Regulatory Challenges Arising from Sovereign Wealth Funds and National Security: Exacerbate Great Power Competition between China and the United States?

Charles Ho Wang Mak* and I-Ju Chen**

China is now a major player in some of the United States’ (US) most important sectors. China’s impact can be found through the acquisition by some of its most influential companies, which are later acquired by the sovereign wealth funds (SWFs) of China. US’ companies, for example, Apple and IBM, and their distributors, are indirectly controlled by China. This dynamic and tension of the two great economic power may play a significant role in the US-China trade war. Moreover, concerns about regulations of the SWFs and national security have never ceased in the US. While the US presidential election is in fall 2020, the foreign relationship between China and the US is an essential agenda in both Trump and Biden’s campaigns. This post examines regulatory challenges arising from the SWFs and national security under this new era of great power competition between China and the US.

National security is closely associated with the concept of state capitalism. This is because the states’ governments mostly control the enterprises that existed in states that adopted state capitalism. Therefore, investors (with political agendas) may invest in some state enterprises, which might affect national security. National security will be negatively affected by the SWFs made by state-owned enterprises. Inward SWFs might affect individual strategic firms (investing in infrastructure) and different sectors in the host countries. This is because those state-owned enterprises, which invest in those host countries by SWFs, can access sensitive information and technology of those strategic firms and then misuse that information. States investors seek to get improved access to sensitive technologies of other countries through investment. Therefore, to safeguard national interests, policies and strong regulations are necessary.

The Santiago Principle could be a reference for governments to govern international investment. Establishment of the Santiago Principle aims to depoliticise foreign investment flows and to structure and implement transparent and sound governance.[1] The Santiago Principle covers the following areas: legal framework and coordination with macroeconomic policies; institutional framework and governance structure; and investment and risk management framework.[2] Hence, the Santiago Principle is one of the most important features in reframing international perceptions of SWFs.

The balance between the protection of national security and open investment policy of SWFs is complex. In addition, SWFs raise ‘potentially controversial questions for international financial regulation and governance’.[3] China’s SWFs, such as the China Investment Corporation (CIC), have sought more access to markets in the US after Chinese deals are under more and stricter scrutiny. Chinese firms have criticized the US’ investment regulations imposing unfair restrictions on funding coming from China. Moreover, in a high-profile talk with the US government in 2015, Xi Jinping raised the issue of SWFs and relevant regulations in the US. Xi addressed that the US government should relax regulations of foreign investment in high-tech sectors.[4]

However, the investment flow of China into the US has prompted US’ concerns about the government of the People Republic of China’s influence. This is because, from the perspective of the US government, there is a potential risk of national security of SWFs. Although it is clear that the national interest ensures long-term capital availability – because much of it must come from SWFs now – several US pressure groups still urge restricting foreign investors’ choices lest they ‘steal’ technology, trade secrets or jobs.[5] On this controversial point, Bu’s research, however, indicated that China has no intention of investing in sensitive sectors pursuing the controlling stake because it has steered away from deals that would trigger any political backlash.[6]

The US has a series of critical legal regimes applicable to SWFs. The US adopted a protectionist approach towards the SWFs inward investments. Since 2000, the companies in the US that were invested by SWFs became a major issue. In the US the principal regulations that burdened SWFs are the Securities Exchange Act 1934, Foreign Investment and National Security Act (FINSA) 2007, Foreign Corrupt Practices Act of 1977 and Defense Production Act of 1950. FINSA codifies the contemporary views of the Committee of Foreign Investment in the United States (CFIUS). FINSA has dramatically strengthened the regulations introduced by CFIUS, those about inward investment, particularly for state-owned entitled such as SWFs. For instance, critical infrastructure needs to be protected against those SWFs that are invested with a political purpose, since those critical infrastructures will give rise an issue of national security. However, with respect to the unpredictability for the transaction parties, an issue arises as to whether the FINSA can strike a balance between the economic benefits of foreign investment and national security concerns about technology and critical infrastructure.[7] Nonetheless, Chinese scholar, Feng, comments that FINSA is unnecessary and even likely to be detrimental to the US capital markets and the overall economy.[8]

Furthermore, the case of Cede & Co. v. Technicolor, Inc. showed that directors and managers owe the duty of loyalty to both the company and shareholders by providing protections from SWFs’ geopolitical agendas. [9] The US government has treated inward investment by SWFs as an issue of national security. Therefore, Congress has greatly strengthened the regulations on equity investment, especially of state-owned bodies. Also, regarding the definition of strategy towards the notion of national security between the US and China, the US is the most protectionist jurisdiction. Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which predecessor (Trans-Pacific Partnership Agreement, TPP) was led by the US, pertains to regulations of SWFs. Definitions for SWFs are at the start of Chapter 17 of CPTPP.[10] In addition, SWFs must be member(s) of the International Forum of Sovereign Wealth Funds or endorse the Santiago Principles, or such other principles and practices as may be agreed to by the parties of the CPTPP.[11]

The US might adopt the European Union (EU) model in the future. To regulate foreign direct investment (FDI) into the EU within the context of SWFs, the EU and its Member States rely on the treaties and EU legislation. The free trade theory – the free movement of capital within the European Common Market is the most fundamental feature of the EU approach to regulating the SWFs. However, this fundamental freedom is restricted in a limited number of cases. This is because the Treaty on the Functioning of the European Union (TFEU) awarded the EU with the competence to adopt different measures to regulate the establishment of foreign investors within the EU. There are two ways to regulate the movement of capital. According to Article 64 of the TFEU, firstly, the EU can impose measures on the movement of capital from third countries involving direct investment, by a qualified majority; secondly, direct investments can be restricted by measures that are introduced by the EU.[12] Since the TFEU explicitly covers the relationship between the Member States and the so-called third party countries, it seems that the EU laws are favourable to the foreign investors in terms of their important rights vis-à-vis their investments in the EU. However, the principle of free movement of capital is subject to two limitations. The limitations are derogations and safeguard clauses respectively. The scope of the limitations determines the extent to which the governments could restrict FDI within their territories. The narrower these limitations are, the easier it is for SWFs to enter the EU market. On the other hand, if the limitations are broader, governments can impose more restrictions to limit access to the Common Market.

In terms of the securitisation of national security, Article 65 of the TFEU is the most important provision as it describes the power retained by the Member States to restrict the concept of free movement of capital within the European Common Market in the name of protection of public order or public security. It also sets out potential obstacles to SWFs that invest in the EU. O’Donnell acknowledged that there are several Member States in the EU which had adopted various measures to restrict investments of SWFs in the defence sector.[13] In Sanz de Lera and Others, the Court of Justice of the European Union (CJEU) produced mixed results for the development of the EU law on capital movements.[14] In this case, CJEU clarified the unconditional nature of Article 65 TFEU, that the principle of free movement of capital prohibits those obstacles between the Member States, and between third countries and the Member States. Until mid-2015, Article 65 had never been applied by any of the Member States to regulate SWFs. In October 2020, an EU regulation establishing a framework for the screening of FDI into the Union has entered into force.[15] This new EU regulation aims to better scrutinise direct investments coming from third countries on the grounds of security or public order. It enhances the European Commission’s existing powers to review foreign investments under the existing merger control rules and sector-specific legislations of the EU.

Currently, some commentators might argue that there are only a few rules that can be applied to regulate SWFs within the EU. Nonetheless, in no small extent, it seems that the legal framework of the EU has provided a comprehensive regime to tackle the phenomenon that the US can take as a reference. For instance, the US can take the new free trade agreement between the EU and, Singapore and Vietnam, and the parallel EU-Vietnam Investment Protection Agreement as a reference, to incorporate SWF provision in the future free trade agreement with China.

To conclude, it is a well-established principle of international law that sovereign immunity does not extend to a state’s commercial activities in another jurisdiction. Thus, SWFs are subject to be assessed by investment host countries’ national laws. However, too excessive scrutiny of SWFs investment is likely to fuel nationalism, and will further hamper the free foreign capital flow. Hence, it has been suggested that the potential consequence of protectionism caused by strict examinations of SWFs should be avoided.[16] Nevertheless, it has been unclear whether the Trump administration would take a tougher stance on trade and investment with China. Since the trade war between China and the US has not ceased yet, the new president of the US would have to deal with the SWFs issue for a mutually beneficial future of the two countries.

*Charles Ho Wang Mak is a PhD Candidate in international law at the University of Glasgow. He studied law at the University of Sussex in England (LL.B. (Hons.)), The Chinese University of Hong Kong (LL.M. in International Economic Law), and the City University of Hong Kong (LL.M.Arb.D.R.(with Credit)).

**Dr I-Ju Chen is assistant lecturer at Birmingham City University in the UK. She holds PhD in law from the University of Birmingham and LLM from University College London. She studied law at National Chung Hsing University in Taiwan (LLB and LLM).

  1. International working group of sovereign wealth funds: Generally accepted principles and practices, “Santiago Principles” 3, 2008. https://www.ifswf.org/sites/default/files/santiagoprinciples_0_0.pdf
  2. Id. at 5.
  3. Benjamin J. Cohen, Sovereign Wealth Funds and National Security: The Great Tradeoff 85(4) International Affairs (2009) 713, 713.
  4. Sui-Lee Wee, China’s $800 Billion Sovereign Wealth Fund Seeks More U.S. Access, Nytimes.com (2020), https://www.nytimes.com/2017/07/11/business/china-investment-infrastructure.html (last visited Aug 30, 2020).
  5. Patrick DeSouza & W. Michael Reisman, Sovereign Wealth Funds and National Security, in SOVEREIGN INVESTMENT: CONCERNS AND POLICY REACTIONS 283, 290 (Karl P. Sauvant, Lisa E. Sachs, and Wouter P.F. Schmit Jongbloed ed., 2012).
  6. Qingxiu Bu, ‘China’s Sovereign Wealth Funds: Problem or Panacea?’ 11(5) The Journal of World Investment and Trade (2010) 849, 868.
  7. Id, at 870.
  8. Zhao Feng, How Should Sovereign Wealth Funds be Regulated?, 3(2) Brook. J. Corp. Fin. & Com. L. 483, 484 (2009).
  9. Cede & Co. v. Technicolor [1988] 542 A.2d 1182.
  10. See Article 17.1, CPTPP.
  11. Id.
  12. Treaty of Lisbon amending the Treaty on European Union and the Treaty establishing the European Community [2007] OJ C306, Article 64.
  13. O’Donnell C. M., ‘How should Europe respond to sovereign investors in its defence sector?’ (Centre For Euroopean Reform- Policy Brief, September, 2010), PAGE <http://www.cer.org.uk/sites/default/files/publications/attachments/pdf/2011/pb_swf_defence_sept10-203.pdf> accessed 21 June 2020.
  14. Sideek M Seyad, European Community Law on The Free Movement of Capital and EMU (Kluwer Law International 1999) 101-102.
  15. Regulation (EU) 2019/452 of the European Parliament and of the Council of 19 March 2019 establishing a framework for the screening of foreign direct investments into the Union, OJEU, L 79I , 21.3.2019, p. 1–14, https://eur-lex.europa.eu/eli/reg/2019/452/oj.
  16. Bu, supra note 6, 871.

Practical Implications of the New Legal Framework for Foreign Direct Investment in the European Union

By Dr. Philipp Stompfe, LL.M. (London)*

In March 2018, following an initiative of Germany, France and Italy, the Council of the European Union (“EU”) approved a Regulation on establishing a framework for screening of foreign direct investments (“FDI”) into the European Union (“Regulation”).

The new Regulation entered into force on 10 April 2019 and will apply from 11 October 2020.

The Regulation creates an enabling framework for Member States to screen foreign direct investments on grounds of security and public order. The Regulation does not require Member States to adopt a screening mechanism for foreign direct investment, nor does it exhaustively mandate the substantive or procedural features for screening mechanisms. It only sets out basic requirements that should be common to Member States’ screening mechanisms.

Furthermore, the Regulation creates a co-operation mechanism between Member States to share information about foreign direct investment planned or completed on the territory of one or several Member States. It also provides the possibility for other Member States and the Commission to comment on such investment, but leaves the final decision on the appropriate response to the Member States in which the investment is planned or completed.

Moreover, the Regulation introduces the possibility for the Commission to screen foreign direct investments which are likely to affect projects or programmes of Union interest on security and public order grounds.

At least according to official EU announcements, the new Regulation does not attempt to harmonize the existing investment screening mechanisms of the Member States or to introduce an EU-wide screening mechanism. However, there is no doubt that the Regulation will have a very practical impact on foreign direct investments into the EU, both in substance and procedure.

Background

The European Commission (“EC”) constantly emphasizes that the EU maintains an open investment environment and welcomes foreign investment.

In its recent Reflection Paper on “Harnessing Globalisation” issued on 10 May 2017, the EC confirmed that openness to foreign investment remains a key principle for the EU and a major source of growth, but at the same time it recognised that there have been some concerns about foreign investors, notably state-owned enterprises, taking over European companies with key technologies for strategic reasons, and that EU investors often do not enjoy the same rights to invest in the country from which the investment originates.

The list of controversial company takeovers and acquisitions of major European companies is getting longer and longer. Kuka, Aixtron or OSRAM light are just a few examples.

Against this backdrop, the growing political will to more actively screen, control, and ultimately even prevent foreign direct investments flowing into Europe does not come as a surprise.

In this regard, screening mechanisms on the national level are not a novel tool. Rather, almost half of the EU Member States maintain foreign investment control regimes, i.e. Austria, Denmark, Germany, Finland, France, Latvia, Lithuania, Italy, Poland, Portugal, Spain, and the United Kingdom.

In particular, the new EU Regulation is to be seen in the context of recent amendments to foreign investment review laws in Europe’s major economies, Germany and France.

On 19 December 2018, the German government passed amendments to the German Foreign Trade and Payments Act (“AWG”) and to the German Foreign Trade and Payment Ordinance (“AWV”).

In this regard, the German legislator has lowered the threshold for the screening of FDI to the acquisition of 10% of the voting rights of a German company being active in the military and encryption sector and of German companies which are operating in the field of critical infrastructure according to the Regulation for Identifying Critical Infrastructure.

At first, the French foreign investment review regime was limited to a small number of business activities, in particular to gambling, private security services, weapons, warfare equipment and cryptology. However, due to serious amendments to the French Monetary and Financial Code by Decree No. 2014-479 dated 14 May 2014 and Decree No. 2018-1057 dated 29 November 2018, the right of the French Ministry to review and restrict foreign investment has been substantially increased.

With solid and reasonable arguments it can be concluded that the Regulation as well as the relevant national laws seriously struggle to establish an appropriate balance between addressing legitimate concerns with regard to certain FDIs, in particular those originating from state-owned enterprises and sovereign wealth funds, and the need to maintain an open and positive regime for such investment into the EU.

The new EU investment screening regime

In general, the overriding objective of the Regulation is to provide a framework of substantial and procedural rules for the Member States, and the EC to screen and control FDI in the EU. The precondition for issuing any screening decisions are impairing grounds on “public order and security”.

The main features of the Regulation are the following:

Scope of application

One main characteristic of the Regulation is a broad definition of FDI.

The Regulation defines FDI as an investment of any kind by a foreign investor aiming to establish or to maintain lasting and direct links between the foreign investor and the entrepreneur to whom or the undertaking to which the capital is made available, in order to carry on an economic activity in a Member State, including investments which enable effective participation in the management or control of a company carrying out an economic activity.

In addition, “foreign investor” means a natural person of a third country or a legal entity (undertaking) of a third country, intending to make or having made a foreign direct investment.

It must be highlighted that any post-Brexit UK investors are going to be qualified as “foreign investors” within the meaning of the Regulation.

Relevant economic sectors

The Regulation introduces a wide scope of economic sectors that may be controlled and reviewed:

  • critical infrastructure, whether physical or virtual, including energy, transport, water, health, communications, media, data processing or storage, aerospace, defence, electoral or financial infrastructure, and sensitive facilities, as well as land and real estate crucial for the use of such infrastructure;
  • critical technologies and dual use items including artificial intelligence, robotics, semiconductors, cybersecurity, aerospace, defence, energy storage, quantum and nuclear technologies as well as nanotechnologies and biotechnologies;
  • supply of critical inputs, including energy or raw materials, as well as food security;
  • access to sensitive information, including personal data, or the ability to control such information; or
  • the freedom and pluralism of the media.

In that regard, it is also possible for Member States and the EC to take into account the context and circumstances of the FDI, in particular whether a foreign investor is controlled directly or indirectly by foreign governments, for example through significant funding, including subsidies, or is pursuing State-led outward projects or programmes.

No minimum threshold

It must explicitly be pointed out that the Regulation, contrary to national regulations such as in Germany and France, does not impose any minimum threshold for the screening of FDI, neither regarding the total amount nor pertaining to the corporate stake.

Minimum requirements

The Regulation establishes framework rules which Member States must adhere to that already maintain an FDI screening regime or wish to adopt one. These rules, inter alia, include the following:

  • Member States shall set out the circumstances triggering the screening, the grounds for screening and the applicable detailed procedural rules;
  • Member States shall apply timeframes under their screening mechanisms;
  • Confidential information, including commercially-sensitive information, made available to the Member State undertaking the screening shall be protected;
  • Foreign investors and the undertakings concerned shall have the possibility to seek recourse against screening decisions of the national authorities;
  • Member States which have a screening mechanism in place shall maintain, amend or adopt measures necessary to identify and prevent circumvention of the screening mechanisms and screening decisions.

Co-operation mechanism regarding FDI undergoing screening

The Regulation introduces a co-operation mechanism between Member States and the EC. In this context, Member States shall notify the EC and the other Member States of any foreign direct investment in their territory that is undergoing screening by providing the following information as soon as possible:

  • Whether the ownership structure of the foreign investor and of the undertaking in which the foreign direct investment is planned or has been completed;
  • the approximate value of the foreign direct investment;
  • Whether the products, services and business operations of the foreign investor and of the undertaking in which the FDI is planned or has been completed;
  • Whether the Member States in which the foreign investor and the undertaking in which the foreign direct investment is planned or has been completed conduct relevant business operations;
  • the funding of the investment and its source, on the basis of the best information available to the Member State;
  • the date when the foreign direct investment is planned to be completed or has been completed.

Based on the information received, Member States are entitled to make comments on FDI in another Member State, if that FDI is likely to affect its security or public order, or has information relevant for such screening.

Where the EC considers that a foreign direct investment undergoing screening is likely to affect security or public order in more than one Member State, or has relevant information in relation to that foreign direct investment, it may issue an opinion addressed to the Member State undertaking the screening. The EC may issue an opinion irrespective of whether other Member States have provided comments.

Generally, comments or opinions shall be addressed to the Member State undertaking the screening and shall be sent to it within a reasonable period of time, and in any case no later than 35 calendar days following receipt of the information stated above. It must be considered though, that this timeframe may be extended to an additional 20 days in cases in which additional information were requested.

In any event, the Member State undertaking the screening shall give due consideration to the comments of the other Member States and to the opinion of the EC. However, the final screening decision shall be taken by the Member State undertaking the screening.

Co-operation mechanism regarding FDI not undergoing screening

Where a Member State considers that an FDI planned or completed in another Member State which is not undergoing screening in that Member State is likely to affect its security or public order, or has relevant information in relation to that foreign direct investment, it may provide comments to that other Member State.

The same applies to the EC which is entitled to issue an opinion in cases where FDI is not undergoing screening in the relevant Member State.

The most controversial element in this regard, resulting in great legal uncertainty for planned and even completed FDI, is that making comments and issuing an opinion is allowed up to 15 months after the FDI has been “successfully” completed.

FDI likely to affect projects or programmes of Union interest

Where the EC considers that an FDI is likely to affect projects or programmes of Union interest on grounds of security or public order, the EC may issue an opinion addressed to the Member State where the foreign direct investment is planned or has been completed.

In this regard, projects or programmes of Union interest shall include those projects and programmes which involve a substantial amount or a significant share of Union funding, or which are covered by Union law regarding critical infrastructure, critical technologies or critical inputs which are essential for security or public order.

In particular, this includes the following projects or programmes: Galileo & EGNOS, Copernicus, Horizon 2020, TEN-T (Trans-European Networks for Transport) and TEN-E (Trana-European Networks for Energy).

Practical implications

The mechanisms on foreign investment screening have become an increasingly relevant issue in cross-border transactions that require in-depth legal risk assessment and management prior to concluding the transaction. As a direct consequence thereof, foreign investors are well-advised to seek comprehensive legal and legal policy advice prior to conducting any investment activities in the EU.

In particular, the new reguation will lead to the following:

  1. The lack of any minimum threshold grants the EC and other Member States wide authority to directly interfere in the screening process of FDI in a specific Member State.
  2. Due to the right to directly interfere in the FDI screening of a particular Member State it cannot be ruled out that major European economies are going to force smaller Member States to impede certain FDI, in particular in sensitive sectors.
  3. The Regulation in conjunction with the current amendments of relevant national laws in major European economies further enlarges legal policy protectionism towards FDI.
  4. The new Regulation establishes a dual-system of review and control of FDI on the European level. In addition to screening acquisition transactions under a merger control perspective pursuant to the EC Merger Regulation, the EC now has the competence to review transactions and issue opinions from an FDI perspective.
  5. The Regulation will have a serious impact on the timing of FDI screening. Due to the right of other affected Member States to provide comments and the right of the EC to issue an opinion, flanked by the obligation of the host state (the state where the investment is made) to properly consider those comments and opinions, national scrutiny procedures are likely to be delayed. Furthermore, as a direct consequence, the Regulation will decouple national scrutiny procedures from the short initial review phase pertaining merger control pursuant to Article 10 EC Merger Regulation.
  6. The statutory right of Member States and the EC to provide comments, and to issue an opinion, respectively, for up to 15 months after the relevant transaction has already been completed, creates great legal uncertainty. Especially taking into consideration that, e.g. in Germany and France, the transaction shall remain pending and ineffective until the final approval of the competent government authority. In consequence, this procedural element by itself may further tremendously delay the finalization of cross-border M&A transactions.
  7. The Regulation, inevitably, will raise further awareness of the sensitivities originating from FDI, which in turn may lead to an alignment of substantial and procedural rules of Member States that, until now, have a less comprehensive investment review regime.
  8. This is not the end – it is just the beginning: until today, the new Regulation only grants the EC a “coordinating role”. However, the EC, on a regular basis, in its own publications, emphasizes that other elements will be further assessed accompanying the Regulation. Therefore, considering the unstoppable regulatory craze in Brussels, it is to be expected that the competences of the EC, regarding the review and control of FDI, will be substantially enlarged in the near future.
  9. One major missing element: the Regulation does not contain any default provision for cases where Member States fail to duly consider the comments of other Member States or the opinion of the EC, or even completely fail to duly inform other Member States likely to be affected by the FDI in question.

*Dr. Philipp Stompfe, LL.M. (London) is attorney at law at Alexander & Partner (Berlin/Stuttgart/Paris/Vienna/Doha/Riyadh/Ras Al Khaimah/Cairo/Muscat). Within the team of Alexander & Partner, Dr. Philipp Stompfe is primarily involved in international litigation and arbitration. He is constantly acting as counsel in commercial and investment arbitrations before all of the major arbitral institutions mainly related to construction, energy, distribution, real estate and M&A disputes. He is specialized in international investment law and further advises on international contract and corporate law and on the structuring and implementation of cross-border investment projects, in particular in the Near and Middle East.

Profit vs. Sustainability: How to pursue a sustainable investment

 

Benedetta Cappiello*

 

It seems that nowadays the debate on fragmentation of international law is not yet ready to reach a prompt solution. On the contrary, every and each occasion, even at the jurisprudential level, seems a good one to offer some new reflections, in brief or at length, on the reason why international law results fragmented within itself and, in parallel, on the instruments suitable to solve that phenomenon.

True the above, we deem, on the contrary, that reference to fragmentation should be avoided, given that the so labeled phenomenon should instead be referred with other concepts such as that of expansion of international law. Today we are indeed witnessing the raise of many different sub-systems of law, almost one for each subject, which “ask” for it. This mean that next or below international law of general character there is a multitude of sub-systems, formed by norms of special character. As such, they reflect the blooming of new needs, deserving a normative qualification, in term of rights and obligations. From this, it derives the raise of conflicts among norms (and values empowered by them), of general and special character, or of norms coming from different sub-systems.

In this respect, our assumption is that sub-systems of law are not completely autonomous. Neither from each other, nor from that of general international law (in which, in case of failure, all fall back to). This interconnection seems to make useless any search for the prevalence of a norm over the other; contrarily, it renders strong the need to find a way to integrate and balance among provisions which, while pursuing opposite aim, result contemporarily binding and applicable to a given situation.

This scenario seems to be well mirrored by the on-going struggle involving norms coming from two sub-systems of law apparently pursuing conflicting interest.

Namely, reference is made to international (and European) investment law and the group of norms empowering the principle of sustainable development (that concept appeared for the very first time in 1967, to later becoming a principle of international law endorsed in binding, or non-binding, normative provisions).

At first sight, the two groups of norms protect opposite interests: investment law has, indeed, been framed in order to guarantee investors’ (economic) rights, thus allowing them to pursue their activity in the most profitable way. The second group of norms aim, instead, to drive economic activity in a sustainable way, thus in respect of all fundamental and social rights involved (such as environment, labor rights, public health).

According to the praxis, host State – especially when developing country – has accepted foreign investment at almost any condition, so to increase investment flow within itself and boost its economy. Accordingly, host State has never asked foreign investor for any special behavior nor it has imposed upon him obligations to contribute to its development. By and large, this has meant investment only with long lasting protection and economic guarantee. Consequently, host State has for long time refused to higher its standard of protection of fundamental right, so to align them to the international ones.

Such an imbalanced relation has been for decades legitimized at the normative level (multilateral and bilateral agreements) and well mirrored by arbitral decision, which have always avoided any chance to reason on (alleged) violation perpetrated by investors against host State’s development. It is enough to remember that, the attempt made in Salini (¶57) case law was not pursued by further jurisprudential praxis.

Despite this, it seems that, in the last decade, a wide spread consensus has evolved on the need to guarantee sustainable development.

The question of this contribution is therefore, whether and how it is possible to pursue a sustainable investment.

A first attempt to remodeled the relation investment law-sustainable development, date back to 2008 when Prof. J. Ruggie, by that time UN SG Special Representative on the issue of Human Rights and Transnational Corporations and other business enterprises, law made a public statement related to the introduction of sustainable development within investment law as a binding concept (§ 12 Protect, Respect, Remedy).

Since then, States have started various tools to integrate SD concerns within FDI sources of law. The relative new born principle on sustainable development has thus started to be empowered also by international investment law, so to render it a binding obligation.

This change seems to have been driven at both political and normative level, where obligations have started to be imposed also on foreign investors, namely if juridical persons (small, medium or multinational enterprises).

To prove this, an excursus through the most recent normative and arbitral praxis is required.

As regard the normative level, it seems on-going a deep reshape of investment treaties (BITs and IIAs) which, for themselves, are not necessarily treacherous legal products. In fact, as any other treaties, they are simply instruments at the disposal of contracting parties to legally protect their respective interests. What really matters is their content, which obviously depends on agendas, choices and concessions of the parties. Consequently, investment agreements have started to change nature, including several innovative provisions able to recalibrate the legal protection of all stakeholders’ interests (host State along foreign investors). This step forward can be expected to enhance the chances for economically, socially and environmentally sustainable investments.

A clear, and virtuous example, comes from the Morocco and Nigeria BIT, which has increased host State’s right to regulate and it has imposed obligation of conduct upon foreign investors. Namely, host State provisions, enacted to pursue a S.D. goal, are legitimate; conversely, foreign investors have to pursue their activity contributing to host State’ sustainable development.

Sustainable Development’ goals are thus not anymore declaration of principle embedded in preambles (thus serving as mere interpretative tools), but they are becoming legally binding provision included right in the text, along with all other clauses on rights and obligations. Parties to the above-mentioned BIT have shown confidence that such an instrument can offer investors solid protection, without compromising on host State’s rights or on social values.

In parallel, also the European Union seems to have endorsed a more sustainable oriented approach, at both the internal and external level (after all, art. 2.5 and art. 21 TFEU oblige the EU to pursue its foreign relation respecting also sustainable development).

As regard the internal level, the European Court of justice, in its Opinion 2/15, found that that the EU has exclusive competence to enter any international agreement including commitments on all aspects of intellectual property and also those concerning sustainable development and environmental protection: all are indeed sufficiently linked to the objective of freeing trade.

At the international level, EU is assuming a leading role in “the sustainability cause”: for instance, it was instrumental in shaping Agenda 2030 and, along with member States, it is fully committed to implementing it and its Sustainable Development Goals into EU policies. This has certainly induced EU negotiator to include provision on SD’ goals in the most recent treaties.

As regard jurisprudential level, it seems that arbitrators have started to allow Respondent-host State’ counterclaims raised versus Claimant-foreign investor for its alleged violation of fundamental rights (Blusun v. Argentina). Besides, it seems spreading the practice to start proceeding against corporations which have allegedly acted, infringing fundamental rights.

Given the above, two last doubt raises.

The first regards the allocation of responsibility: who respond for infringement of a SD obligation? Our tenet is that the same fact could potentially raise joint and several responsibilities of both host State and foreign investor.

Investor responds where international agreement, or contracts, binding the parties involved, include specific obligations on SD. Host State is responsible where it has bound it-self with international treaties (Basel Convention, 1989, Kyoto protocol, 1997; Paris Agreement, 2016) or other instruments (Protocol of finance and investment binding States parties to South African Development Community and requiring them to pursue their investment relations according to SD principle) providing for obligations on SD.

The second doubt is strictly related to the first one: if host State can be held responsible for infringement of a SD provision, any action pursued to align itself to that latter (or other international standard), should not engage State responsibility (in Gabcikovo-Nagymaros, Respondent State casted doubt upon whether “ecological necessity” or “ecological risk” could […] constitute a circumstance precluding the wrongfulness of an act). Some have qualified that circumstance as State of necessity, but this seems of limited practical application. It should, instead, be viewed as exercise of sovereign power in the public interest. Given this, and provided that the measure adopted is necessary to the aim pursued, the act is legitimate and the compensation due should be defined according to proportionality test, as endorsed by the ECtHR.

To conclude, it seems that at both normative and jurisprudential level there is a widespread consensus aimed at legitimizing a more balanced investment relation, leading to a sustainable investment.

The better avenue for a State seeking to further its SD’ goal, is to harmonize them with its investment obligations, rather than to seek outright relief from investment obligations.


Benedetta Cappiello, Post-Doctoral Researcher, Università degli Studi di Milano, Italy.

 

The Vodafone Tax Dispute: Abuse of Process in International Investment Arbitration?

by Malcolm Katrak*

Recently, the Delhi High Court in the case of Union of India v. Vodafone Group, passed an ex-parte order restraining the Vodafone Group from pursuing an investment arbitration claim against India under the India-United Kingdom Bilateral Investment Treaty (India- UK BIT). The Court held that multiple claims cannot be permitted by corporate entities in a single vertical chain against the same measure of the host state under various bilateral investment treaties and protection agreements. Thereafter, the court proceeded to pass an anti-arbitration injunction against Vodafone from initiating arbitration proceedings under the India-UK BIT.

Before analyzing the issues in this case, it is necessary to consider the facts that led to the dispute. Vodafone (Netherlands) bought a Cayman Island entity of Hutchison group, in order to acquire controlling interest in the Indian entity Hutchison-Essar Ltd. The Indian Income tax statute, before amendment, did not tax transactions outside India which did not involve transfer of shares of any Indian entity. Thereafter, the Indian government amended the tax statute, which interpreted according to the government, included transactions which changed the control of an Indian entity, as was the Vodafone transaction. The Supreme Court of India rejected the Indian government’s contention that the text of the statute, as it stood then, could be interpreted to include such a transaction under the tax ambit.

In 2012, the Vodafone group initiated proceedings against India under the India-Netherlands BIT before the Permanent Court of Arbitration (PCA). Vodafone was challenging the imposition of a million-dollar tax bill arising out of the retrospective amendment of the Indian Income Tax Act in 2012. Thereafter, Vodafone on 24th January, 2017 issued another BIT arbitration notice for the same cause of action. However, the second BIT arbitration notice was initiated under the India-UK BIT. Since Vodafone had already initiated a BIT against India, on the issue of retrospective taxation, the Indian Government proceeded to the Delhi High Court, seeking an order restraining Vodafone from initiating parallel BIT proceedings on the same issue before another BIT Tribunal citing ‘abuse of process’.

The case has been much publicized and raises several intriguing legal propositions; the first being the domestic court’s jurisdiction to try the dispute, the second being basis to pass an anti-arbitration injunction and the third being whether there is an abuse of process by Vodafone by initiating arbitration proceedings under different BITs.

As far as the jurisdiction of the domestic court is concerned, the Delhi High Court held, “India constitutes a natural forum for the litigation of the defendants’ claim (the India-UK BIT claim) against the plaintiff.” The counsel for the government laid a two-pronged approach for the purpose of facilitating a jurisdictional argument; first being that disputes encompassing tax demands raised by host State are beyond the scope of arbitration provided under the BIT as taxation is a sovereign function and the second being that under the constitutional scheme of India, laws passed by the Parliament cannot be adjudicated by an arbitral tribunal. This, according to me, is a fallacious interpretation of the India-UK BIT. The BIT allows taxation to be considered under its ambit except for the provisions pertaining to National Treatment and Most-favoured Nation. A treaty must not be construed liberally or restrictively but literally. The India-UK BIT being broadly worded allows taxation to come under the ambit of the BIT.

The second issue being the anti-arbitration injunction, it is necessary to analyze when exactly is a domestic court allowed to pass an anti-arbitration injunction. In the case of Board of Trustees of the Port of Kolkata v. Louis Dreyfus Armaturs SAS & Ors (behind paywall), the Calcutta High Court has held that an anti-arbitral injunction could be issued under the following circumstances – first, there is no arbitral agreement between the parties; second, the arbitration agreement is null and void, inoperative or incapable of being performed; third, continuation of foreign arbitration proceeding might be oppressive, vexatious or unconscionable.

The Vodafone case initiated under the India-UK BIT in itself constitutes a valid arbitration agreement and thus, the basis to pass an anti-arbitration injunction falls. However, it must be remembered that in the case of SGS v. Pakistan, the Supreme Court of Pakistan restrained the foreign investor from carrying out arbitration through the BIT albeit the ICSID Tribunal still took cognizance of the matter and exercised its jurisdiction.

The claims which have risen in the India-UK BIT and Indian-Netherlands BIT are based on the same cause of action and the reliefs sought are identical but from two different arbitral tribunals against the same host state. This is a perfect example of abuse of process. Emmanuel Gaillard states, ‘abuse of process in BIT arbitration does not violate any hard and fast legal rule but nonetheless causes significant prejudice to the party against whom it is aimed and can undermine the fair and orderly resolution of disputes by International arbitration.’ To facilitate the argument of abuse of process, the counsel for the State relied on the case of Orascom TMT Investments v. Algeria, wherein the ICSID Tribunal stated:

In particular, an investor who controls several entities in a vertical chain of companies may commit an abuse if it seeks to impugn the same host state measures and claims for the same harm at various levels of the chain in reliance on several investment treaties concluded by the host state. It goes without saying that structuring an investment through several layers of corporate entities in different states is not illegitimate […] Several corporate entities in the chain may be in a position to bring an arbitration against the host state in relation to the same investment. This possibility, however, does not mean that the host state has accepted to be sued multiple times by various entities under the same control that are part of the vertical chain in relation to the same investment, the same measures and the same harm.

As far as the abuse of process goes, it would be correct to say that Vodafone utilized the process which is formulated to enhance economic benefits to the host state and protect investments of the companies, in a negative manner. On the other hand, it can be argued that the law pertaining to abuse of process in international investment arbitration is not clear. For example, Yosef Maimam, a German-born Israeli businessman sought arbitration proceedings against Egypt under the US-Egypt BIT by one of his companies and another arbitration under the Egypt-Poland BIT through his own name. Thus, abuse of process in investment arbitration is not a clear picture.

It is fair to say that the Delhi High Court has exceeded its jurisdiction by restraining Vodafone from proceeding with its arbitration proceedings under the India-UK BIT. On the other hand, it cannot be denied that there was no abuse of process. As far as the consequence of an anti-arbitration injunction goes, the same would be impossible to analyze or presume. However, the Delhi High Court has failed to provide a comprehensive, logical and reasoned backing to its judgment, which only shows how far the Courts have been reluctant to interpret BITs.


Malcolm Katrak is currently a Law Clerk to Justice (Retd.) S. N. Variava, Former Judge, Supreme Court of India. In the past, he has worked under Mr. D. J. Khambata, Former Vice-President, London Court of International Arbitration and Justice S. J. Kathawalla, Jugde, Bombay High Court. He may be contacted at malcolmkatrak@yahoo.in.

Avoiding ISDS: National Contact Points for Investor Guidelines and Mediation

by Tabe van Hoolwerff* 

Imagine, you are an EU trade minister and you want to attract foreign investors by offering a stable investment climate. At the same time, you also want to avoid potential claims arising from government measures that seek to protect the environment or labor standards – a fear your non-business stakeholders have been very vocal about. You have also learned from the business sector that Investor-State Dispute Settlement (ISDS) is a means of last resort. So there must be room for maneuvering in the area of conflict prevention. Two keywords from your experience in the policy field of responsible business conduct spring to mind: transparency and mediation. How to go from there?

Despite the public belief that foreign investors will easily sue their host governments when faced with measures that impair their profitability, you realize that by far and large such measures remain uncontested at the investor-to-state level. Moreover, measures aimed at business activities in order to e.g. reduce their environmental impact are also in the self-interest of companies and a business sector as a whole. When a laggard in the industry fails to uphold common yet not mandatory levels of environmental protection, then that may put the social license to operate of the industry as a whole at risk.

So, new legislation requiring particular environmental standards to be upheld for that industry is likely to help them all in the long run. You smile when realizing that it ‘only’ takes a fine minister as yourself and your colleagues to find the right balance between adequate environmental protection and reasonable costs for the business sector. Typical Brussels jargon such as subsidiarity and proportionality may even spring to mind.

Back to transparency. Although you are not likely to be an expert in international investment law, you have learned that cases often center around ‘legitimate expectations’ of the investor. So in order to guide these expectations, you want to inform (potential) foreign investors about the basic regulatory framework in your country and the democratic process for making new laws and regulations, in which they could perhaps even participate. It would indeed be useful to compile this information on such issues as disclosure, corporate governance, labor and consumer rights, environmental standards, anti-bribery laws and taxation into one convenient document.

Of course you want to mention that these laws and regulations are upheld in a non-discriminatory manner, in case an investor might think he could be bullied on the basis of all these norms and standards. You decide to call them ‘Guidelines for Responsible Investment’ or something similar. You want to use that word ‘responsible’ because it reassures your non-business stakeholders what kind of investment and investors you want to attract and it tells investors to be responsible by making themselves aware of laws and regulations and how to appropriately engage in their making.

Obviously, these Guidelines need to be disseminated. If you do not yet have a special agency for attracting foreign investment, you might consider doing so now and give it a catchy name that will send the right signals to all stakeholders, like ‘National Contact Point for Responsible Investment’. This Contact Point can draw a communication plan, visit trade fairs and help organizing incoming trade missions where potential investors learn of both the opportunities and obligations when investing in your country.

But no matter how clearly you and your government communicate about laws, regulations, individual permit procedures and subsidy schemes, a conflict between your government and a foreign investor might still emerge one day. You know investors are not happy to resort to investor-state arbitration – it is expensive and the odds are not with the investors – and neither are you. Investor-state conflicts are bad publicity of course. Similar to legal disputes between private parties, you think that a state and a foreign investor should be able to try amicable venues first, such as mediation.

Of course, when offering mediation, you do want to keep some level of control, but also provide assurance to the investor that the entity providing its good offices knows about doing business and the various risks involved. Well, why not put that same Contact Point in charge here? All it needs is some procedural guidance on how to handle specific instances in which a foreign investor alleges discriminatory government measures have run counter to his legitimate expectations. The objective should not be to render verdicts about right or wrong, but to produce future-oriented recommendations that enable the investor to continue his/her business, so creating jobs and government revenue while observing applicable norms and standards that protect public goods.

In short, you could come up with the idea of drafting Guidelines for Responsible Investment that would be disseminated by a National Contact Point that would also deal with complaints by offering its good offices to aggrieved investors. It would be helpful of course if all your EU colleagues would apply a similar model, for purposes of a level playing field and exchanging experiences with handling investor complaints. Only then you realize that this plan sounds all too familiar. You call your investment policy expert to verify your thoughts. (S)He will indeed confirm that your plan strikingly resembles the 1976 OECD Guidelines for Multinational Enterprises, the related National Contact Points and their tasks, responsibilities and procedural guidance, most recently updated in 2011.

Only that it has been used in the past two decades by civil society to hold companies to account. But indeed, with some creativity the OECD Guidelines and NCPs could also be applied as an ISDS prevention mechanism. After all, the Guidelines are part of the OECD Declaration on International Investment and they include an encouragement of the use of arbitration as an appropriate means of dispute resolution between enterprises and host governments. How come nobody else ever thought of this? Would it not be worth exploring?


Tabe van Hoolwerff is a legal counsel with Shell. This blog was written and published on a personal title and not on behalf of Shell. The views reflected are Tabe’s own and do not necessarily reflect those of Shell.

The Polish Government’s Standpoint on ISDS Inclusion in the Scope of TTIP

by Pawel Sikora, Kubas Kos Gałkowski

It is beyond any doubts that the ongoing procedure of negotiating Transatlantic Trade and Investment Partnership (TTIP) between the European Union (EU) and the United States of America (US) raises essential controversies among the EU member states societies. However, it is not the first time such controversies occur, as just three years ago a similar confusion has risen in the course of talks over the Anti-Counterfeiting Trade Agreement (ACTA), which has been widely criticized.

Just to remind, the Polish Government initially had approved ACTA but changed its position under the pressure from the society and non-governmental organizations. The exactly same story is now happening in relation to TTIP and, in particular, the Investor-State Dispute Settlement Mechanism (ISDS). The Polish Government has presented its official position in which it widely supports the negotiations of TTIP and the idea of the inclusion of mechanism of ISDS in the scope of the future agreement. But that does not mean it will eventually happen.

As it is known, the common argumentation raised against TTIP and ISDS is i.e. that upon signing the treaty, the “flood of US investors’ claims” against EU countries may purportedly be expected, that would be heard by international arbitration tribunals instead of domestic courts. Altogether, amongst diverse organizations this may be considered as a forecast of one-sided dispute between the investors and states. However, Poland denotes that is does not have to be so – as it was otherwise in the past. Polish Ministry of Economy argues that the Republic of Poland is a party to over sixty bilateral treaties, including a Treaty with the United States of America concerning business and economic relations signed, entered into on March 21, 1990.

For almost three decades only six claims have been filed under the Treaty by US investors. In only one of these cases investor’s claims were partially allowed (approximately one fifth of the claimed amount has been awarded to the investor). In another two cases, claims were dismissed in whole, and one is still pending. Two cases ended with non-substantive decisions. What we need to keep in mind, is that Poland for many years has been an important direction for US investors. Currently, the value of US direct and indirect investments in Poland is estimated for PLN 25 billion (c.a. USD 6,5 billion). There are over 800 entities with US equity, employing over 200,000 people. This proves that there is no direct dependency between amount of claims and decisions in favor of the investor on existence of bilateral treaties and ISDS mechanism.

The Ministry of Economy validates that the future treaty will also introduce a better balance between the foreign investor rights and the state authorities’ right to regulate. In addition, it will guarantee a higher level of protection against the unreasonable lawsuits than currently existing. The TTIP opponents remain adamant to these arguments; also so called “social resistance” still tends to be strong. Seventy five Polish NGOs have recently teamed up in their struggle against the inclusion of the ISDS mechanism into the future treaty; they consequently keep pressing the officials. We are going to witness whether Polish Government’s stands firm with its current view or surrenders to this pressure. Due to the current situation in Poland, concerning the upcoming parliamentary elections (November 25th) and its outcome, this question is of vast importance.