Reassessing the utility of Investor-State arbitration: what lessons should be taken from the recent Australian policy shift?

The zeitgeist of international investment law is one of deep and fluid change. After decades of stability (if not rigidity), many states are now engaged in a remarkable process of transforming the investment treaty network. Australia is the most recent entry to that group. In June 2011, the Australian Government publicly announced in a Trade Policy Statement that it would no longer include investor-state dispute settlement (ISDS) provisions in future trade agreements.

The Australian policy shift is surprising on a number of fronts. It is certainly a visible break from the preferred strategy of other developed states when recalibrating their exposure to investment law commitments. The U.S and Canada, for instance, have tended to manage their risk profile by tightening the substantive provisions within investment treaties and/or inserting exceptions clauses modeled on the law of the World Trade Organization (WTO).

Unlike a number of Latin American countries also, the Australian policy shift is not explicable simply by reference to individual state experience as respondent to investment arbitration. Until very recently, Australia had never been subject to investor-state arbitration and there are a mere handful of publicly reported investor-state claims initiated by Australian companies. Instead, the policy shift is grounded in the specific recommendations of an independent statutory agency – the Australian Productivity Commission – whose past work has injected admirable rigor and objectivity in the Australian policy-making process.

Yet even to those sympathetic to recalibration of investment law, the Productivity Commission’s approach is disappointing. The framing of the Commission’s inquiry is, quite properly, an attempt to identify the cost-benefit calculus (to Australia) on the question of treaty-based disciplines on foreign investment. But as actually implemented by the Commission, that methodology is marked by a set of problematic assumptions and omissions that necessarily cast doubt on its substantive recommendations.

This includes no real attempt to balance the significant costs of investment rules (understood conceptually as the restriction of Australian policy space against a counterfactual of full sovereignty) to any likely benefits that can flow from entry into such rules. When it comes to the question of benefits, it is important to note that Australia is both a capital importer and exporter. Indeed, as recorded by the Commission itself, there was steep growth in outward investment by Australian companies in the mining sector from 2001 to 2008. Yet those particular Australian companies face unique political economy risks abroad because natural resource projects are usually location or relation specific, have a long duration and are characterized by high, up-front capital costs.

Those enormous costs then are truly sunk, having little or no alternative use value thereby significantly constraining the ability of foreign investor to exit the host state. It is this deep ex post immobility of FDI in the resources sector that creates strong potential for host government to opportunistically raise demands on foreign investment. It may well be therefore that investment treaty protections could play a logical role in countering these type of particular risks (in the absence of credible and sufficient alternatives).

Politics too however has clearly played a hand in shaping the Australian Government’s sudden hostility to investor-state dispute settlement over the course of 2010 to 2011. During this period, Australia began to put in place steps for pioneering public health regulation of tobacco consumption.

The new legislation triggered a wave of litigation both in the form of domestic constitutional challenge by affected cigarette producers (recently successfully defended by the Australian Government) and pending claims both under investment treaty protections (by Philip Morris Asia Ltd under the 1993 Hong – Kong Australia BIT) and before the World Trade Organization.

It is difficult to escape the impression that it is simply anathema to the current Australian Government that legal regulation appropriately directed at a compelling public health objective should even be subject to international legal complaint. Even for those attracted to that position, it is important to recall that the very contingency of investor-state claims against Australian public health measures is partly the result of poor choices made by past Australian governments (and their advisors).

Almost all of Australia’s older BITs contain no general exception modeled on Article XX of the General Agreement on Tariffs and Trade 1947 which enables state to regulate for, inter alia, public health purposes. Even though that exception has been in place as a matter of Australian treaty practice on foreign trade since 1947, it has not been deployed in Australia’s BITs.

Ultimately, the story of the Australian policy shift is one of opportunity lost. A powerful case can be made for deep contemporary reconsideration of investment disciplines, both substantively and procedurally. Regrettably however, the analysis that underpins the policy shift simply produced more heat than light. Commentators sympathetic to the direction of the new Australian policy will inevitably be tempted to ignore these superficialities and sizeable process failures. That option should, however, be foreclosed for those states that wish to rigorously and accurately reconsider their own future engagement with investment treaty disciplines.

For a fuller assessment of the process and reasoning that led to the Australian policy shift on investor-state arbitration (on which this summary is based), please see Jurgen Kurtz, “Australia’s Rejection of Investor-State Arbitration: Causation, Omission and Implication” (2012) 27 (1) ICSID Review 65-86.

See also IPFSD clauses:

5. Public policy exceptions

6.2 Investor-State dispute settlement

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The Australian policy shift is an interesting and indeed a very topical issue, with potential ramifications not only for Australia and its investment partners, but also for the entire international investment law system. It appears as a symptom of international investment law’s much-talked-about systemic imbalance; after all, it is easily evident from the Australian Government’s public statement that the proposed policy move is seen as a means to compensate for circumscribed policy space. Although Australia’s participation in ongoing negotiations – e.g. in the context of the TPPA, where reportedly it pursues the same policy – seems to demonstrate continued support for the system, in effect ISDS discontinuance removes the possibility for aggrieved investors of enforcing their rights, essentially rendering them dead letter on paper. In my view, this brings the Australian policy shift conceptually close to other apparently more radical developments in the field – denunciations of the ICSID Convention, BIT terminations, non-payment of awards and the like. Therefore, I am wondering whether policy exceptions (standard specific, general exceptions of the Article XX GATT type, general exceptions for essential security interests, etc) would not be preferable for Australia, Australian investors, Australia’s investment partners and for the international system of investment protection in general.

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I agree with Dr Kurtz. The following comment is adapted from my postings to the East Asia Forum and "Japanese Law and the Asia-Pacific" blog, which contains hyperlinks to related resources: see
http://blogs.usyd.edu.au/japaneselaw/2012/08/abandoning_all_investor-state.html -

It is unfortunate that the ongoing arbitration claim of “expropriation”, initiated by Philip Morris Asia under the 1993 Hong Kong – Australia bilateral investment treaty, seems to have led the present Australian "Gillard Government" to change over 20 years of treaty practice, rejecting any forms of investor-state dispute settlement (ISDS) in investment treaties. Although that system has flaws, it also has benefits, and there is ample scope to draft treaties to provide clear and appropriate mechanisms to balancing private and public interests. With others familiar with international investment law, I provide further examples of the most promising substantive and procedural law reforms in an Open Letter dated 28 July 2012, in response to a recent OECD Public Consultation on ISDS.

My comment will therefore address points made recently on "The Conversation" blog by Dr Kyla Tienhaara, who remains completely opposed to any form of ISDS. In fact, she urges the Gillard Government to try to excise ISDS from all Australia's existing FTAs and investment treaties (dating back to 1988), in addition to eschewing them for future treaties – as the Government seems to be attempting, pursuant to its policy shift on ISDS announced in the 2011 Trade Policy Statement (TPS). An alternative is for the Government to approach Hong Kong authorities to seek agreement on amending the 1993 treaty to suspend PMA’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, for example regarding public health issues. This compromise approach is already essentially found in investment treaty practice where the claim involves allegations of “expropriatory taxation”.

Dr Tienhaara’s recent posting, entitled “ACCI’s right to sue compaign not supported by the facts”, responds to a 13 July 2012 letter to Prime Minister Gillard in which the Australian Chamber of Commerce and Industry joined with others to urge reconsideration of the TPS policy shift. The ACCI’s succinct letter urges Australia to return to allowing some forms of ISDS in appropriate cases, particularly in treaties with countries with less developed court systems and protections for property and other rights.

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In her blog posting, Dr Tienhaara also remarks that the 2010 Report of the Productivity Commission (PC), which succinctly analysed ISDS before recommending that Australia seek not to include treaty protections for foreign investors greater than those offered to local investors, did not find a clear economic problem requiring such protections. The PC did canvass the argument that foreign investors encounter greater discrimination from some host states compared to local investors. But it pointed to an econometric study based on World Bank surveys from 1999-2000, which noted that foreign firms instead enjoyed regulatory advantages not shared by their domestic equivalents.

Yet that study also found that such relative advantages disappeared when foreign investors were benchmarked against politically-connected domestic firms; there was even evidence that foreign investors were then disadvantaged. Further, comparing foreign investors versus all domestic firms, a related World Bank study found that any “foreign privilege” phenomenon was stronger in Eastern Europe and South America compared to East Asia. For a more contemporary specific example of discrimination against foreign investors in our region, consider Indonesia’s new regulations requiring divestment of majority interests in mining investments. Such concerns on the part of Australian investors abroad appear to be the driving force behind the ACCI’s present campaign to bring back the possibility of ISDS in some future treaties.

Dr Tienhaara also highlights the PC’s other major finding, that econometric evidence does not clearly show that offering treaty-based ISDS protections significantly increases inbound investment. But the PC relied primarily on a Working Paper published in 2010 by the WTO, containing data only through to 2004, which in fact found a significant increase on one regression analysis regarding regional investment treaties. Some estimations and studies find significant effects, although others don’t. Econometrics is not an exact science, especially in the field of FDI, as I noted in a response last year. Anyway, econometrics 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 be relevant – including views expressed by Australian industry groups on whether and how ISDS protections may impact on investments into Australia.

Thus, the evidentiary base provided by the PC is a weak foundation for Australia to “go it alone” in the Asia-Pacific region – altering our two-decade-long treaty practice by refusing now to countenance any forms of ISDS. Instead, while acknowledging that the benefits of ISDS may be less apparent or harder to prove than many had assumed, we should look for ways at minimizing risks and disadvantages that may be associated with ISDS. For example, concerns about “regulatory chill” from expropriation claims can be limited by tightly defining the scope of that protection, along the lines found in one Annex on ISDS (among several) in the Australia-Chile FTA signed in 2009. Indeed, if Australia caps treaty protections at its domestic law levels (such as “acquisition” under our Constitution), this obviates concerns about extra compensation payouts at taxpayers’ expense – yet Australian outbound investors could “take abroad” such protections, probably higher that those available in many developing countries.

Dr Tienhaara remains rightly concerned about delays and costs involved in ISDS proceedings. Indeed, more recent data from the OECD’s Scoping Paper (at p19) suggests that average legal and arbitration costs (in a subset of publically available cases) are around US$8 million. But that Paper also points out efforts recently to control costs by redrafting treaties and Arbitration Rules, and several Public Comments note that costs anyway must be assessed relative to complexity and the amounts in dispute. Other Comments indicate various ways to control costs more effectively, as further explored by me and Dr Kate Miles in 2009. Anyway, inter-state dispute resolution (not excluded under the TPS) is often costly and time-consuming, as WTO proceedings show. Domestic court proceedings, typically involving multiple appeals, can often be too.

There are also hidden costs in moving to a regime without any form of treaty-based ISDS. Dr Tienhaara suggests that investors can and should negotiate individual contracts with each host state. But often those would include an arbitration clause anyway, and ironically this risks diminishing transparency of any arbitral proceedings compared to contemporary investment arbitration. Anyway, individual negotiations will significantly increase drafting and negotiating costs both for investors and host states, adding for example to the Australian government’s growing bill for legal services. It also disfavours small- to medium-sized investors, as do inter-state dispute resolution processes, and the OECD Paper indicates that such investors (not just big bad tobacco companies) are significant users of treaty-based ISDS (pp 17-18).

Dr Tienhaara argues that investors can turn to investment (political risks) insurance. But such policies are often for shorter terms and cover more limited risks than contemporary treaties. Political risks insurers also often piggy-back on treaties providing for ISDS, and can be state-supported anyway. Private insurance is less readily available too, after the Global Financial Crisis.

Foreign investors have another, but very unpalatable “alternative” to ISDS, which is not considered by Dr Tienhaara or the PC: bribery of officials (and others) in the host state. Recently I co-authored a partly empirical analysis of why Asian host states and especially claimants appear relatively under-represented in investment arbitrations. One factor that has been highlighted to me in follow-up interview-based research is that Asian-based companies are perceived as more likely to bribe, particularly in some sectors (such as resources). That seems to be corroborated in the 2011 Transparency International survey of bribe-payers. If we want to reduce incentives for such egregious “investment risk management”, then ISDS can be an attractive measure. Anti-bribery conventions and legislation are not proving sufficient, as shown by the recent debacle in South East Asia involving a subsidiary of the Reserve Bank of Australia.

In sum, it is time to engage in fuller debate over Australia’s policy position on ISDS, including its theoretical and empirical foundations. More research is needed to justify the unusual shift, for a developed country, of completely eschewing any forms of ISDS. It 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 (including Japan) have treaty practice now supportive of ISDS. There is a real risk that at the final stage of negotiations, Australia will either have to compromise its position, or 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.

[See also: 'Negotiating and Applying Investor-State Arbitration Provisions in Free Trade Agreements and Investment Treaties: Australia, Japan and the Asia-Pacific', at http://blogs.usyd.edu.au/japaneselaw/2012/12/negotiating_and_applying_inves.html]

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