Recent Developments and Trends in International Investment Agreements and Investor-State Dispute Settlement

Anna JOUBIN-BRET
Global FDI flows have been declining since the middle of 2008. They have been severely affected by the global financial crisis, falling by 14% in 2008 to US$1.7 trillion, then to US$1.2 trillion in 2009. However, a slow recovery is expected in 2010, with a projected global FDI level of US$1.4 trillion, and gaining momentum in 2011, with projections at US$1.8 trillion.

Compared to FDI flows in 2008, data for the first quarter of 2009 shows a decline of 46% for developed countries, 39% for developing countries and 46% for transition economies. In connection with this data, UNCTAD's world investment report is going to come out in July 2010 and most of the data that is published in that report is under an information embargo, so some recent figures may not make it into the presentation and will have to be looked for in the WIR report.

On global FDI prospects, the recovery curve is expected to be V-shaped. The upturn is currently underway, and the relevance of this turnaround in FDI flows will be noticeable in the early part of 2010. Further, there is a clear shift in the FDI landscape towards developing economies. The share of developing and transition economies in inward FDI accounted for 43% in 2008 versus 31% in 2007. There will be a continuous trend of changing geometry and geography of the FDI landscape tilting more and more toward the bigger developing economies that are becoming the main source of FDI outflows and will continue to be main receivers of inflows of FDI.

Looking at the FDI outflows in 2008 and 2009 of the APEC economies not counting Brazil and India, there were still strong outflows from the United States, Japan and the Russian Federation. Concerning the global FDI quarterly index, after falling steeply at the beginning of 2009, it is recovering and stabilizing. Also, a major trend has been the sharp decrease in the number of mergers and acquisitions. This is one of the vehicles of investment that has suffered a lot from the economic crisis, and there have been far fewer M&As since Q4 2007. On the contrary, greenfield projects have been relatively stable throughout. Equity investment has also been severely affected by the economic crisis, particularly because of the credit crunch. Hong Kong, China; China; and Ireland are still receiving the lion's share of equity-type investments.

Among the top recipients of FDI flows, the main receiver remains the United States, with sharp declines seen in France, the United Kingdom, and Canada. There are a few countries in the Asian region, in addition to China, that have seen FDI inflow increases. Australia, also, has been quite stable in its receipt of FDI last year. Half of the top 20 recipients of FDI are emerging economies, which is yet another indicator of a changing global FDI landscape.

Transnational corporations' investments are only expected to increase significantly in 2011, further strengthening the perspective that the recovery in global FDI flows will be V-shaped. Investment thus remains a key driver for managing the effects of the crisis and the recovery strategies of all countries, whether developed or developing. There is now a key role for strong emerging economies, including the BRIC economies, as they have a major role in both inward and outward FDI flows and in sustaining a South-South flow of investment. It is important to highlight that in this new global FDI map, new types of investors are coming forward including sovereign wealth funds, which were pivotal in countries' bailouts at the onset of the crisis. Also, there is a strong emphasis on state-owned enterprises, correlated to China's strong posture.

Additionally, new investment vehicles are becoming prominent. For example, carbon offset contracts are at the heart of investments in green industry. In this system of carbon pricing, both host and home governments play a key role, very different from the role experienced in earlier economic relationships. Investments in green technologies are carried out under a new relationship, which is based on the "climate change economy." It must be ascertained as to whether the framework that is available for the climate change economy takes into account the existing investment framework of IIAs and whether in turn, IIAs can capture changes in the global investment situation.

Moving to recent trends in international investment agreements (IIA), while the economy was declining sharply, there has been no slowdown in international negotiations with over 2,600 bilateral investment treaties in place and 290 economic agreements with investment provisions. The steady growth in bilateral investment treaties is paralleled by steady growth in double tax agreements.

Looking at the number of bilateral investment treaties (BIT) by APEC economies, though there may be a decline in the number of treaties concluded each year, the aggregate number of treaties bring the APEC economies to account for 31% of investment treaties concluded around the world. China is by far the most active country in concluding BITs, and it has recently embarked on a revision of older agreements from the early 1970s. Regarding Chile and Singapore, although they concluded many BITs in the early 1990s, since 2000, they have stopped concluding BITs and shifted toward concluding broader-scoped free trade agreements (FTA).

The APEC countries are the most active countries in terms of conclusions of FTAs. While there has been a decline in the number of BITs concluded among APEC economies, there is a strong increase in the number of FTAs, making the APEC region the most active in this area. There is clearly a shift in BITs that only focus on investment protection to FTAs that include investment chapters that include the same level of protection plus liberalization provisions.

Parallel with the increase in BITs and FTAs has been an increase since the early 2000s a sharp increase in investor-state dispute settlement (ISDS) cases arising out of these investment agreements. This illustrates that the investment treaties have teeth, in that they are being invoked more and more by investors against host states, and are being used to challenge measures or particular acts from the states. The sharp increase starts from 2000, which can be explained by the numerous cases that arose over NAFTA, as well as the economic crisis in Argentina, which generated at least 45 ISDS cases. Since the peak in 2003 and 2004, the number of cases introduced has remained relatively steady.

What will follow is a brief overview of interpretations of the arbitral awards. The overview will focus on the substance of the different areas and core elements of investment agreements. In recent cases that have been decided upon by arbitral tribunals, there are some areas in which convergence can be seen in the interpretation of the substantive core elements as well as divergence, which leads to inconsistent interpretations and in turn unpredictability as to the content of these provisions.

On convergence, regarding the definition of investors, arbitral tribunals have consistently looked at the wording of the treaty and since the wording of the treaty is a link between the home country of the investor and the investor, arbitral tribunals have consistently not gone beyond the nationality criteria, and have not looked into who is actually controlling the investment.

Regarding the role of host state laws and regulations, it must be emphasized that reference to host state laws and regulations can be found in various provisions at various levels. For some time, arbitral tribunals declined to look into host state laws and regulations under the assumption that they did not have the mandate to look into host state laws. Increasingly, arbitral tribunals are now looking into host state laws and regulations as a core element of the relationship between the host state and the investor. Two cases in this regard include one where an anti-dumping law from the Philippines had been circumvented by a foreign investor, and the arbitral tribunal found that because the law was not respected, they were not eligible for protection under the investment treaty(¹). In the other case, the arbitral tribunal looked into the different criteria that an economic activity has to meet in order to be qualified as an investment and the importance of the investment being made in accordance with the host state's laws and regulations was highlighted(²).

Regarding indirect expropriation, tribunals have been quite consistent in their approach or in the qualification of indirect expropriation, and have consistently emphasized the requirement for substantive deprivation of property or control on the part of the investor in order to qualify as an indirect expropriation. There has thus been much fine tuning and narrowing down of what constitutes an indirect expropriation, which would give rise to compensation.

The last area of clear convergence is at the level of national treatment. This is one of the relative standards that requires a comparison between the treatment afforded to foreign investors and the treatment that is granted by the state to other national investors. Here, one of the difficult areas was to identify the proper comparator. What was found was that after some lack of clarity and divergent approaches, was that the identification of the comparator has narrowed down to a national company that is in like circumstances, but from a narrow approach.

Moving to areas of divergence, there has been a trend in tribunals to look into the elements of an investment in order to be protected under a BIT. What has been found in recent cases is that there has been great divergence, particularly in two cases. In one of them, the sole arbitrator identified four criteria that an investment must meet in order to qualify as an investment. Among these criteria, the arbitrator has discussed the importance of the economic impact on the development of the host state. The idea was that in order to be protected under a BIT, the investment also had to have an impact on the host country's economy, rather than only a sales contract or a transaction that would not impact on economic development. This is difficult to ascertain and difficult to evaluate. Therefore, there has been much discussion in the last two years on this point. Some arbitral tribunals stress that these criteria must be sought out and other tribunals have labeled this an irrelevant criteria to the definition of an investment. Some countries are trying to include a better definition of what the criteria are of an investment.

On fair and equitable, and minimum standards of treatment, there is a large divide between the two. There is also a divide against case law and jurisprudence between cases where the arbitrators find that a gross violation must be shown on the part of the state, and on the other hand an expansive view based on the legitimate expectations of the investor.

On most-favored nation (MFN) treatment, there is also much disagreement. Some cases are moving toward a broader interpretation on how the MFN clause can be used, and another school of interpretation is reluctant to go beyond what is actual treatment of the investor where other treaties do not count as treatment of the investor.

Regarding the system of IIA, there is a clear trend in substantive IIA content to enhance clarity and predictability not only for the investor but for the countries that are entering into the negotiations. The second important point is the trend to go for more coherence between investment policies and other legitimate public policies. This is all done by means of including more exceptions. Exceptions have become the norm in IIAs and this makes it very difficult to negotiate because every rule comes with relevant exceptions.

Practically, countries are reviewing their model BITs and some are even revising for the third or fourth time, like the United States. The second element is BITs renegotiation, which is led by two main factors. The first is China renegotiating older BITs, and the second is the EU renegotiating BITs after the Lisbon treaty and with the accession of new member states. The third systemic trend is the modernization of treaty content, which takes into account a better knowledge and understanding of the outcome of arbitral awards, and adjusting treaty language to these interpretations.

KOTERA Akira
The IIA universe is very special and I will make three comments in order to give an understanding of the broader picture. The Japanese government and Japanese industries are very positive in regard to IIAs. However, IIAs are only tools and knowing how to handle those tools is difficult.

First, regarding systematic evolution of the APEC IIA universe, early in the 21st century, when investment arbitration began to be used, many NGOs criticized several investment arbitration cases. In arbitration cases, investor claims against host state measures on environmental protection were recognized to be contrary to the obligations of host states, causing criticism from NGOs. But at the present moment, it appears that in the majority of cases that even if legitimate measures of host states are brought to arbitration, host state arguments are justified.

Second, in Japan, IIA arbitrations are very much appreciated, but it must be pointed out that when Japan and the Philippines negotiated their FTA, the Philippines fiercely refused an arbitration clause. If the Japanese government had insisted on an arbitration clause, the FTA would not have been concluded. Also, Venezuela and Bolivia expressed intentions to withdraw from the ICSID, the main international body for arbitration.

In the case of the Philippines, this can be understood. The Philippines suffered in two arbitrated cases and thus argued against an arbitration clause in its FTA with Japan. As for Venezuela and Bolivia, they accepted arbitration clauses, but withdrew only from the ICSID. This issue concerns the assessment of the arbitration clauses among developing country.

Third, regarding UNCTAD's attitude toward IIAs, it is a little different from the attitude of the Japanese government. UNCTAD seems very positive toward investment protection but reluctant to engage in investment liberalization. In renegotiations of the APEC IIAs, there is no discussion of liberalization. Today's presentation also only concerns investment protection. On the contrary, Japanese governments are very positive about investment liberalization. So, why is UNCTAD so reluctant regarding investment liberalization?

MITA Noriyuki
I would like to introduce three aspects that the IIA community is now discussing. First, most agree that continuous effort is needed to increase understanding of IIAs' evolution, especially in developing countries. There have been concerns and hesitation on the part of developing countries for stronger protection and liberalization clauses. Though these benefit both investors and host countries, developing countries are worried about sacrificing their national policies. Current trends represent a kind of compromise in this regard. It is very important to disseminate information on recent developments and build confidence among developing countries. At the same time, developing countries do understand the value of greater protection, like in China, since it is steadily increasing its outward investment. For example, the Philippines hosted two seminars with UNCTAD on ISDS, reflecting a gradual understanding of the importance of ISDS. And the Philippines adopted ISDS provisions in the ASEAN Comprehensive Investment Agreement.

Second, on prevention and avoidance of disputes, many countries, including the United States and other developed countries, are putting considerable pressure on their relevant authorities, including local governments, to keep their obligations under IIAs to avoid the federal government having to make compensatory payments on their behalf.

Third, arbitration is only one way to solve disputes and in fact require lengthy and cumbersome procedures. In the United States and other countries, mediation, among other options, is being considered as an alternative to arbitration. Japan has experience with more amicable dispute settlement mechanisms, known as the Business Environment Mechanism. Many now realize that such combinations and tools are quite important.

Anna JOUBIN-BRET
Regarding Dr. Kotera's comments, on the current reluctance to go for investor-state arbitration and the steps that some countries have taken to leave the ICSID convention, there is indeed a problem of legitimacy. There is more concern among states about the ways these cases would be perceived if they went against them. As such, capital-exporting states have realized that these mechanisms are not just for their investors to seek protection against violations by the host states but that they can be used against them as well. With the changes in the global FDI situation, countries like China for example are negotiating to protect themselves as well as protect their investors abroad. This is done by clarifying treaty language and by questioning how states can avoid getting into problems in the first place.

Regarding UNCTAD's attitude toward IIAs, UNCTAD has a very scientific/clinical attitude where IIAs are looked at from a wide, neutral standpoint. UNCTAD also has its own views on investment agreements and where they should go. UNCTAD has been very actively pushing to avoid investment treaties becoming an area where all sorts of policies and all sorts of issues are discussed. It is very important to keep IIAs in focus and not discuss outside matters, as IIAs are instruments to protect investors. Regarding liberalization, UNCTAD is not against liberalization, but it has to be done in an appropriate way, at an appropriate pace, in the appropriate forum and with the appropriate instrument(s). Personally, I had reservations about the WTO being the appropriate place to negotiate investment agreements. While UNCTAD is not reluctant to have a multilateral approach to investment, on the contrary, it is important that all players are at the table, rather than having small clubs discussing these issues and others are left out.

Q: Looking at recent arbitral tribunal's awards, there are several awards that pay proper consideration or regard to the public interests of the host state, but much depends on the mindset of arbitrators. Do you have any suggestions on how to educate arbitrators or have a world investment court?

Anna JOUBIN-BRET
On educating arbitrators, to begin with, it is important for end users, be they investors or states, to understand the role of arbitral tribunals. It is important to get the message across that they are not meant to say what international law is or create international law; they are meant to apply it and possibly interpret it. This is something that can be done by academia, but it is also the responsibility of the states to be more active and more involved in this regard. For example, it is important for states to be more proactive and show more concern through such mechanisms as model treaties. Also, with the increase in publication of awards, there is more sensitivity on the part of the arbitrators as to the scrutiny of what they are writing.

KOTERA Akira
Arbitration and national courts are completely different because parties can choose and nominate arbitrators. The responsibility then lies with the parties. If the arbitration is not right, then the wrong party is one of the parties. In Europe, being an arbitrator is a very competitive position. This is the most efficient way to educate arbitrators.

Q: Regarding human resources, as Mr. Kotera indicated, even in Japan, the IIA community is quite a special area and not many government officials can recognize the importance of IIAs. One of the points of reluctance on the part of developing countries comes from a lack of human resources and recognition of the importance of human resources in this field. What kind of support does UNCTAD or other international organizations give to such developing countries?

Second, the circulated materials indicate that certain development of IIAs include introducing general exceptions, such as environmental clauses and others. Is this a good move toward convergence, or is it leading toward divergence?

Anna JOUBIN-BRET
The first question points to a very poignant issue: the problem of resources on the part of developing countries. It is a problem of human resources as well as support for technical assistance, training, awareness building, consensus building, and others. UNCTAD is basically a think tank for all member states, and research is being done for them. Research should get out of the shelves of those in the know. UNCTAD thus engages in capacity building, training, technical assistance, and advice, but this is all resource intensive and UNCTAD is quite alone in this niche as there are not many organizations doing this. There are other organizations working on investment promotion and facilitation, but on investment agreements, UNCTAD is unique, and depends on support and the multiplier effect like in the APEC Forum, where in one meeting a very broad constituency is reached.

1. Fraport v. Philippines
2. Phoenix v. Czech Republic  * Enter "Phoenix v. Czech Republic" in the search box of the linked web page. Then select "Cases" from the drop-down menu box next to the search box and press "GO."