Treaty-based investor–state dispute settlement mechanisms not all bad

Author: Luke Nottage, University of Sydney

The High Court of Australia on Wednesday rejected the argument by major tobacco companies that Australia’s plain packaging legislation is an unconstitutional ‘acquisition’ of their rights.

But the ongoing arbitration claim of ‘expropriation’ that Philip Morris Asia initiated under the 1993 Hong Kong–Australia bilateral investment treaty should not feed into a blanket rejection of any forms of investor–state dispute settlement (ISDS) in investment treaties.

Some commentators now urge the Gillard government to excise ISDS from all of Australia’s existing FTAs and investment treaties, as well as eschewing them for future treaties in accordance with its 2011 Trade Policy Statement.

An alternative is for the government to amend the 1993 treaty to suspend Philip Morris Asia’s pending claim. More generally, Australia should consider including ISDS provisions in future treaties but expressly reserve its right to agree with the treaty partner to suspend particular types of claims, such as claims regarding public health issues.

Other supporters of ISDS also urge Australia to return to allowing some forms of ISDS in appropriate cases, particularly in treaties with countries that have less developed court systems and protections for property and other rights.

Those rejecting all ISDS argue that the Productivity Commission’s 2010 report, succinctly analysing ISDS before recommending that Australia should not offer greater treaty protections for foreign investors compared to local investors, did not find a clear economic problem requiring such protections. The Productivity Commission did note the argument that foreign investors may encounter greater discrimination from some host states compared to local investors. But it cited an econometric study based on World Bank surveys from 1999–2000, suggesting that foreign firms instead enjoyed regulatory advantages not shared by their domestic counterparts.

Yet such relative advantages disappeared when foreign investors were benchmarked against politically connected domestic firms, and there was even evidence to suggest that foreign investors were subsequently disadvantaged. Further, a related World Bank study found that any ‘foreign privilege’ phenomenon was stronger in Eastern Europe and South America compared to East Asia. More recently, discrimination against foreign investors in the Asia Pacific region remains particularly evident in Indonesia’s new regulations requiring divestment of majority interests in mining investments.

The Productivity Commission also found that econometric evidence does not clearly show that offering treaty-based ISDS protections significantly increases inbound investment. But the Commission relied primarily on a WTO Working Paper published in 2010, containing data only through to 2004. Econometrics is not an exact science, especially in the field of FDI. In any case, it only deals in aggregates. Australian policy makers should concentrate, for example, on the links between ISDS protections and investment flows in the subset of Australia’s major existing and likely partners, particularly in Asia. As well as future quantitative analysis, qualitative evidence should also be considered. That should not exclude the recently expressed views of Australian industry groups and others that ISDS protections may impact on decisions on whether to invest Australia, as well as outbound investment from Australia – especially into developing markets.

Thus, the evidentiary base the Productivity Commission provides is a weak foundation for Australia to ‘go it alone’ in the Asia Pacific region. Instead, as it was doing in treaties like the Australia–Chile FTA (2009) and AANZFTA (2009), Australia should look for ways of minimising risks and disadvantages that may be associated with ISDS. Those do include the delays and costs involved in ISDS proceedings. Recent data from the OECD’s Scoping Paper suggest that average legal and arbitration costs are around US$8 million. But it points to recent efforts to control costs by redrafting treaties and Arbitration Rules, and several public comments note that costs must nevertheless be assessed relative to complexity and the amounts in dispute. Anyway, there are costs and delays involved in inter-state dispute resolution (still provided and envisaged in Australia’s treaties), let alone domestic court proceedings — which typically involve multiple appeals, even if judges are expert and not open to corruption.

There are also hidden costs in moving to a regime without any form of treaty-based ISDS. While some commentators suggest that investors can and should negotiate individual contracts with each host state, these contracts will often include an arbitration clause anyway. And ironically, individual negotiations will risk diminishing transparency of any arbitral proceedings (another concern of these commentators), while significantly increasing drafting and negotiating costs both for investors and host states.

Foreign investors have another — but very undesirable — ‘alternative’ to ISDS: bribery of officials (and others) in the host state. Asian host states are relatively under-represented in investment arbitrations, especially as claimants. One factor may that Asian-based companies are perceived as more likely to pay bribes, particularly in sectors such as resources. If Australia wants to reduce incentives for such ‘private investment risk management’, then ISDS can be an attractive measure. Anti-bribery conventions and legislation, while laudable, are proving insufficient.

It is time to engage in a fuller debate about Australia’s policy position on ISDS. More research is needed to justify its unusual shift of completely eschewing any forms of ISDS. Australia’s shift may not completely stymie pending negotiations over important FTAs, such as the Trans-Pacific Partnership Agreement, but it will surely complicate negotiations as all other actual and potential parties now have treaties supportive of ISDS. There is a real risk that at the final stage of negotiations, Australia will either have to compromise its position (allowing some form of ISDS after all) or otherwise give up a major trade or other concession, without an adequate ‘back-up plan’ or full assessment of the real pros and cons involved in retaining some forms of ISDS.

Luke Nottage is Professor and Associate Dean at the Sydney Law School, University of Sydney, and founding co-director of the Australian Network for Japanese Law.

A longer version of this article, with a postscript and hyperlinks to further sources, is available here on the ‘Japanese Law and the Asia-Pacific’ blog.

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