Investment Risk and International Investment Agreements (Summary)

A study group on "Legal Protection for Overseas Investment" established at RIETI has researched jurisprudence of the decisions of investment treaty arbitration since the end of 2006. Based on the discussions of the study group, RIETI held an international seminar "Investment Risk and International Investment Agreements" on July 25, 2008 to demonstrate the issues and stimulate discussion with respect to the functions and significance of international investment agreements (IIAs) and investment treaty arbitration. The Japan Commercial Arbitration Association supported the seminar.

The theme of the seminar is as follows. Today, the number of IIAs exceeds 2600 and the incidence of investment treaty arbitration is increasing with 290 known cases to date. In light of these facts it is important to increase awareness of the following issues: a) How companies deal with risks arising from the acts of the states where they invest; and b) How should future international investment rules be formulated. Multifaceted perspectives are needed from managerial, policy- and rule-making viewpoints.

In the first session Akira Kotera, Faculty Fellow at RIETI and Professor at the University of Tokyo, spoke about the functions and significance of IIAs. According to Professor Kotera, companies should structure their investments by using the protection provided by IIAs to hedge risks. Companies should also decide when it is appropriate to rely on international investment arbitration in the course of negotiation with host governments. He also suggested that governments should draft IIAs in anticipation of how arbitrators would interpret the meaning of these agreements when arbitrating future disputes.

Next, Anna Joubin-Bret, Senior Legal Adviser at UNCTAD, demonstrated recent trends in IIAs and investment treaty arbitration by referring to both bilateral investment treaties and free trade agreements (FTAs) containing investment rules. She also described some concerns of investment treaty arbitration such as the high cost involved in conducting procedures, possible arbitration awards with huge sums, and the impact on the country's right to regulate.

In the second session, Professor Louis T. Wells of Harvard Business School spoke on whether IIAs can protect investments. He explained why the incidence of investment treaty arbitration is increasing and described some of its problems. Professor Wells concluded that investment treaties (or arbitration) protect only a portion of investors due to the bitterness that results from the arbitration process, inconsistency of arbitration decisions, and huge costs involved with arbitration. He also suggested that the ultimate safety of investments is not dependent on IIAs or investment insurance because investors would never be in an inferior negotiating position if they provided the technologies and access to the export markets that host governments need.

Next, Hidehiro Konno, President of Nippon Export and Import Insurance (NEXI), gave a presentation on the relationship between investment insurance and IIAs. He showed that the actual functions of NEXI's investment insurance are to prevent as well as indemnify damages. He also indicated that investment insurance and IIAs are complementary, and further emphasized that double taxation treaties and social security agreements are needed in addition to IIAs to improve investment circumstances.

The following speaker, Soichiro Sakuma, General Manager in the Legal Department of Nippon Steel Corporation, addressed the role of IIAs from a business perspective. He highlighted the role of IIAs by saying that companies can rely on them during negotiations with host governments and use them to seek assistance from their home country when a "violation of an international agreement" occurs. Mr. Sakuma also pointed out that IIAs enable companies to argue disputes before international arbitral tribunals and he attributed the limited use of international arbitration by Japanese investors to the small number of Japan's IIAs. Mr. Sakuma said that IIAs are a necessary part of the infrastructure for companies to invest abroad.

Kazuhiro Asakawa, Faculty Fellow at RIETI and Professor at the Graduate School of Business at Keio University, next spoke about the risk management of companies investing abroad. He introduced the OLI Paradigm evolved by John Dunning that encourages companies to consider the ownership, location, and Internalization advantages of investing abroad. In his opinion, extensive communication with the government is important during the course of negotiations with host governments and that companies should consider what they want to protect - the continuation of businesses, brand image, societal relationships with countries or regions, core technologies, or money - before deciding how to respond to risks.

In the third session Noriyuki Mita, Director of FTA affairs for METI, spoke about Japanese government policy on IIAs and other work to improve the overseas business environment. He identified policy changes since 2000 that originally focused on economic partnership agreements (EPAs) but now recognize IIAs as another important tool for creating favorable economic relations. He pointed out that to maintain the sustainability of the scheme of investment protection both sides need to establish a win-win relationship with partner countries. Mr. Mita also referred to the "Sub-Committees on Improvement of the Business Environment" established in Japan's EPAs. These sub-committees provide opportunities for investors to discuss various issues related to the business environment directly with government officials of the other party.

Shotaro Hamamoto, Professor in the Graduate School of Law at Kobe University, then shared his ideas on a sustainable legal system of international investment. He said that it is wrong to attribute the withdrawal of several Latin American countries from the International Centre for Settlement of Investment Disputes (ICSID) to possible defects in the legal system of international investment. Rather, he said, their withdrawal should be regarded as a power game played by these countries. He pointed out that recent IIAs concluded by Japan and other countries reflect trends which are consistent with environmental concerns and governments' right to regulate. Professor Hamamoto concluded that international investment law now integrates public policy concerns through treaty-making and jurisprudence.

Next, Anna Joubin-Bret raised the following issues: 1) whose point of view is considered when we interpret "consistency" or "fair and equitable treatment;" 2) how IIAs function for small countries and small companies; 3) considering that early IIAs were created during the days when nationalization and expropriation took place very often, are the same tools needed between Japan and other developed countries?

Professor Wells then proposed three ways to improve the process of investment treaty arbitration: a) create an appeals process, b) change the system to a more symmetrical one where arbitrators place more consideration on the change of circumstances with a less rigid interpretation of contracts; c) encourage arbitrators to seek settlements whenever possible.

After the questions and answer session, Professor Kotera made the following concluding remarks on IIAs and investment treaty arbitration: a) They involve issues of good governance by countries and good management by companies; b) They concern the interests of various actors and c) They have room for improvement.

Q: China has concluded more than 120 IIAs. Do China's IIAs contain the provisions for the treatment of investors such as fair and equitable treatment? How about arbitration provisions? If China's IIAs have both provisions, why isn't China in the list of respondent states?

A: China changed its policy and began to conclude IIAs which contain full-fledged arbitration provisions. Investor-state dispute settlements provided in China's IIAs which were concluded before the policy change are only to consider the amount of compensation for expropriation. On the other hand, fair and equitable treatment provisions are not modern – modern means that a provision is restricted and clarified in meaning – and arbitrators have wide latitude to interpret them. So far, there is no known case in which China is a respondent. Chinese investors will rely on investment treaty arbitration in the future.

Q: It is true that the number of IIAs is increasing, but the pace of the increase has been declining during the past 5 years. Latin American countries are reported to be frequent respondents. Could you speak more about the concerns for arbitration risks arising from the government side?

A: There is a link between investment treaty arbitration and the fear for the network of IIAs. Some countries terminate treaties unilaterally but usually we should negotiate for terminating bilateral investment treaties. Some countries reconsider IIAs while others re-negotiate them. One of the reasons for renegotiations is that investment flow has become two-way.

Q: I have the impression that Japanese companies do not rely on arbitration very frequently. Therefore are they reluctant to use investment treaty arbitration as well?

A: Companies should consider the following things. First, are relevant IIAs applicable? Will they be able to win? Will winning the arbitration lead to solving the problem? In other words, it is a timing issue and an issue of cost. If these conditions were met, companies would decide to resort to arbitration as the first move. Of course, they might also think about the possible influence on other businesses. It is doubtful that companies could avoid arbitration even if all of these conditions and considerations were cleared up. In addition, based on my experiences the argument of a treaty violation is effective in the negotiation with governments.

Q: Some proposed to introduce the appeals system into investment treaty arbitration but the proposal was denied several years ago because governments and companies were both concerned about the length of the appeals process. What do you think about it? With respect to the proposal of encouraging settlement, arbitrators could first issue an interim award that decides whether IIAs have been violated, and later decide the amount of compensation. This could encourage the settlement process.

A: An appeals process could ultimately reduce the number of arbitration cases because some legal issues would be clarified. If the parties involved know the results beforehand, they will not go to court. When would the appeals process be introduced? First, an arbitration award, which is obviously unjust, is rendered. Second, major OECD countries need to support it.

*This summary was compiled by RIETI fellow Kayo Matsumoto.