In December 2015, the China-Australia Free Trade Agreement (ChAFTA) entered into force. Although the agreement was hailed as ground-breaking for both nations, it was missing a generous investor-state dispute settlement (ISDS) provision. Under ChAFTA, an investor may only bring an arbitration claim under Article 9.12 if there has been a breach of Article 9.3 (national treatment). This claim can also be brought only after consultations have taken place under Article 9.11. Article 9.3 provides for the national treatment of investors. Investors should not be treated less favourably than nationals of the host state in circumstances such as the operation and sale of their assets. This blog aims to briefly examine whether this narrow ISDS clause will impact foreign direct investment (FDI) inflows.
Taking a step back
Australia’s attitude towards ISDS since the early 2000s has been wavering, with a slight leaning towards anti-ISDS sentiment. The Philip Morris plain packaging claim became a catalyst for a more definitive anti-ISDS stance. Australia now maintains a case-by-case consideration with no predictable standard applying to its treaties and agreements.
Although Australia’s legal system is known for being rational, fair and predictable, the same cannot be said for China, due to the strong link between the ruling party and the legal system. Thus, Chinese businesses will not be discouraged by the narrow ISDS clause in conducting trade within Australian territory because the strong and well respected Australian legal system can be relied on. The same may not be the case for Australian businesses. In bringing a claim concerning an adverse government policy, the chances of success, much less fairness, in a party controlled court system is quite slim. It should be noted that the Australia-China bilateral investment treaty (BIT) 1988, which falls into the first generation of BITs signed by China, also provides a limited scope for ISDS. Only disputes regarding the compensation from expropriation is allowed to be referred to arbitration. Otherwise, Australian investors are at the mercy of Chinese courts.
While Australia’s stance with regards to ISDS may be understandable, China, as a strong capital exporting economy, has become a proponent of ISDS since the late 1990s. China is second only to Germany in the number of BITs concluded worldwide, and Chinese investors have been taking advantage of this vast network of treaties. Two successful claims have so far been brought by Chinese investors under the China-Peru BIT and China-Belgium BIT.
Is there an FDI risk?
Large corporations can afford to take out political risk insurance, have a one on one negotiation with sovereign governments, and treaty plan in order to come under more favourable free trade agreements (FTAs) and BITs. Along these lines, it can be said that the narrow ISDS provisions in CHAFTA will have no significant impact on FDI, due at least to the alternative ways in which larger businesses can protect themselves from any adverse governmental policy. Nevertheless, a closer look is warranted.
A correlation has been shown between countries signing BITs and FDI inflows. As investor protection is at the crux of BITs, it can be deduced that ISDS provisions also have an impact on FDI. Developing countries especially have signed BITs in order to make themselves more attractive to investors and accordingly draw in FDI. Studies have shown that signing a new BIT, especially one which favours the mining and exploration industry, can increase overall FDI by as much as 4% of the total inflow.
However, a point is eventually reached where there is no overall FDI effect of signing a new BIT. At this point, there may be visible benefits in the form of jobs, for example, to a particular sector, but the overall impact will be negligible. Moreover, studies have also shown that for these developing countries to benefit, other coefficients, such as political stability and the state of the economy, must be taken into account. Furthermore, the more developed an economy and its institutions, the less the need to sign BITs in order to attract FDI. Thus, as mentioned earlier, Australia, with its sophisticated and developed institutions, does not need broad and generous ISDS provisions in its BITs or FTAs to attract investment.
On the other hand, there is also the argument that there is no intrinsic difference for Australian investors whether or not ChAFTA has a wider ISDS clause. There are two main reasons why there have been only two known investment arbitration claims against China. One is fear. Foreign investors do not want to risk their current and future investments, or gamble against facing spuriously devised charges by the state. Secondly, China has virtually unlimited resources to participate in protracted arbitration proceedings due to its vast wealth. It is therefore a potentially difficult respondent state.
Taking into consideration Article 9.12 of ChAFTA, which, as stated above, stipulates that claims can only be submitted to arbitration if there has been a breach of Article 9.3 by the respondent state, Australian businesses are likely to be the overall losers with this provision. Article 9.3 is imbalanced. It favours Chinese investors. Under Article 9.3, national treatment for Chinese investors and covered investments in Australia applies to the establishment, acquisition, expansion, management, conduct, operation and sale or other disposition of assets. On the other hand, coverage for Australian investors and covered investments only apply to the expansion, management, conduct, operation and sale of assets in China. Not to be left out is the fact that national treatment in China equates to being treated the same as private Chinese firms, and not necessarily state-owned companies (SOEs). SOEs hold a very dominant position in China; they are not subject to market forces and enjoy a high level of protection by the government.
Despite all of this, China trails only slightly behind India in being the highest recipient of FDI projects in the Middle-East and Asia. It seems that the availability of ISDS clauses in any agreement may not be the be all and end all for FDI inflows into a country.