China, national security, and investment treaties

Author: Luke Nottage

Peter Drysdale’s weekly editorial,  along with related postings to this blog and enormous media attention in Australia and elsewhere, focuses ‘on the continuing detention of Rio Tinto executive, Stern Hu, in Shanghai on allegations of espionage’. Drysdale signposts some future analysis of ‘the legal framework under which Hu’s detention has taken place’. He also emphasises that we need ‘a cooperative framework—bilaterally, regionally and globally’ for ‘China’s authorities to avoid damage to the reliability of markets and for Australia to avoid the perception of investment protectionism’.

A worker with the flotation cells in the concentrator at Oz Minerals Century Mine in Lawn Hill, Queensland, Australia. Photo: Reuters

The most pressing legal (and diplomatic) issues concern China’s criminal justice system, especially when ‘national security’ is allegedly involved. But we need to consider some broader ramifications, including investment treaty protections. Part of the backdrop to the Hu saga could be that nations retain considerable sovereignty when it comes to deciding on the operational ambit of foreign investments. Investment treaties – which may be bilateral or regional, stand-alone or folded into broader Free Trade Agreements – now often entrench substantive liberalisation. But these treaties maintain exceptions for national security or subject investments to national interest tests. So even if Australia and China conclude their current FTA negotiations making it broadly easier for firms from either country to invest in the other, that sort of exception could be invoked by Australia, for example, to block or restrict an investment like the now scuttled proposal by Minmetals to acquire Oz Minerals back in March 2009.

Explicit restrictions along these lines had diminished considerably since the 1990s, especially in developed countries like Australia, as competition for FDI burgeoned world-wide. But now they appear to be on the rise again. Concerns have grown about sovereign wealth funds, for example, as well as China’s push to secure resources directly (rather than through long-term contracts combined with smaller equity stakes, the longer-standing approach pursued by Japanese companies in Australia). And after an initial period where countries were desperate to attract funds after the GFC, those market collapses are perhaps forcing a rethink of (explicit or mostly implicit) models based on the merits of lightly regulated markets.

However, part of the recent shift may be due to the growing importance of investor-state arbitration provisions in investment treaties. Under these procedural rights, the investor can claim directly against the host state for breaching substantive protections (such as expropriations, or transparent ‘fair and equitable treatment’) for investments that have been made. Thus, for example, the NZ-China FTA contains an exception for certain ‘essential security interests’ (Art. 201) but also full investor-state arbitration provisions.

Even without such provisions, the foreign investor may be more likely nowadays to be able to get their home state to bring a claim in public international law (say before the International Court of Justice) against the host state, with any compensation obtained from the host state then passed on to the investor. This indirect means of protecting investors was less popular when states tended to temper economics with politics or broader strategic issues. But nowadays in the WTO, for example, they often sue each other over economic issues, with interested industries or firms egging them on (think of Microsoft and the US enforcing TRIPS obligations). And investment disputes, thanks to burgeoning arbitrations that are brought directly by investors against hosts, are increasingly seen as economic rather than political or diplomatic disputes, likewise resolved through a much more ‘judicialised’ procedure.

Either way, the indirect or increasingly direct threat of a claim about an investment that has been made provides an incentive for a host state to rely more on residual exceptions to allowing investments in the first place, such as the national security exception. If so, however, we are likely to see more cases like that involving Stern Hu. That is, the (more broadly frustrated) home state of a frustrated investor reacts – even in a later context – against what it may have perceived as over-eager invocation of the national security exception. The irony in this case, perhaps intentional, is that China is now using its own national security law against a citizen of Australia. But it would be particularly unfair to be making an example of an individual for the actions of his country, particularly when employed by a firm (Rio Tinto) not involved in Australia’s original invocation of the national security exception currently retained in its FDI legislation.

These sorts of issues are likely to become even more acute in light of some very recent developments in investment treaty arbitration practice (Investment Arbitration Reporter 2(11), 29 June 2009). In cases involving treaties with Russia and now China, tribunals have ruled that provisions that seemed to restrict arbitrations to quantification of compensation amounts should be read to extend arbitrability to the question of whether expropriation took place. Thus, even first- or second-generation investment treaties with China (including Australia’s dating back to 1988) may already apply far more extensively than almost everyone had thought (cf. e.g. Gallagher and Shan, Chinese Investment Treaties, OUP 2009). In any event, China is renegotiating such treaties or concluding ones with new partners (like NZ) that clearly allow arbitrability of all issues. The backdrop is that China is now a major FDI-exporter, whose investors are already beginning to bring claims abroad – although so far no investor (or law firm wanting to do other business in China) has risked claiming against China (see my paper with Romesh Weeramantry on this here [pdf]).

If these trends continue, namely direct investor-state arbitration provisions are concluded or reinterpreted to restrict the ability of home states to have second thoughts about foreign investments once they have been accepted, it seems to me that they will be more careful in allowing in FDI. But when they do, somewhere down the line, they may get a ‘Hu’ reaction from the frustrated home state. If so, then how Australia now reacts to China’s detention of Hu will be very important for the evolving field of investment treaties.

This post originally appeared on the Japanese Law and the Asia-Pacific blog