The growing pains of investment treaties

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Today’s post is from OECD Secretary-General Angel Gurría

International investment treaties are in the spotlight as articles in the Financial Times and The Economist last week show. An ad hoc investment arbitration tribunal recently awarded $50 billion to shareholders in Yukos. EU consultations on proposed investment provisions in the Transatlantic Trade and Investment Partnership (TTIP) with the United States generated a record 150,000 comments. There is intense public interest in treaty challenges to the regulation of tobacco marketing, nuclear power and health care.

Some 3000 investment treaties provide special rights for covered foreign investors to bring arbitration claims against governments. Principles of fair and equitable treatment included in many treaties are uncontroversial as general principles of good public governance. But the treaty procedures for interpreting and enforcing them in arbitration claims for damages are increasingly controversial.

A trickle of arbitration claims under these treaties has become a surging stream. Over 500 foreign investors have brought claims, mostly in the last few years. Investor claims regularly seek hundreds of millions or billions of dollars. High damages awards and high costs have attracted institutional investors who finance claims.

Providing investors with recourse against governments is valuable. Governments can and do expropriate investors or discriminate against them. Domestic judicial and administrative systems provide investors with one option for protecting themselves. The threat of international arbitration gives substantial additional leverage to foreign investors in their dealings with host governments, especially when domestic systems are weak.

At the same time, there is mounting criticism. Arbitration cases can involve challenges to the actions of national parliaments and supreme courts. As Chief Justice Roberts of the US Supreme Court wrote earlier this year, “by acquiescing to [investment] arbitration, a state permits private adjudicators to review its public policies and effectively annul the authoritative acts of its legislature, executive, and judiciary”. In a similar vein, Chief Justice French of the High Court of Australia recently noted that the judiciary in his country had not yet made any “collective input” to the design of investment arbitration and that it was time to start “catching up”. This broadening interest in the system will enrich the debate on the future of investment treaties.

Governments and business leaders are also seeking to reform treaties so as to ensure that they help attract investment, not litigation. Some major countries, such as South Africa, Indonesia and India, are terminating, reconsidering or updating what they perceive to be outdated treaties that excessively curtail their “policy space” and entail unacceptable legal risks. Germany opposes the inclusion of investment arbitration in TTIP. The B20 grouping of world business leaders recently called on the G20 to address investment treaties.

International organisations such as the OECD can help governments and others to shape the future of investment treaties. I propose the following agenda for joint action to reform and strengthen the investment treaty system.

Resolve investor claims in public. The frequently secretive nature of investment arbitration under many treaties heightens public concerns. The treaties of NAFTA countries and some other countries have instituted transparent procedures. But nearly 80% of investment treaties create procedures that fall well short of international standards for public sector transparency. This is a major weakness. In July, UNCITRAL (the United Nations Commission on International Trade Law) approved a multilateral convention on transparency. Governments can now easily make all investor claims public. Over a century ago, Lord Atkinson emphasised that a public trial is “the best security for the pure, impartial, and efficient administration of justice, the best means of winning for it public confidence and respect”. Governments – with the support of major investors — should rapidly take action to ensure that investment arbitration adopts high standards of transparency.

Boost public confidence in investment arbitration. Governments have borrowed the ad hoc commercial arbitration system for their investment treaties. But this borrowing is increasingly questioned. Sundaresh Menon, as Attorney-General of Singapore, has observed that “entrepreneurial” arbitrators are subject to troubling economic incentives when making decisions on investor state cases. Advanced domestic systems for settling disputes between investors and governments go to great lengths to avoid the appearance of economic interests influencing decisions. Investment arbitration needs to do the same.

Do not distort competition. The concept of national treatment is a core component of investment and trade agreements. It promotes valuable competition on a level playing field. Investment treaties should not turn this idea on its head, giving privileges to foreign companies that are not available to domestic companies. Governments should protect competition and domestic investment by, for example, ensuring that treaty standards of protection do not exceed those provided to investors under the domestic legal systems of advanced economies. Some case law interpretations of vague investment treaty provisions go beyond these standards, and are unrelated to protectionism, bias against foreign investors or expropriation. Governments that allow for such interpretations should either make public a persuasive policy rationale for these exceptional protections for only certain investors, or take action to preclude such interpretations of their treaties.

Eliminate incentives to create multi-tiered corporate structures. By allowing a wide range of claims by direct and indirect shareholders of a company injured by a government, most investment treaties encourage multi-tiered corporate structures. Each shareholder can be a potential claimant. Indeed, many treaties encourage even a domestic investor to create foreign subsidiaries – it can then claim treaty benefits as a “foreign” investor.

If complex structures were cost-free, perhaps it wouldn’t matter. But they aren’t. Complex structures increase the cost of insolvencies and mergers. They also interfere with the fight against bribery, tax fraud and money laundering because they can obscure the beneficial owner of the investment. Governments should promptly eliminate investment treaty incentives to create multi-tiered corporate structures.

We need international capital flows to support long-term growth through a better international allocation of saving and investment. But the investment treaty system needs to be reformed to ensure that the rights of citizens, governments, enterprises and investors are respected in a mutually beneficial way.

Useful links

OECD work on international investment

OECD work on international investment law

Legal principles applicable to joint government interpretation of investment treaties was one of the issues discussed at the March 2014 OECD Roundtable on Freedom of Investment

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