State-owned enterprises, international investment and national security: The way forward

Frédéric Wehrlé and Hans Christiansen, OECD Directorate for Financial and Enterprise Affairs

For most of the past half century, countries around the world have gradually opened up to foreign investment, and with good effect. Investment from other countries has supported growth and development, created jobs and enhanced welfare. Today, as our data show, OECD economies retain only limited traditional regulatory restrictions to inward foreign investment in the form of foreign ownership ceilings and other discriminatory conditions. While many emerging economies are generally less open, they have made their legal regimes for foreign direct investment less restrictive. Ongoing monitoring by the OECD shows that these liberalisation efforts continued after the 2008 financial crisis.

However, since the 2000s, a new and opposing trend has emerged: the screening and review of foreign investment projects, particularly those by state-owned enterprises (SOEs), to mitigate risks to national security. In fact, a recent survey shows that more and more governments are introducing or enhancing screening mechanisms for inbound investment projects to identify and address perceived threats. A third of the 59 advanced and emerging economies that participate in our investment policy dialogue now operate such mechanisms. Several governments are now subjecting investment proposals involving SOEs to greater scrutiny, and at times prohibiting these investments. Some countries have established special rules for the review and admission of investments by SOEs or are considering new policies to address the issue.

Could the precedent offered by the Santiago Principles help to point a way forward? In 2008, following widely publicised concerns in some large OECD countries regarding high profile investment projects by non-OECD sovereign wealth funds (SWFs), the community of SWFs and their government owners adopted a code of good conduct, the Santiago Principles, that was motivated by a desire to ensure that countries would not use national security arguments as a cover for protectionism against foreign SWFs. A decade later, the upsurge of SOEs in global investment and related national security concerns expressed by recipient countries could motivate similar arrangements with respect to investment by foreign SOEs.

International investment by SOEs is a growing concern

The increasing participation of SOEs in the global marketplace, particularly as international investors, makes it all the more important to balance concerns about the good governance of SOEs and to maintain a level playing field. As bearers of state as well as commercial interests, SOEs may place their emphasis on strategic acquisitions, such as advanced technologies for example, on non-market terms. It is fitting therefore that the rise of SOEs should revive interest in investment policies related to national security.

Australia, for instance, screens all SOE investments, whereas it screens private investments only when they exceed a value threshold. Canada applies different trigger thresholds for the application of its net-benefit test if the investor is state-owned. The United States has established specific rules regarding SOEs as part of its national security review mechanism (CFIUS), which require investigation of all government-controlled investments concerning US businesses. Germany has just strengthened its review mechanism. France, Germany and Italy have called for EU policies to address the issue. Strengthening screening of foreign direct investment (FDI) on national security grounds is also under consideration in the Netherlands, the United Kingdom and the United States.

Heightened awareness of the implications of SOE investment has also been evident in more recent international investment agreements. The Trans-Pacific Partnership agreement (TPP), for example, dedicates an entire chapter to SOE investments, whereas in older agreements SOEs were effectively afforded a status broadly similar to that of private investors.

Governments have always been careful to secure policy space to safeguard national security needs. The OECD Codes of Liberalisation, for instance, just as many investment treaties, contain corresponding national security exceptions. These exceptions are typically self-judging, and the term “national security” is intentionally broad.

Because of the discretionary nature of invoking national security as a ground for restricting foreign investment, the OECD Guidelines for Recipient Country Investment Policies relating to National Security were issued as an OECD Recommendation in 2009. These guidelines offer a set of specific recommendations providing for non-discrimination, transparency and predictability, as well as regulatory proportionality and accountability, including effective safeguards against undue influence and conflict of interest.

Internationally agreed rules on SOEs would bring benefits

While concerns relating to SOE investments are legitimate–and many SOEs are less transparent than private firms–the imposition of outright or unqualified restrictions on SOE investments in recipient countries benefit neither host nor home countries as opportunities for mutually beneficial international investment are forgone.

Applying internationally agreed commitments to SOEs and their government owners would help reassure recipient country regulators by offering greater transparency, addressing potential distortions that may arise from state ownership, and ensuring that the SOE owners also observe high standards of governance, disclosure and accountability. In turn, these regulators could be expected to apply the same conditions to SOEs that they apply to investment proposals by privately-owned companies.

A similar outcome to that agreed by SWFs can be achieved for SOE investments today. After all, recommendations on good practices for governance, disclosure accountability and transparency of SOEs have already been agreed under the OECD Guidelines on Corporate Governance of State-Owned Enterprises. These guidelines include specific provisions by which the legal and regulatory framework for SOEs, as well as their practices, should ensure a level playing field and fair competition in the marketplace when SOEs engage in economic activities. If translated to an international market context, and if fully implemented, these provisions could fully address the concerns of investment regulators. The last element required to emulate the “Santiago arrangement” would be to secure a commitment by SOEs to abide by these standards.

This could help convince recipient countries to keep their economies open and to uphold both the letter and the spirit of the principles of OECD guidance on national security.

The OECD stands ready to help forge a mutually beneficial and trusted arrangement for SOEs so that home and host societies can reap the benefits of international investment, while addressing important security concerns that inhibit certain investments proposed by SOEs today.

References and further reading

International Forum of Sovereign Wealth Funds (2008), the Santiago Principles

OECD (2016), State-Owned Enterprises as Global Competitors: A Challenge or an Opportunity?

OECD, OECD Codes of Liberalisation of Capital Movements and of Current Invisible Operations, 2012-2017

OECD, Corporate governance of SOEs: Guidance and research, 2011-2017

OECD, Monitoring investment and trade measures, 2008-2017

OECD, Freedom of investment at the OECD, 2007-2017

OECD (2015), OECD Guidelines on Corporate Governance of State-Owned Enterprises

OECD (2009), OECD Guidelines for Recipient Country Investment Policies Relating to National Security, Recommendation adopted by the OECD Council on 25 May 2009

OECD, FDI Regulatory Restrictiveness Index, 1997-2017

Shima, Y. (2015), The Policy Landscape for International Investment by Government-controlled Investors: A Fact Finding Survey, OECD Working Papers on International Investment, No. 2015/01, OECD Publishing, Paris.

Wehrlé, F. and J. Pohl (2016), Investment Policies Related to National Security: A Survey of Country Practices, OECD Working Papers on International Investment, No. 2016/02, OECD Publishing, Paris.

Addressing the imbalance between investment protection and people protection: Making globalisation work for all

Roel Nieuwenkamp, Chair of the OECD Working Party on Responsible Business Conduct (@nieuwenkamp_csr)

We are facing a backlash against globalisation. This has gone hand in hand with a push back against investment treaties and trade agreements: just watch the election campaigns and the downfall of TTIP and TPP negotiations.

Nowadays, at the OECD many policymakers talk about “Making globalisation work for all”. If we really want to achieve this, policymakers have to take another critical look at the following.

A number of people have argued that investment policy today is marked by an imbalance between investor rights and investor responsibilities. I would frame it slightly differently.

We have developed investment protection of foreign investment because of states with failing policies and inadequate legal systems to safeguard investor rights. In regions where courts are dysfunctional, corrupt, politically biased or incompetent, foreign investors want extraterritorial protection. Fair point.

A related issue is that some people are victims of foreign economic activities. They also lack protection and remedy because of the exact same reasons: failing policies and weak legal systems. However, they do not have access to extraterritorial protection of their rights. So there is a fundamental asymmetry between investment protection and people protection. There is hard protection of investments and soft protection of people. Why do we protect investments with hard law and protect people with soft law? We have no credible answers.

This imbalance is fuelling two trends: a declining support for investment protection, which even undermines trade policy in general and free trade agreements in particular, and on the other hand societal and political pressures towards mandatory legislation on responsible business conduct, such as the recent due diligence law in France and the modern slavery act in the UK. It has also led to discussions in the UN on a binding treaty on business and human rights.

This topic will not disappear from the agenda. The imbalance will haunt policymakers for decades.

There should be at least two responses in my view: first, strengthening access to remedy for people, for example by strengthening the National Contact Points for responsible business conduct under the OECD Guidelines, and second, making investment protection more responsible. The inclusion of aspirational provisions on corporate social responsibility and cooperation in this field will not do the trick. It will only lead to accusations of “greenwashing” investment treaties.

Are there feasible options? Yes there are. We have seen recent precedents to make investment protection more responsible. Not all of them are easy or without controversy, but worth exploring.

One option is to exclude sectors that are considered as not responsible. There is a precedent for this approach: the TPP exemption of tobacco products from protection. This is controversial and the question remains whether this the way forward: will the coal sector be excluded in the future too?

A second option could include a provision ensuring that only those investors that comply with the OECD Guidelines for Multinational Enterprises are assured protection under such a treaty. This would be very complex from a procedural point of view, but not impossible.

A third option, which is more easily conceivable, is to exclude protection for investments that are linked to corruption and egregious human rights violations. This would be nothing more than “codifying” the “clean hands doctrine” that is already accepted by several arbitration tribunals. In the cases Metal-Tech Ltd v the Republic of Uzbekistan and World Duty Free Company Limited v The Republic of Kenya (2006) the tribunal excluded jurisdiction because of corruption related to the investment.[1]

A fourth feasible option worth exploring is to include a provision that specifies that material breaches of the OECD Guidelines – for example severe human rights violations  –  are taken into account by a tribunal when deciding on the merits of a claim or on potential damages awarded.

Of course these ideas are controversial and complex. It takes investment policymakers and treaty negotiators out of their comfort zone. As a former investment negotiator myself it even makes me uneasy, but we have to explore these options further. This is not impossible: precedents are available. Doing so requires political will and action is urgent. Why? Because we must respond to the backlash against investment and trade policy and make globalisation work for all.

Useful links

OECD Conference on investment treaties: The quest for balance between investor protection and governments’ right to regulate 14 March 2016, Paris

The growing pains of investment treaties OECD Secretary-General Angel Gurría on Insights

[1] Metal-Tech Ltd v Republic of Uzbekistan (2013): http://www.italaw.com/sites/default/files/case-documents/italaw3012.pdf  para110 iii ‘clean hands doctrine’165 &166; 236,237; 243; 372; World Duty Free Company Limited v The Republic of Kenya (2006): http://www.italaw.com/documents/WDFv.KenyaAward.pdf

The challenge: How can foreign direct investment fulfil its development potential?

DCR 2016Today’s post, by Karl P. Sauvant, Resident Senior Fellow, Columbia Center on Sustainable Investment, Columbia University, is published in collaboration with the 2016 OECD Development Co-operation Report: The Sustainable Development Goals as Business Opportunities.

International investment, and in particular foreign direct investment, has an important role to play in helping to achieve the Sustainable Development Goals. It can be a powerful international mechanism for mobilising the tangible and intangible assets (such as capital, technology, skills, access to markets) that are essential for sustainable growth and development.

Yet to fulfil this potential, foreign direct investment must increase substantially; it must be geared as much as possible towards sustainable development; and it must take place within a framework of international investment law and policy that is enabling, yet at the same time respectful of host governments’ own legitimate public policy objectives.

Foreign direct investment flows reached their peak in 2007 at around USD 2 trillion, dropping to USD 1.2 trillion by 2009 as a result of the international financial crisis. While this represents a relatively small share – about 10% – of gross domestic capital formation, in individual countries this share can be even higher than domestic investment.

To help meet the investment needs of the future, these flows have to increase substantially. There is no apparent reason why they could not do so over the longer term, say to a level of USD 4 or 5 trillion annually.

How to get there? Improving the economic determinants, the principal factors governing investment decisions, is fundamental. Official development assistance will continue to be important, especially for the least developed countries, including to leverage higher foreign direct investment flows. This is a long-term challenge.

However, national regulatory frameworks and investment promotion efforts can be improved in the short term, especially in the least developed countries.

The first challenge is to increase foreign direct investment through a concerted international effort to help developing countries, and especially the least developed among them, to improve their foreign direct investment regulatory frameworks and investment promotion capacities. At present, there is no such international effort – along the lines of the Aid-for-Trade Initiative and especially the Trade Facilitation Agreement – in the area of foreign direct investment. But in a world of global value chains, these trade arrangements can help only so much, precisely because they address only one side of the task, namely to increase trade. But a concerted international effort for foreign direct investment, such as an international Aid-for-Investment Initiative or even a Sustainable Investment Facilitation Understanding, could help developing countries, and especially the least developed among them, rapidly to improve their regulatory frameworks as well as their capacity to promote investment – thereby helping to increase investment flows to developing countries.

Encouraging higher foreign direct investment flows is, however, not enough.

The second challenge is to promote foreign direct investment that is geared as closely as possible towards sustainable development: “sustainable foreign direct investment for sustainable development”. This presents the challenge of defining “sustainable foreign direct investment”. A first approximation could be: commercially viable investment that makes a maximum contribution to the economic, social and environmental development of the host country and takes place in the context of fair governance mechanisms, as established by host countries and reflected, for instance, in the incentives they offer. Yet any definition needs to be operationalised. So this challenge would also involve developing an indicative list of sustainability characteristics to be considered by governments seeking to attract sustainable foreign direct investment (and to encourage sustainable domestic investment). Such a list would also be a helpful tool for international arbitrators considering (as they should) the development impact of investments, as well as for identifying the mechanisms – beyond those deployed to attract foreign direct investment in general – that encourage the flow of sustainable investment and increase its benefits for host countries.

The third challenge is to reform the international investment law and policy regime. National foreign direct investment rule making increasingly takes place in the framework of international investment law and policy. For this reason, it is important to ensure that the international investment regime constitutes an enabling framework for encouraging the flow of sustainable foreign direct investment, while at the same time allowing governments to pursue their legitimate public policy objectives. This requires asking several questions, including: How can the objective of sustainable development be made the lodestar of the international law and policy regime? What are the implications of such a concept for the regime’s rights and obligations? How will this affect the mechanism for settling disputes between investors and states? This last function is central to the regime and gives it its strength, yet it is precisely the existing dispute-settlement mechanism that is strongly questioned – especially by non-governmental organisations, but also by a number of governments. Any reform needs to address this challenge adequately to avoid threatening the very legitimacy of the regime.

In conclusion, governments need to find ways and means to increase sustainable foreign direct investment flows within a reformed international investment law and policy regime to realise the sustainable development potential of this investment.

Useful Links

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DCR2016fullsizeinfographic eng

G20 serves an appetiser to a potential investment policy feast

G20-China-2016-logo-300Following endorsement of the G20 Guiding Principles for Global Investment Policymaking by G20 Trade Ministers in Shanghai on 10 July 2016, Ana Novik, Head of the OECD Investment Division, highlights the importance of follow-through on this important stepping stone to greater policy coherence.

In an economy where global value chains (GVCs) are increasingly pervasive – with the production of goods and provision of services fragmented across borders – and where the growth in cross-border trade and investment flows remains relatively sluggish, structural reform and policy coherence in the “trade-investment nexus” is more important than ever. As the global economy still struggles to achieve “escape velocity” from its post-crisis torpor, these can be the keys to unlock stronger growth and raise living standards for all.

Investment is understood to be a critical component of the GVC equation. So, recognising the economic salience of more coherent investment policymaking, G20 Trade Ministers endorsed new G20 Guiding Principles for Global Investment Policymaking at their meeting in Shanghai on 9-10 July 2016. This came about as a result of careful negotiation, supported by the OECD and other international organisations, through the G20’s new Trade & Investment Working Group (TIWG).

China’s initiative in establishing the TIWG during its 2016 G20 Presidency, and in putting investment policy coherence centre stage, sets a high bar for the German and Argentine Presidencies to follow in 2017 and 2018. Not only is this new working group an ideal forum for high-level policy makers to advance the multilateral trade and investment agendas separately but, crucially, it represents an opportunity to bolster policy coherence between them by exploiting synergies and recognising interdependencies.

Under China’s dynamic leadership, the G20 TIWG has served up a taste of what is possible. If policy makers can maintain this momentum at a global level, and implement conforming investment policy reforms at domestic level, these Guiding Principles may yet come to be seen as the appetiser to a feast. Critically, while the Guiding Principles help chart a way forward, it will be the political will of G20 member countries to advance reforms and engage in further constructive global dialogue that will determine their ultimate impact.

Sound, coherent policy frameworks in home and host countries can both ensure that private and international investment contribute significantly towards economic and social development, and enhance the attractiveness of countries’ investment climates. Getting these policy frameworks right is the rationale underpinning both the new G20 Guiding Principles for Global Investment Policymaking and the existing OECD Policy Framework for Investment, with which they are closely aligned.

The Guiding Principles entail nine key elements of guidance for policy makers:

  1. Avoid protectionism.
  2. Ensure non-discrimination.
  3. Protect investors.
  4. Make policy transparently.
  5. Aim for policy coherence for sustainable growth and inclusive growth.
  6. Recognise government’s right to regulate.
  7. Pursue effective and efficient promotion and facilitation policies.
  8. Observe best practices for responsible business conduct and corporate governance.
  9. Continue international investment dialogue.

Together, the Guiding Principles aim to foster an open, transparent and conducive global policy environment for investment. Although they are non-binding in nature, the Guiding Principles can help promote coherence in national and international policymaking, providing greater predictability and certainty for businesses so long as policy makers ensure they are well reflected through policy reforms.

The Role of the OECD and its Policy Framework for Investment

Providing critical support to TIWG negotiations over the first half of 2016, the OECD – working closely with the Chinese Presidency and UNCTAD – helped facilitate the constructive discussions leading to agreement on the Guiding Principles. In particular, inspiration was drawn from the OECD Policy Framework for Investment to ensure the Guiding Principles were as strong and balanced as possible. For example, there is a good balance between strong protection for investors, on the one hand, and, on the other hand, the imperative for investors to observe applicable instruments for corporate governance, such as the G20/OECD Principles of Corporate Governance, and responsible business conduct, such as the OECD Guidelines for Multinational Enterprises. Building on its existing body of work, the OECD also contributed substantively to the TIWG’s broader discussions on policy coherence in the trade-investment nexus as well as on investment facilitation and related policy issues. Furthermore, the OECD played host to a meeting of the TIWG, on the margins of its annual Ministerial Council Meeting during the first week of June 2016.

First developed in 2006 as a response to the Monterrey Consensus, and updated in 2015 as a means to mobilise private investment for development in the context of the Sustainable Development Goals, the OECD Policy Framework for Investment (PFI) takes a comprehensive, whole-of-government approach to investment climate reform. The objective of the PFI is to mobilise private investment that supports steady economic growth and sustainable development, contributing to economic and social well-being around the world. Covering 12 policy areas (from investment policy to trade policy, and from responsible business conduct to green investment), the PFI is non-prescriptive and emphasises policy coherence across those areas. It eschews one-size-fits-all solutions and encourages policy makers to ask appropriate questions about their economy, their institutions and their policy settings.

Useful links

G20 agrees Guiding Principles for Global Investment Policymaking

G20 Guiding Principles for Global Investment Policymaking

OECD Policy Framework for Investment

OECD Guidelines for Multinational Enterprises

G20/OECD Principles of Corporate Governance

Let’s Get Realistic About a Multilateral Investment Agreement

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Any chance they’ll all agree?

Shaun Donnelly, retired U.S. diplomat and trade negotiator, now Vice President for Investment Policy at the US Council for International Business (USCIB).  He is a regular participant in the Business and Industry Advisory Committee to the OECD (BIAC) and  OECD Investment work.

I found some very interesting questions and even a few answers in the recent “OECD Insights” blog post on international investment agreements by Professor Jan Wouters from the University of Leuven.  But it seems to me that Professor Wouters’ prescriptions may fit better in a university classroom or a theoretical computer model than in real world of government-to-government diplomatic investment negotiations or in a corporate headquarters making real-world cross-border investment decisions.  As a former U.S. Government trade and investment negotiator and now in the private sector advising/assisting member companies of the U.S. Council for International Business (USCIB), as well as an active participant over the past three years in the investment policy work the OECD and its Business and Industry Advisory Committee (BIAC), I’d like to offer an alternative perspective on some of the international investment issues the professor addresses.

I’m tempted to challenge several of the assumptions that seem to underlie Dr. Wouters’ analysis and prescriptions.  His assertion that multilateralism is an inherently superior venue for all investment issues seems a little naïve to me as a practitioner.  Everyone accepts the theoretical point that in a textbook or the laboratory, multilateral can be the optimal approach – one set of comprehensive, high-standard rules applying to all countries and, by extension, to all investors – a WTO for investment if you will.

The reality is that diplomatic negotiations, investment projects, and job creation take place in the real world, driven by real people representing concrete, real-world interests.  In that real world, governments have a wide range of views on what should or shouldn’t be in an investment agreement. How strong are the protections accorded to investors? Does the agreement include (as U.S. government investment agreements typically do) market opening or “pre-establishment” provisions? Do investors have access to a credible, neutral arbitration process to resolve disputes with host governments?  These are key issues for any government or investor.

Unfortunately, not all players in the investment policy world would share all my views, or those of Dr. Wouters.  Governments vary widely on their policy and political approaches to international investment and, more specifically, to international investment agreements.  Many have views generally in line with those of the U.S. government, sharing a commitment to high-standard international investment agreements.  But some other governments only seem willing to accept much lower standards of investment protection; still other governments are hostile to any international investment agreements.

Some OECD veterans like me recall that some 20 years ago, the then-25 OECD members made a serious attempt to negotiate a Multilateral Agreement on Investment or “MAI.”  Unfortunately, after some early promise, the negotiations broke down over some of the key pillar issues I noted above.  Neither the OECD nor any of its member governments have attempted to revive the search for the elusive multilateral investment agreement framework.  Most OECD member nations seem, explicitly or implicitly, to have accepted the reality that, while multilateralism may be the optimal path, in the investment policy area, it is not, at least for now, a practical way forward.

The lesson I personally draw is clear, and it’s quite different from the approach advocated by Dr. Wouters.  Those Governments around the world that think foreign direct investment is a positive force for economic growth, are trying to make practical progress, not simply engage in endless and frustrating political debates.  They want to negotiate investment agreements that can attract real investment and, thereby, create real economic growth and jobs.  While some of them may see intellectual debates about a theoretical multilateral investment regime at some point in the future as an interesting exercise, their priority is on finding ways to grow their economies today and tomorrow.

So my questions to Dr. Wouters and other advocates of a focus on multilateralism in international investment regimes would include:

  • What kind of investment regime do you really envision?  How strong an agreement would it be?  Would it include the sorts of high-standard protections for investors currently found in recent investment agreements of OECD member countries?
  • What causes you to think there is realistic chance for success in a multilateral investment negotiation?  “Multilateral” now requires nearly 200 sovereign nations reaching a consensus.  Countries ranging from Cuba and Argentina to Japan and Canada; from India and China to the U.S. and the EU; from Russia and Venezuela to Saudi Arabia and Singapore would have to be major players in any multilateral investment effort. What sort of consensus could emerge from that wide-ranging group?
  • When the then 25 “like-minded” OECD member nations couldn’t negotiate an MAI, what causes you to think 200 diverse and widely diverging nations could come together now to negotiate a multilateral investment agreement or framework?

I’d love to be proven wrong, by Dr. Wouters or anyone else, if they can show me a credible path to that elusive high-standard multilateral agreement.  But until someone can show me how to get that done, I believe strongly the better path in the real world is to keep doing what individual governments and groups of countries have been doing for some time, to find willing partners and negotiate strong bilateral or regional investment agreements that work in the real world.  Here in the U.S., we in the business community are excited about the possibility of two “mega-regional” agreements, the recently-concluded Transpacific Partnership (TPP) and the on-going Transatlantic Trade and Investment Partnership (TTIP) as vehicles to update and strengthen investment protections with key partners.

When it comes to investment protection/promotion agreements, let’s focus all of our efforts on paths that we know can work – negotiating high-standard investment agreements.  If/when someone can find that elusive path to a high-standard multilateral agreement, great! I’ll be at the front of the line applauding. But until that path really emerges, let’s stay focused on what works – the bilateral and regional path that has proven it can deliver real results, real investment, growth, and jobs and leave the multilateral investment framework to the theoreticians.

The OECD, specifically its Investment Committee, has long been a place for serious investment policy research, analysis and debate. I’ve been privileged recently to participate in some of those sessions as a business stakeholder as a BIAC representative. I encourage OECD to continue, indeed redouble, that policy work. There are important and challenging issues to address. We in the international business community, along with other stakeholders, can add much to that OECD work.   I simply urge that the OECD investment work focus on concrete investment “deliverables” which can be implemented, rather than idealistic pursuits of some theoretical multilateral panacea.

Useful links

OECD Conference on investment treaties: The quest for balance between investor protection and governments’ right to regulate OECD, Paris, 14 March, 2016. This second OECD Investment Treaty conference will explore: How governments are balancing investor protection and the right to regulate; the search for improved balance through new institutions or improved rules for dispute settlement including the new Investment Court System developed by the European Union; a case study on addressing the balance through substantive law in particular through approaches to the fair and equitable treatment (FET) provision; and how the OECD, working with other international organisations, can support constructive improvement of governments’ investment treaty policies in this regard.

BIAC’s strategic recommendations on investment

Reconciling Regionalism and Multilateralism in a Post-Bali World, OECD Global Forum on TradeParis, 11 February 2014, Rapporteur’s report

The OECD’s Revised Benchmark Definition of Foreign Direct Investment: Better data for better policy

See if you can spot one of the world's biggest investors
See if you can spot one of the world’s biggest investors

Maria Borga, OECD Investment Division

Let’s start with a quiz. Which country is the second biggest direct investor in China? Who are the largest investors in India and Russia? You probably won’t believe it, but the answers are (a) British Virgin Islands, (b) Mauritius and (c) Cyprus. It’s not a sordid tale of hot money but rather a more mundane story of companies investing abroad through a holding company or affiliate located in a third country. They might be driven by the presence of a double taxation or bilateral investment treaty, or it might simply reflect corporate strategy to invest through an existing affiliate rather than by sending cash from the parent company.

Whatever the reason, it’s all perfectly legal. But as a consequence, we sometimes know very little about who owns what. Those Cypriot investors in Russia are almost certainly owned by an investor in another country, sometimes even a Russian investor. As a result, national statistics on flows of foreign direct investment (FDI) tell us less and less about what we want to know. Who is investing in our country and where are our own companies investing? To know the truth about a country’s FDI you need a comprehensive standard for measurement, which is why the OECD produced its standard: the Benchmark Definition of Foreign Direct Investment, 4th Edition (BMD4).

BMD4 makes two key recommendations which address the problems posed by the complex ownership structures of MNEs. The first is to compile FDI statistics separately for resident special purpose entities (SPEs). But what are SPEs? The OECD defines them as  “entities with no or few employees, little or no physical presence in the host economy and whose assets and liabilities represent investments in or from other countries and whose core business consists of group financing or holding activities”.  You may have seen images of them in TV reports about tax avoidance, when the camera shows a wall in a grubby building lined with mail boxes representing gigantic multinational firms. SPEs are often used to channel investments through several countries before reaching their final destinations. By separately compiling FDI statistics for SPEs, you can derive FDI into real businesses, giving countries a much better measure of the FDI into their country that is having a real impact on their economy. The second is to compile inward investment positions according to the ultimate investing country (UIC) to identify the country of the investor that ultimately controls the investments in their country.

This boils down to less double counting and more meaningful FDI statistics.

By recommending that countries compile FDI statistics separately for resident SPEs, BMD4 eliminates a layer of complication due to the ownership structures of MNEs.

The figure below shows the percentage of the inward stock of FDI—that is the accumulated value of investment by foreigners in the economy—accounted for by resident SPEs for 13 OECD economies. SPEs are very significant in Luxembourg and the Netherlands, accounting for more than 80% of all inward investment. SPEs are also significant in Hungary, Austria, and Iceland, where they account for more than 40% of inward investment. SPEs play smaller, but still important, roles in investment for Spain, Portugal, Denmark, and Sweden. In contrast, SPEs are not significant in Korea, Chile, Poland, and Norway.

Share of FDI into SPEs and non-SPEs, end of 2014

SPI non SPI

Source: OECD Foreign Direct Investment statistics (BMD4) database

BMD4 also eliminates the lack of transparency regarding the country of the direct investor who ultimately controls the investment and, thus, bears the risks and reaps the rewards of it by recommending countries compile statistics by ultimate investing country (UIC) in addition to the standard presentation by immediate investing country.

The presentation by UIC can shed light on another important issue: round-tripping. Round-tripping is when funds that have been channelled abroad by resident investors are returned to the domestic economy in the form of direct investment. It is of interest to know how important round-tripping is to the total inward FDI in a country because it can be argued that round-tripping is not genuine FDI. The presentation by UIC identifies round-tripping by showing the amount of inward FDI controlled by investors in the reporting economy.

We can illustrate this by looking in more detail at France and Estonia and comparing the inward stock of FDI of the top ten ultimate investors to the amounts coming from the immediate investing country.

On the UIC basis, the United States is a much more important investor in France than it appears when presented by immediate partner country. Indeed, the inward stock of the United States increases from USD 79.6 billion to USD 142.1 billion. The inward investment stocks from Luxembourg and the Netherlands drop considerably, indicating that US companies may be using affiliates in these countries to handle business done in France. French investors are the 8th largest source of FDI into France. While this indicates there is some round-tripping, it accounts for less than 4% of the inward stock of FDI in France.

Inward direct investment by immediate partner country and by ultimate investing country, France end of 2012 (USD millions)

FDI France

Source: OECD Foreign Direct Investment statistics (BMD4) database

On the UIC basis, Estonia becomes its own second largest source of investment, indicating that round-tripping is more common than in France. Given that Sweden, Finland, the Netherlands, Russia, and Norway become less important as sources of investment when measured according to the ultimate investor, it appears that some of the round-tripping from Estonia is going through some or all of these countries. In contrast, the United States, Austria, Germany and Denmark are all more important sources of FDI in Estonia than the standard presentation indicates.

Inward direct investment position by immediate partner country and by ultimate investment company (excluding resident SPEs), Estonia end of 2013 (USD millions)

Inward FDI Estonia

Source: OECD Foreign Direct Investment statistics (BMD4) database

Does removing these layers of complexity matter? Yes. Every country has a strategy to attract investment and high quality statistics must be the empirical basis for any informed policy dialogue. Following the recommendations in BMD4 produces more meaningful FDI statistics that enable us to better understand who is really investing where internationally.

Useful links

Today’s OECD Technical Workshop on Foreign Direct Investment and Global Value Chains will discuss the first results of OECD work on integrating FDI statistics into the analysis of Global Value Chains  to better account for foreign ownership.

For the latest FDI statistics

For information on implementing BMD4

The OECD newsletter, FDI in Figures, discusses recent developments in FDI

We need global policy coherence in trade and investment to boost growth

Investment Forum

Gabriela Ramos, OECD Chief of Staff and Sherpa to the G20 @gabramosp

Mounting fears of another slowdown in the global economy call for bolder policy responses. Trade and investment are a case in point.

The latest WTO forecasts suggest 2015 will be the fourth year running that global trade volumes grow less than 3%, barely at—or below—the rate of GDP growth. Before the crisis, trade was growing faster than GDP. In addition, global flows of foreign direct investment (FDI) remain 40% below pre-crisis levels. If we are to achieve the ambitious Sustainable Development Goals agreed in New York in late-September, and underpin broad-based improvements in living standards, we need to reignite these twin engines of growth and we need to do it for the ultimate goal of improving people’s prospects and wellbeing.

Trade and investment have always been intertwined in business, but they have never quite come together in policymaking. In a world of Global Value Chains (GVCs), characterised by the fragmentation of production processes across countries, the interdependencies between trade and FDI are sharper. Technological improvements, reductions in transport and communications costs, and regulatory developments allow firms to combine multiple channels–- imports, FDI, movement of business personnel, licenses — to optimize their international business strategies. Businesses do not think in terms of trade or investment, but in terms of maximizing expected profitability. On the contrary, policymakers have long addressed trade and investment on separate tracks. In the face of new economic realities, policymakers need to up their game.

The symbiosis between trade and investment is more complex than ever before. Multinational enterprises (MNEs) play a key role in this relationship, with their activities driving a large share of world trade. The decision of a firm to invest in a foreign country is influenced by the ease with which it can sell its products, but also by how easy it is to source inputs from its affiliates (intra-firm trade) or independent suppliers (extra-firm trade) abroad. Hence, trade barriers become indirect barriers to investment. In addition, “world factories” make emerging trade patterns more complex, as not only goods and services cross borders, but capital, people, technology, and data do too. Without a transparent framework, it is also difficult to upgrade and upscale responsible business conduct.

Services are an increasingly critical node in the relationship between trade and investment. The WTO’s General Agreement on Trade in Services (GATS) explicitly recognizes this by defining FDI in services as one of the four ways in which services can be traded (mode 3, or ‘commercial presence’). This reflects how trade and investment interact with one another. Clearly, services will be central in any further efforts to liberalize investment and to improve the business environment. The OECD FDI Regulatory Restrictiveness Index shows that investment barriers are overwhelmingly in the services economy. Reforms in backbone services, notably digital services, transport, and logistics are key to unclogging GVCs. Domestic reforms to allow for more competition in the service sectors is also a source of growth and equality. Moreover, there is untapped potential in services value chains that could be realized if services markets were opened further. The OECD Services Trade Restrictiveness Index (STRI) provides a tool for identifying these barriers and measuring their costs, in order to prioritize and sequence reforms.

There is still no global set of rules governing investment and trade, however. Apart from GATS, two other WTO agreements—TRIMS and SCM–cover aspects of FDI, but they are not comprehensive. The OECD Codes are also a reference on capital flows, but does not address the link with the trade dynamics. The void has been filled with a complex network of nearly 3,000 bilateral investment treaties (BITs) of different quality and with different coverage.. Investors and States need certainty. A uniform regime would help, providing a consistent interpretation of the rules that apply to investment flows, taking into account the interest of all stakeholders. We urgently need a clear, coherent and coordinated approach at multilateral level. Multiplying the number of BITs further muddies the water and moves us further away from the multilateral ideal. A better way forward may be to start consolidating and replacing BITs on the road to a comprehensive multilateral framework. We also need to take a hard look at investment dispute settlement mechanisms, transparently addressing stakeholders’ legitimate concerns.

Replace BITs with what? Regional Trade Agreements (RTAs) are already providing some closer policy linkages. Over 330 RTAs contain comprehensive investment chapters, reflecting more advanced thinking of how trade and FDI interact in the real economy. These agreements also cover ‘deep integration’ disciplines that are essential to investments, such as movement of capital, business persons, intellectual property rights, competition, state-owned enterprises, and anti-corruption. New generation RTAs are not perfect, but they are taking us several steps forward in addressing the services-trade-investment-technology nexus. Being regional, however, they are not applied uniformly at a global level, and create their own overlaps and incoherence. It would therefore be useful to create clearer rules for co-existence among RTAs and mega-regional blocs. Above all, it is important to foster information-sharing on emerging practices from these negotiations, so that good practices can be diffused more widely and uniformly, and provide a pathway for multilateral convergence. In this way, RTAs and mega-regionals can become the building blocks of an integrated and truly multilateral trade and investment regime.

We are at a critical juncture, both economically and politically. The global economy needs a helping hand for recovery from the global financial crisis and to give people the improvements they expect in their daily lives. At the same time, we have both an opportunity and obligation to upgrade the policy framework to meet the changing reality of how trade and investment are conducted across the world, to enhance policy coordination, and to ensure that both have a positive impact on people’s well-being. Mega-regional agreements like TTIP and TPP are on track to deliver new frameworks over the coming months. These can be stepping stones towards the future of global trade and investment rules. As these mega-regional deals approach the finish line, the 10th WTO Ministerial in Nairobi in December is an opportunity to break the current impasse in the Doha Round. Finally, all of this is taking place as we enter a new “Post-2015” era with the new SDGs, where trade and investment are expected to do more of the heavy-lifting in global development.

Against this backdrop, the G20-OECD Global Forum on International Investment (GFII), being held on 5 October 2015 in Istanbul, back-to-back with the meeting of G20 Trade Ministers, will bring together the trade and investment policy communities—along with the business community–to reflect on the main axes of a pragmatic strategy to enhance the international regime for investment, including through closer links with trade. The agenda cannot be delayed: trade and investment decisions must go hand-in-hand in policy, just as they do in global business.

Useful links

G20-OECD Global Forum on International Investment

OECD work on International Investment Law

OECD work on Regional Trade Agreements

OECD work on Global Value Chains

OECD work on Trade Facilitation