ISDS

Reprint: ISDS: A Little Bit of Knowledge is a Dangerous Thing

This is a reprint of a 2015 Talking Trade post on the Investor-State Dispute Settlement System (ISDS) provisions that are included in the Trans-Pacific Partnership (TPP) and in nearly 3000 existing trade agreements.  It explains why ISDS has been included in the TPP, what it is intended to do and what it does do.

TPP First Impressions: Investment

Hanoi--Chapter 9 of the Trans-Pacific Partnership (TPP) addresses a critical issue for many firms:  the rules of the game that apply to foreign investors in TPP countries.  Currently, TPP investors can face a complicated thicket of regulations, shifting rules, and informal practices that make it difficult or even impossible to open and maintain businesses and investments in some TPP member countries. 

This chapter aims to simplify and clarify the rules for inward investment by TPP firms.  Doing so should make it easier for firms to operate across TPP countries and help unleash new growth for member countries.  It may ultimately be the most important chapter for a member like Vietnam.

While most of the attention has been given to one aspect of this chapter, Investor-State Dispute Settlement (ISDS), let me begin by highlighting the rest of the rules in the chapter before turning to ISDS specifically.  As in many TPP chapters, the legal language can be dense and should be used with guidance from a good legal team that has experience decoding other trade agreement provisions.

When TPP parties speak of investments that are covered, they have a broad range of activities in mind, including: an enterprise; shares, stock and other forms of equity participation in an enterprise; bonds, debentures, other debt instruments and loans;  futures, options and other derivatives; turnkey, construction, management, production, concession, revenue-sharing and other similar contracts; intellectual property rights; licences, authorisations, permits and similar rights conferred pursuant to the Party’s law; and other tangible or intangible, movable or immovable property, and related property rights, such as leases, mortgages liens and pledges.

The basic point of the chapter is to ensure that investors are granted greater certainty with fewer risks of government action that could negate or destroy their investments. 

Investors are also promised free transfers of things like profits, dividends, proceeds, and payments from the investment in and out of the member country.  Investors are also granted the ability to invest without being subject to certain performance requirements, such as a possible demand that investors export a certain amount, or include a certain percentage of local content, or transfer technology as a condition for investment permission. 

The rules create opportunities for firms, but are not a guarantee of success.  Nothing in the chapter promises profits or will compensate investors for normal business risks and losses. 

What is spelled out in detail, however, are the rules regarding what happens when a TPP member government directly or indirectly seizes property through expropriation (nationalization). Government can, it should be emphasized, continue to make policy in the public interest and render decisions that could invalidate investments.  For instance, a government can legitimately order the demolition of shops if these stand in the way of land needed for new roadways.  However, the TPP makes clear that the government must follow certain policy steps prior to expropriation and provide adequate compensation.   

In most of the rest of the TPP agreement, member states are legally bound to follow the rules.  If they do not, other member governments can challenge their behavior, using the provisions in the dispute settlement chapter. 

Investors also have recourse to another mechanism for ensuring compliance.  Section B of the chapter spells out in detail the rules around ISDS that allows investors to directly sue a government for breach of the agreement (illegal seizure of property).  The lengthy passages devoted to ISDS spell out in detail how investors can claim arbitration to resolve the dispute.

Investors, like all business owners, also have the right to use domestic court procedures to resolve issues.  However, if the government seizes property, it is not unreasonable to assume that some court systems in some countries might not view the matters of the case dispassionately or may hesitate before deciding against their own government.  In these situations, investors have the ability under the TPP to have the matter dealt with by arbitration. 

The concerns about ISDS generally involve a few points.  First, it means that domestic government decisions could be overturned by a foreign entity.  TPP officials were keenly aware of this possibility and have tried to ensure that governments maintain their right to regulate and make laws in the public interest while balancing the needs of investors.  Early versions of ISDS, as found in many of the nearly 3000 bilateral investment treaties (BITs) and free trade agreements (FTAs), had much less precise rules around the use of ISDS.

Second, firms could use ISDS to sue governments with great regularity.  In practice, this has not happened.  Companies do not launch complaints very often.  I would argue that ISDS is a bit like a “nuclear option.”  This is an approach that can only be used when all other approaches have been tried and found lacking, because a company that complains about a foreign government is not likely to find a hospitable environment for doing business in the country in the future. 

Third, ISDS can be used for any type of breach.  This is not correct for the TPP, which takes great care to detail the conditions that warrant the use of ISDS.  Annex 9B spells out in detail exactly what constitutes an expropriation for the TPP. 

Just like the services commitments discussed in yesterday's post, understanding TPP investment provisions requires carefully reading the specific text with the rules that apply to all 12 parties and then sorting through the annexes.  Note that Chapter 9 contains several short annexes in the text—several of which are country specific or applicable to, for instance, Peru, Mexico or Canada.

Investors or potential investors will also need to carefully review the country-specific annexes that list all non-conforming measures (NCMs).  Just like the services negotiations, investment commitments were made on the basis of a negative list.  If your sector or industry is NOT listed, it means you have access.

The list of NCMs for investment also contains a range of prohibited investments or restrictions on full access for TPP members.  Some of these restrictions may be problematic as the exemption can be deep and broad while others are likely to be of limited commercial significance. 

Canada, for instance, maintains the right to regulate the sales and marketing for air transportation services, as well as many rules around maritime services and transport, and maintains a possible cultural exception that allows the government to create rules or subsidize books, videos, music and other forms of cultural expression.  Malaysia reserved the right to review materials for consistency with domestic decency standards.

Japan has an odd commitment that allows it to create any measure it wants for “telegraph services, betting and gambling services, manufacture of tobacco products, manufacture of Bank of Japan notes, minting and sale of coinage, and postal services in Japan.”  Vietnam bundled together potential restrictions on the manufacturing of paper and buses with more than 29 seats.  The complicated nature of these commitments—combining things that may not appear logically connected—highlights the importance of reviewing the entire TPP document for hidden barriers.

Malaysia has scheduled a broad exception for Bumiputera policies.  These are the programmes that provide advantages for Malay citizens, somewhat akin to affirmative action programmes used elsewhere.  While considerably less sweeping, several other TPP members also lodged NCMs to protect native peoples.

How much these measures will affect your potential investment depends on whether you had hoped to manufacture buses with more than 29 seats or planned to operate a taxi or create movies you wanted to show in some local theaters.  For most investors, however, the TPP will grant significant new access to investment markets.  Equally important, the investment chapter and its provisions help ensure that the rules that allow such foreign investment will not shift overnight in the future.  For most investors, greater certainty and less risk are always helpful.

***Talking Trade is a blog post written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***

ISDS: A Little Bit of Knowledge is a Dangerous Thing

I was preparing to write a different blog post when I came across a news article that got me so fired up that I have switched topics for today.  

There is an article in The Guardian that quotes Michael Moore, of the Public Health Association, at length.  He argues that a provision in the upcoming Trans-Pacific Partnership (TPP) negotiations will wreck the Australian government’s ability to protect public health.

This provision, known as Investor-State Dispute Settlement (ISDS), has gotten an astonishing amount of airtime lately.  Nearly all of the commentary around what ISDS does and what it does not do is, frankly, wrong.

So, let’s see if we can straighten out the record somewhat, using the misguided statements attributed to Mr. Moore, written by Gabrielle Chan, as our guideposts.

First, the article suggests that Australia’s efforts to change labeling laws to include clear provisions on country-of-origin could be undermined by the TPP.  The Australian government wants to change the way it labels produce to help eliminate problems like a recent hepatitis A outbreak related to imported frozen berries.  (We will skip over, for now, the issue of whether such labeling would, in fact, reduce the risks of hepatitis or the fact that better product testing might be a more sensible response to such a risk.)

The Australian government, like every government, has always had the right to regulate in the interest of public health, as well as animal and plant health.  This right is enshrined in the multilateral trading system under the World Trade Organization (WTO) and has been carried through in every single preferential trade agreement since then.  There is nothing in the TPP or any other trade agreement that will fundamentally undermine the government’s sovereign right to ensure the safety of its citizens.

No government would ever agree to an agreement that would abrogate this right either.  Thus, the argument that somehow the TPP has forced governments like Australia to take decisions that violate their own rights to regulate simply does not make any sense.  Government officials are just not that stupid.

Second, the TPP’s investor state dispute settlement (ISDS) clause does not give companies the right to sue governments over being given an “unfair advantage” as Mr. Moore claims.  The ISDS provisions of this agreement run to over 60 pages and spell out, as specifically as possible, exactly what constitutes an example of government expropriation of rights under which a foreign investor could consider launching an ISDS suit.

The basic issue that ISDS is trying to address is the following.  Governments sometimes seize property (expropriate) for the public interest.  The clearest example is when the government decides to build a road through your shop.  In many countries, the rules that govern what happens in this situation are murky.  Investors may suddenly find their property seized without warning or without receiving fair compensation for their loss of the shop.

ISDS is designed to make the provisions around expropriation much more clear.  A good clause explains in detail what sort of conditions must be in place when a government decides to act.  Note that ISDS does not prevent the government from acting—if the road must be built through my shop, the government has the right to do so.  Instead, the rules spell out how I am to be notified about this decision, how I will be compensated, and what I can do if I want to appeal what I think is an arbitrary decision or an unfair amount of compensation.

The reason why I, as a foreign investor, might want to use an outside arbitrator to resolve my potential dispute with the government is that I am not always confident that the court system in the other country will rule fairly on my dispute.  Remember that the issue here is whether or not the government has followed the proper procedures.  Not every judge in every country will be willing to find against its own government.

But what I cannot do as an investor is simply claim that I am losing revenue somehow because other products get an “unfair advantage.”  ISDS does not say anything about making or losing money. 

Globally, there are more than 3,000 different bilateral investment treaties (BITS) as well as hundreds of free trade agreements.  Of these, more than 90 percent contain ISDS provisions.  The total number of disputes using ISDS is amazingly small, particularly given the volume of foreign investment covered by this welter of treaties.

What makes this relatively small number of disputes even more impressive is that the earlier versions of ISDS were much broader than later versions.  In other words, the earlier ISDS rules were quite expansive, allowing investors to use the arbitration system relatively easily.  Yet, most businesses do not resort to an outside system but continue to use the domestic court procedures to resolve disputes. 

In part this stems from a lack of certainty about how any given arbitration case will be resolved which adds an element of risk to a decision to sue.  Plus, most investors would prefer to remain in their host country and recognize the chilling effect that suing the government tends to have on their business operations.  Hence, few investors are likely to sue, even if their case would likely be ruled in their favor. 

The case that has made ISDS internationally famous actually highlights the changes underway in newer ISDS provisions.  Philip Morris sued the Australian government using a BIT between Hong Kong and Australia.  The specific issue was Australia’s new regulations on packaging for cigarettes.  Under the rules, it was not just that the cigarette manufacturers had to put graphic photos of damage done to smokers and others or carry large-size warnings about the dangers of smoking.  Instead, the government required every carton, packet and even every cigarette, to look exactly identical to one another.  Manufacturers were required to use exactly the same courier font, same colors, and same information on every single product. 

As a result, it is not possible to tell one manufacturers product apart from another.  For Philip Morris, this represented more than just a change in labeling.  The company argued it would invalidate the intellectual property (IP) contained in their products—particularly the value of their brands and trademarks since consumers could no longer see at a glance which cigarette was which.

We can argue about whether the result is appropriate or not.  The bottom line is that the BIT used by Philip Morris gave investors the right to sue over expropriation of intellectual property rights, as well as other kinds of rights. 

Recent trade agreements have not been so expansive.  Instead, deals like the TPP have much more narrowly defined the scope of potential lawsuits and many have explicitly set aside IP.  This is the main reason why ISDS provisions have grown in length over time, as governments have tried to strike a more appropriate balance between their right to regulate and the right of investors to ensure that their investments are not unfairly seized.

Elizabeth Warren, an American senator, wrote an op-ed this week in the Washington Post that was also problematic.  She argued that there is no point in including an ISDS provision in the TPP because the domestic court structure in countries like the United States, Japan and Australia can be used to resolve these sorts of disputes fairly. 

There are two reasons to continue to push for ISDS in the TPP that Warren overlooks.  First, although it might be true that the American or New Zealand court systems can handle investor disputes, not every TPP member is equally capable.  The current TPP membership includes 12 countries at diverse levels of development and government capacity.  For example, Mexico is rated 79 out of 99 by the World Justice Project Rule of Law ranking project.  Vietnam is 65 on the same scale and Peru is 62.  

Second, the TPP is also intended to expand further.  Even if all current members are able to handle investment disputes, future members might be less able to do so.  Adding in ISDS at a later date will likely be impossible.

Finally, once governments start to cut out ISDS from some agreements, it might be more difficult to include the provisions in other deals.  Thus, if the United States (in particular) wants to include ISDS in a future trade or bilateral investment treaties (like the one currently under negotiation with China), it could be very problematic to have carved out the ISDS provision in the TPP.