What future for investor-state arbitration provisions in Asia Pacific treaties?

Author: Luke Nottage, The University of Sydney

In its recent review of Bilateral and Regional Trade Agreements (BRTAs), the majority report from Australia’s Productivity Commission remained opposed to including treaty provisions for investor-state dispute settlement (ISDS).

Recommendation 4(c) advised that Australia should not include ISDS ‘provisions in BRTAs that grant foreign investors in Australia substantive or procedural rights greater than those enjoyed by Australian investors.’

This threshold would exclude ISDS in almost all situations, at least where host states — like Australia and 145 others — are party to the 1965 Convention on the Settlement of Investment Disputes (ICSID) between States and Nationals of Other States. This is because subsidiary BRTAs or Bilateral Investment Treaties typically allow investors from those treaty partners to commence arbitration against host states through the World Bank’s ICSID facility, established by the 1965 Convention. The arbitral award then enjoys a special regime for enforcement: it can be reviewed for serious irregularities by other ICSID arbitrators, but not by host state courts. By contrast, local investors seeking remedies for their own state’s illegal interference with their investments must generally sue in local courts.

The Productivity Commission is therefore implying that Australia should never allow ICSID arbitration in its BRTAs. Arbitration administered under the Rules of the International Chamber of Commerce, for example, would be acceptable: such awards cannot obtain the special enforcement mechanism provided by the ICSID. This is contrary to Australia’s investment treaty practice, and to the spirit of the ICSID Convention to which Australia is party. Australian investors will also no longer be able to enjoy protection under ICSID when partners illegally interfere with their own investments abroad.

The Productivity Commission also insists that the obligations imposed on Australia as host state go no further than those already stipulated in local Australian law. Yet it is often difficult to compare the two, especially as both treaty and local law are continuously evolving. Further, if a potential treaty partner (such as the US) adopts a similar policy, and its local law protections are higher than those under Australian domestic law, then no investment treaty can be concluded involving ISDS. The partner will want its higher standards built into the treaty to protect its own investors, but the Australian government is now unable to provide them.

The Productivity Commission suggests that ‘other options are available to investors’ to protect their investments abroad. But host state courts and domestic law are usually unattractive. The court system may be unreliable and provisions may be idiosyncratic even if offering substantive law protections similar to those found in the home state. Litigation procedures are unfamiliar and may involve more scope for appeals than international arbitration. Judges will also be less specialised in cross-border investment dispute resolution and hearings will often be in a foreign language.

An alternative suggested by the Productivity Commission is political risks insurance. But coverage is typically narrower than under treaty protections and governments often support such schemes anyway. Another given is an investment contract between an investor and the host states, but these involve considerable transaction costs (possibly including lateral pressure brought by the investor’s home state), and such contracts are much less feasible for smaller investors or projects.

A further option is the inter-state claim process that the home state can invoke, on behalf of its affected investor, against the host state. The main problem is that the home state retains discretion and control over this claim process, and again it is less likely to be invoked for smaller investors or projects. An alternative would be to structure an investment through a third country that has an investment treaty with the destination state, which includes full ISDS protections. But the transaction costs and inefficiencies will be large.

The Productivity Commission’s analysis and recommendations are therefore unconvincing, and hopefully will not be followed by the rest of the Australian Government — let alone others in the region. The Commission’s concern that inefficient foreign investors might enter Australia due to artificial advantages created by treaty protections seems more theoretical than real and its proposed responses lack practicality. Concerns over adverse effects from investor-state arbitration are better addressed by drafting exceptions more carefully and building other innovations into investment treaties. Active engagement by Australia in refashioning the investment dispute resolution system in such ways is also crucial to promote its legitimacy, not just its efficiency advantages. This is particularly true for the Asia Pacific region, where investor-state arbitration provisions have become increasingly pervasive in treaty practice.

Luke Nottage is Associate Professor at Sydney Law School, The University of Sydney.

This is based on research for the project, ‘Fostering a Common Culture in Cross-Border Dispute Resolution: Australia, Japan and the Asia-Pacific‘, supported by the Commonwealth through the Australia-Japan Foundation which is part of the Department of Foreign Affairs and Trade. For further arguments and references, see also http://blogs.usyd.edu.au/japaneselaw/.

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  • Hee-Young Shin

    The relevant question is not whether to accept the ISDS provision in the proposed bilateral and regional trade agreements and how to mitigate the potential abuse, but whether to accept and join the trend of the bilateral trade agreement from the beginning. What is the benefit and justification for this agreement in favor against multi-lateral trade agreement? Is there any empirical evidence that support that the bilateral and regional trade agreement would bring about more benefits than the WTO regime? If there were, what are the social cost associated with them. Once the frame is formulate in this way, discussing about the ISDS in bilateral trade agreement is simply non-existent.

  • Jonathan Bonnitcha

    Professor Nottage’s contribution is a timely comment on an important question of public policy. However, I disagree with two of his arguments.

    First, Nottage suggests that:

    ‘if a potential treaty partner (such as the US) adopts a similar policy, and its local law protections are higher than those under Australian domestic law, then no investment treaty can be concluded involving ISDS.’

    This is misleading. The Productivity Commission’s recommendation was that Australia’s FTAs should not ‘grant foreign investors in Australia substantive or procedural rights greater than those enjoyed by Australian investors.’ (See Chapter 14, page 285). This recommendation does not demand that Australian investors be entitled to rights equivalent to those they enjoy under Australian law when they invest abroad. If the US government had a similar policy to that recommended by the Productivity Commission – a policy that foreign investors in the US should not be granted greater rights than US investors – an investment treaty could be agreed between Australia and the US. For example, both countries could guarantee substantive rights of non-discrimination (national treatment) to foreign investors. I agree with Professor Nottage that the Productivity Commission’s recommendation might preclude such a treaty including ISDS, on the grounds that ISDS constitutes a procedural right granted to foreign investors beyond the procedural rights enjoyed by national investors. But, contrary to what he implies, this result has nothing to do with the question of whether substantive US law protections are higher than those under Australian domestic law.

    More generally, I disagree with the implicit premise of Professor Nottage’s analysis that public policy should be motivated by the objective of ensuring the highest possible standards of protection for foreign investors. This notion does not stand up to scrutiny; it is as bizarre as suggesting that the objective of tort law should be to ensure the highest possible standards of protection for victims of accidents. The principal objective of economic treaties between states should be to maximise welfare in those states. This was the view of the Productivity Commission and it was affirmed by the Australian government in its new policy on FTAs. If one agrees with the Productivity and the Australian government, as I do, then it is important to engage seriously with economic arguments about whether protections for foreign investors are likely to increase efficiency. While one may reasonably disagree with the Producitivity Commission’s economic analysis, I do not think that Professor Nottage’s cursory dismissal of its analysis as ‘unconvincing’ and ‘theoretical’ constitutes serious engagement with the economic issues at stake.

  • Luke Nottage

    My blog reproduced here on the EAF goes back to one posted my own blog in mid-December (http://blogs.usyd.edu.au/japaneselaw/2010/12/isapc.html), soon after the Productivity Commission released its final report on trade and investment treaties. Last month the Australian government in fact released a new “Trade Policy Statement” (http://www.dfat.gov.au/publications/trade/trading-our-way-to-more-jobs-and-prosperity.html) that has basically accepted many of the Commission’s recommendations, including recommendation 4(c), ie:

    “the Government does not support [investor-state arbitration (ISA)] provisions that would confer greater legal rights on foreign businesses than those available to domestic businesses”.

    That sounds superficially attractive but I still struggle with the implications, as well as the underlying rationales and arguments presented on this particular point in the Commission’s final report.

    First, Australia’s policy means that ICSID Arbitration Rules cannot be included in future treaties at all, because they lead into the unique regime for enforcing awards etc that is provided by the framework ICSID Convention. (Any ISA provisions would have to provide only for non-ICSID arbitration, as under the UNCITRAL Arbitration Rules.)

    Secondly, it means no ISA in treaties with any country that has a higher level of domestic substantive law protection for (all) investors (eg perhaps Japan or the USA) compared to protection under Australian domestic law, IF that country seeks to extend its higher level of protection abroad by entrenching it through ISA in a treaty with Australia. (Under Australia’s new policy, ISA can only be included if the substantive protections in the treaty are instead capped at the lower, Australian domestic law level – but the other country will have little incentive to press for that, especially if ICSID Arbitration is no longer an option anyway, because it can get that level of protection through Australian courts anyway.)

    Thirdly, it means no ISA in treaties with any country that has a lower level of domestic law protections for all investors (eg possibly Chile, certainly Vietnam), compared to Australia’s domestic law, IF the former adopts a similar approach to Australia’s recent policy statement. Other countries may now mimic Australia’s policy stance, which seems to be underpinned by the happy reality that foreign investors are increasingly desperate for Australia’s rich energy and natural resources (probably with or without any ISA), IF those countries begin to believe that offering ISA will not materially increase inbound investment given their own particular circumstances.

    So how will this play out in current negotiations to add an investment chapter and more countries (including Vietnam, Australia and the US) to the Trans-Pacific Partnership Agreement (including already Chile, NZ, Singapore and Brunei)? Will there be multiple bilateral carve-outs, after a very complicated exercise trying to compare levels of protection offered anyway to all investors under domestic legal systems? Will the problem become so intractable that the TPPA ends up omitting an investment chapter or some of these countries altogether?

    In other words, will the treaty-based ISA system begin to unravel, especially in a regional context? Will foreign investors instead either obtain ICSID Convention “consent” by having host states agree to arbitration through one-off investment contracts, or investment-specific legislation – with all the extra transaction costs that will entail on both sides? Will foreign investors from home states that may not be able now to obtain ISA protections in bilateral agreements with Australia (like Japan or China, both still negotiating FTAs with Australia) instead incur transaction costs to route their investments into Australia through jurisdictions (eg Singapore or Hong Kong) that already have treaties containing ISA protections? Or will (especially politically-connected) investors just lobby their home states harder to initiate “diplomatic protection” claims on their behalf against host states, but at the taxpayer’s expense?

    I don’t think the Government has thought through these sorts of implications carefully enough. I’m not saying that foreign investors need to be protected at all costs, or that the present ISA system is perfect – what set of legal rules ever is? But I do think this policy position probably represents “overkill” and is unlikely to be in the long-term national, regional or international interest compared to various other “middle way” alternatives available to improve the system. Several such alternatives are set out in the Table downloadable from my own blog posting (at http://blogs.usyd.edu.au/japaneselaw/2010/12/isapc.html) and one is elaborated here:

    Nottage, Luke R. and Miles, Kate, ‘Back to the Future’ for Investor-State Arbitrations: Revising Rules in Australia and Japan to Meet Public Interests (June 25, 2008). In L Nottage & R Garnett (eds), ‘International Arbiration in Australia’, Federation Press: Sydney, 2010; Journal of International Arbitration, Vol. 26, No.1, pp. 25-58, 2009; Sydney Law School Research Paper No. 08/62. Available at SSRN: http://ssrn.com/abstract=1151167