By Luke Nottage

International investment treaties and investor-state dispute settlement (ISDS) are in the news again, notably in Australia and India, which are negotiating a bilateral Free Trade Agreement (FTA) as well as the Regional Comprehensive Economic Partnership (RCEP or “ASEAN+6” FTA).  A new compromise between the interests of foreign investors and host states may emerge in the broader Asian region, including a shift in the drafting of the standards of protection in treaties from broad protections akin to those previously found in US treaties towards more specific contemporary EU-style standards. However, the inconclusive outcome from Australia’s general election held on 2 July 2016 may hinder the occurrence of this possible shift.

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During the June run-up to the election, one reporter for The Guardian has recently described ISDS as allowing “foreign corporations to sue the Australian government in an international tribunal if they think the government has introduced or changed laws that significantly hurt their interests”. In fact, this is inaccurate. Investment treaties never contain such a broad substantive commitment on the part of the host state. Instead, investors need to establish violations of specific measures of protection, such as the prohibitions against discrimination, denial of justice or other egregious lack of fair and equitable treatment, or expropriation without adequate compensation.

Further, only a small proportion of ISDS claims challenge legislation – the vast majority of claims instead contest executive (in)action, such as not issuing or renewing a licence – and investors usually don’t succeed. For example, last year the arbitral tribunal ruled against Philip Morris Asia on jurisdictional grounds, its challenge to Australia’s tobacco plain packaging laws under an old Bilateral Investment Treaty (BIT) with Hong Kong. In the recently released award, the Tribunal found an ‘abuse of rights’ in obtaining trade mark rights in Australia when it was reasonably foreseeable (and even in fact foreseen) by the company that the legislation would be enacted and therefore a dispute would arise.

Investment treaties almost invariably commit to inter-state arbitration. It’s just that host states have wanted to more credibly commit to living up to their substantive commitments by allowing the option also of a direct claim by foreign investors through ISDS if their home state didn’t feel like pursuing the inter-state arbitration claim. State-to-state arbitration has proven much less popular in practice due to cost or diplomatic reasons, which is probably why Australia has declined to join New Zealand in its World Trade Organization claim against Indonesia for discriminatory treatment of imported beef and other agricultural products.

Yet why was the Australian reporter concerned about ISDS? First, because the government had confirmed that it had commenced with Japan a review of their Free Trade Agreement (FTA) concluded in 2014. That had omitted ISDS, for reasons I’ve suggested elsewhere, but added a provision for such consultations “with a view to establishing an equivalent mechanism”, within 3 months of another treaty containing ISDS being concluded by Australia and coming into force. The process has been triggered by the China-Australia FTA coming in force from 20 December 2015, although its ISDS-backed protections in fact were very narrow (and superimposed on an early BIT, with an agreement for a 3-year Work Program to consider consolidating the two treaties). But I’d pointed that out on my commentary last year on the China FTA, so this is old news.

More interesting is what might now happen, as Japan and Australia should try to complete their FTA review “with the aim of concluding it within six months”. They will probably just agree to wait and see whether the Trans-Pacific Partnership (TPP) Agreement signed on 4 February 2016, with ten other economies and containing ISDS, is ratified and comes into effect over the ensuing two years. Both countries may also obtain ISDS through RCEP, although those negotiations have been delayed.

That leads to the second and more significant reason for the renewed interest in ISDS. Australia’s main Labor Party opposition’s trade spokesperson announced on 7 June that, if elected, a Shorten Government “would not accept … ISDS provisions in new trade agreements”, like the Gillard Government over 2011-2013. It is unclear whether this includes the TPP, as it may not be considered “new”.

In addition, a Shorten Labor Government would “develop a negotiating plan to remove ISDS provisions” in all of Australia’s existing FTAs and BITs. If impossible (as seems very likely with the recent FTAs), it would “seek to update the provisions with modern safeguards”. The rationale is that: “Some of these provisions were drafted many years ago and do not contain the safeguards, carve-outs and tighter definitions of more contemporary ISDS provisions”.

Although the spokesperson’s statement focuses on the ISDS procedure, the policy shift might extend to attempting to dial back the substantive commitments made to investors in earlier treaties. This should be the government’s primary focus in my view, as it should surely remain necessary to preserve an inter-state arbitration enforcement mechanism. Indeed, I recommended such a review of old treaties in by the Greens, which ended up being opposed also by Labor parliamentarians for unduly constraining the executive’s prerogative to negotiate treaties. But I also envisaged improving (without abandoning) the ISDS provisions. This is especially important for BITs signed between 1988 and 2005 by Australia, which followed the more pro-investor template common worldwide from that era.

The question is then what new types of provisions should be proposed in any potential renegotiations. One obvious candidate is the language in the FTAs signed by Australia’s Coalition Government since 2014  (with Korea, as well as Japan, China, and the TPP member states). Perhaps the substantive provisions as drafted in these FTAs will be palatable even to the Labor Party, as they are broadly similar to those in FTAs signed since 2003 – including several by the first Rudd Labor Government. Yet it cannot include the safeguards built into those FTAs also around ISDS itself (such as enhanced transparency for the procedure), because Labor will not countenance any ISDS in future treaties. This is unfortunate because Australia’s FTA investment chapters are heavily influenced by US treaty drafting, which itself was already significantly rebalanced in favour of host states from the early 2000s.

An alternative candidate is the model now proposed by the European Union, after extensive public consultations, especially for its ongoing Transatlantic Trade and Investment Partnership negotiation with the US, but already reflected in FTAs with Canada and Vietnam. Substantive commitments by host states are even more constrained (except perhaps for the National Treatment obligation, where the TPP drafting clearly limits liability to intentional discrimination).

Most interestingly, the EU model substitutes a permanent investment court (including appellate review for serious errors of law) for the usual ISDS mechanism involving the appointment of ad hoc arbitrators. This aims to address concerns about lack of transparency or consistency, while allowing investors to pursue direct claims against host states. Perhaps even the Labor Party might consider this model not to include “ISDS” in its pathological form, and therefore propose such a court in Australia’s future treaties as well as older treaties subject to review.

Many in Australia familiar with the trajectory and details of international investment law, including myself, would probably be comfortable with the latter alternative. More importantly, it seems to be the more plausible way forward in Australia’s ongoing FTA negotiations with India, bilaterally as well as via RCEP. After all, the other breaking news is that India has already written to counterparties to 47 BITs (perhaps including Australia) notifying them that treaties will be allowed to lapse so that a new text can be negotiated. The starting point will be India’s Model BIT revised this year, which will also be proposed in pending FTA negotiations.

India’s model has even more restrictive substantive commitments than the recent EU drafts, let alone those based on the US template as reflected in the TPP. It also includes ISDS, but subject to extremely strict conditions including “exhaustion of local remedies” – where the investor must first seek relief through local courts. India’s new Model is toned back from back last year’s draft, but still represents a reaction to a successful ISDS claim brought by an Australian investor. Tellingly, that was for interminable delays in enforcing a commercial arbitration award against an Indian State-owned enterprise, and it has been followed by several more ISDS claims by investors under other BITs.

Treaty counterparties being approached by India are unlikely to accept such an extreme model, but the EU model may well be an acceptable way forward. This may also be the case for Indonesia, which is negotiating FTAs with Australia (and indeed the EU) bilaterally, as well as through RCEP. After facing few treaty-based ISDS claims (including one claim brought by an Australian investor), Indonesia has also been letting old BITs lapse to negotiate new treaties based on its own revised Model BIT, although that remains undecided or at least undisclosed. But other Asian economies like Korea and Thailand are comfortable with ISDS-backed investment treaties, despite having been subject to their first claims, so may be attracted to an EU-style compromise for RCEP and other future negotiations. Australia now has an opportunity to help lead the way, and perhaps even restore a more bipartisan approach to foreign investment policy generally, at least after the dust settles from the (closely contested) general election on 2 July.

However, the implications of that election remain unclear. The Turnbull Coalition Government retained a razor-thin majority in the lower House of Representatives, but its minority in the upper-house Senate diminished further (30 out of 76 Senators). The Labor Party may be emboldened by such a result, and therefore refuse to vote with the government on FTAs such as TPP or eventually RCEP containing ISDS or even an EU-style investment court procedure. The Greens (with 9 Senators) will certainly refuse. The Turnbull Government would then need to find 9 more votes from among the (11) cross-bench Senators, but Pauline Hanson’s ‘One Nation’ (4) Senators are notoriously xenophobic and the Nick Xenophon Team (3) Senators favour more support for local manufacturing. This difficult political landscape will make it even more likely that the Turnbull Government will now wait to see if and when the US ratifies the TPP.

In addition, “Brexit” will impede the pace of existing and future negotiations of the EU’s negotiations with Asian countries and Australia, as they must consider parallel negotiations with the UK. The models for investment chapters advanced by the EU and the UK may even now diverge. The potential for a shift from US-style to EU-style investment treaty drafting in the Asian region is therefore now even more uncertain.

[A shorter version of this posting was published on 1 July 2016 on the East Asia Forum blog.]

Towards a European model for investor–state disputes?

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