the United Kingdom[12] and Spain[13] against Russia, using corresponding BITs. Consequently, the fact that it is harder to distinguish between domestic and foreign investments creates more opportunities for investors to seek redress for the violation of their rights.
But there is also another normative aspect of the globalization of investment protection clauses, namely the spread of corporate and judicial discipline, where investment protection clauses seek to minimize the risk of corrupt practices of companies. Here, World Duty Free v Kenya[14] and Metal-Tech v Uzbekistan[15] ought to serve as warnings for investors not to enter into illegal activities, since being involved in bribery causes the investor to lose its rights to seek redress in investment arbitration courts. In this sense, ISDS has a disciplining effect in both the global corporate sphere as well as on state behaviour.
What is the alternative to ISDS?
Lastly, Lester argues that investors ought not to rely on the state to set out the conditions for safeguarding investments on their behalf. Whilst I do understand the libertarian idea behind such an argument, I would argue that political risk insurances or letting companies negotiate conditions for investment protection with the host state will leave smaller investors at risk. I highly doubt that smaller investors would have the leverage to negotiate good investment protection against powerful states or will be able to afford a political risk insurance. Instead it is mutually beneficial for both small and bigger investors to create a level playing field in the protection of investors entering a foreign market, as they do under the market access chapters of FTAs.
Furthermore, Lester brings forward the argument that investment disputes ought to be treated in the same way as any other disputes. Although I would agree that state-to-state dispute settlement is sometimes better in trade disputes - though it increases the risk of politicization - investment disputes are not of the same character. Investment disputes are often the result of individual and targeted discrimination (and 22 percent are small or individual investors.[16] On the other hand, trade disputes are mostly systemic and impact all interested parties. Therefore the dispute settlement must be established accordingly.
But ultimately, there is a libertarian argument for why investor-to-state dispute settlement is preferable. Investors ought to fight their own battles, and not rely on the defence of their government. Investors should also carry their own costs, where the losing party is made liable for all arbitration expenses. This should be part of all future ISDS clauses, as it is in CETA[17] and most likely TTIP.
Conclusion
In conclusion, Lester points out some of the more opaque problems of investment protection through ISDS that are worthy of more attention. But despite concerns of giving investors too much room for maneuver to litigate against states, hardly any frivolous claims have been ruled in favor of the investor. Perhaps that shows that ISDS does not need substantial reform.
Today, foreign direct investment takes place in a setting of proliferated global value chains, but also in a more democratic world. Expropriation and discrimination might be on the decline exactly because of all the investment treaties signed during the last 50 years. Removing the protection that investors have been using for decades would put at risk the gains that investors have made in assuring their property rights around the world. In fact, the success of investment protection should rather make us think of expanding it to other policy areas, such as environmental protection.[18]
Even so, investors do experience both expropriation and discrimination despite all the investment treaties that they enjoy. The discrimination is arguably less a result of nationalism and the search for independence, but rather a result of certain political agendas or political whims. As a libertarian, I therefore welcome ISDS in order to safeguard property rights.
Notes
[1] The mega-regionals currently negotiated are the Transatlantic Trade and Investment Partnership (TTIP), Trans-Pacific Partnership (TPP), and Comprehensive Economic and Trade Agreement (CETA).
[2] Christopher Hajzler, “Expropriation of Foreign Direct Investment: Sectoral Patterns from 1993 to 2006,” Review of World Economics, Vol. 148, No. 1, 2012, p. 2.
[3] Idem, p. 24.
[4] “Recent trends in IIAs and ISDS”, IIAs Issues Note N0 1, UNCTAD, February 2015, p. 8. Available at: http://unctad.org/en/PublicationsLibrary/webdiaepcb2015d1_en.pdf
[5] Idem, p. 7.
[6] “Recent trends in IIAs and ISDS”, p. 5.
[7] See, e.g., Max Roser, “Democratisation,” 2015, published online at OurWorldInData.org. Available at: http://ourworldindata.org/data/political-regimes/democratisation/
[8] “Competitiveness Report 2014-2015,” World Economic Forum. Available at: http://reports.weforum.org/global-competitiveness-report-2014-2015/rankings/.
[9] AbitibiBowater Inc., v. Government of Canada, no case number since settled before Tribunal was established. Available at: http://www.italaw.com/cases/39
[10] Vattenfall AB, Vattenfall Europe AG, Vattenfall Europe Generation AG v. Federal Republic of Germany, ICSID Case No. ARB/09/6. Available at: http://www.italaw.com/cases/1148#sthash.kgrUvHLw.dpuf
[11] Yukos Universal Limited (Isle of Man) v. The Russian Federation, UNCITRAL, PCA Case No. AA 227. Available at: http://www.italaw.com/cases/1175#sthash.xOF0CD0G.dpuf
[12] RosInvestCo UK Ltd. v. The Russian Federation, SCC Case No. V079/2005. Available at: http://www.italaw.com/cases/923#sthash.7IZCPjiB.dpuf
[13] Renta 4 S.V.S.A, Ahorro Corporación Emergentes F.I., Ahorro Corporación Eurofondo F.I., Rovime Inversiones SICAV S.A., Quasar de Valors SICAV S.A., Orgor de Valores SICAV S.A., GBI 9000 SICAV S.A. v. The Russian Federation, SCC No. 24/2007. Available at: http://www.italaw.com/cases/915#sthash.UDoYtxAp.dpuf
[14] World Duty Free Company Limited v The Republic of Kenya, ICSID Case No. ARB/00/7. Available at: http://www.italaw.com/documents/WDFv.KenyaAward.pdf
[15] Metal-Tech Ltd. v. Republic of Uzbekistan, ICSID Case No. ARB/10/3. Available at: http://www.italaw.com/cases/2272#sthash.t8z1MF63.dpuf
[16] David Gaukrodger and Kathryn Gordon, “Investor-State Dispute Settlement: A Scoping Paper for the Investment Policy Community,” OECD Working Papers on International Investment, 2012/03, OECD Publishing, p. 17. Available at: http://www.oecd-ilibrary.org/docserver/download/5k46b1r85j6f.pdf?expires=1431330380&id=id&accname=guest&checksum=610791AC86E2028D2D16F1A1112CAE91
[17] Consolidated text of the “Comprehensive Economic and Trade Agreement” between the European Union and Canada, published on September 26th 2014, p. 176. Available at: http://trade.ec.europa.eu/doclib/docs/2014/september/tradoc_152806.pdf
[18] “The environment needs more investment protection – not less,” The ISDS Blog, Stockholm Chamber of Commerce Arbitration Institute, November 10th, 2014. Available at: http://isdsbloggen.se/blog/2014/11/10/the-environment-needs-more-investment-protection-not-less/#sthash.iebq2MWO.dpuf