The Brave New (American) World of International Investment Law: Substantive Investment Protection Standards in Mega-Regionals

Carve-outs are a popular tool in Mega-Regionals to protect host states’ regulatory freedom by ensuring that certain measures are not subject to investment treaty disciplines in the first place. Mega-Regionals may offer three main types of carve-outs: 1) carve-outs from the entire agreement; 2) carve-outs from specific treaty obligations; and 3) carve-outs for certain industries or areas of regulation. Notably, all three types of carve-outs can be found in U.S. and NAFTA practice.

For example, the U.S. Model BIT 2012, supra note 21, provides a carve-out for taxation measures (art. 21), government procurement or subsidies or grants (art. 14(5)(a)-(b)); offers exceptions to the prohibition on certain performance requirements (art. 8(3)); and establishes an exception for certain measures related to intellectual property (art. 14(4)).

Some of the most common carve-outs for entire Mega-Regional agreements include those for taxation measures, subsidies or grants, government procurement, and services supplied in the exercise of governmental authority.

ACIA, supra note 6, art. 3(4); ASEAN-PRC Investment Agreement, supra note 7, art. 3(4); asean-aus-nz fta, supra note 7, ch. 11, art. 1(2); ASEAN-Korea Investment Agreement, supra note 7, art. 2(2). See further CETA, supra note 8, art. 8.15, which excludes government procurement and subsidies, or government support relating to trade in services, from the scope of the market access, national treatment, MFN treatment, and senior management and board of directors provisions. CETA’s treatment of taxation measures is more sophisticated than a simple carve-out and tries to balance taxation powers and investment protection in a more fine-tuned manner. See CETA, supra note 8, art. 28.7.

In addition to carve-outs, Mega-Regionals also regularly include general exception clauses that clarify that investment treaty disciplines do not override the governments’ right to take measures for the protection of competing concerns. General exception clauses appear in a variety of forms and contexts and may vary in their content. Often they are modelled on Article XX of the General Agreement on Tariffs and Trade (GATT) and Article XIV of the GATS. General exception clauses permit states to take measures that, for example, are necessary to “protect public morals or to maintain public order,”

ACIA, supra note 6, art. 17(1)(a); ASEAN-PRC Investment Agreement, supra note 7, art. 16(1)(a).

CETA, for example, includes a general exception clause that is contained in a separate chapter.

See CETA, supra note 8, art. 28.3(1) and (2).

“Denial of benefits”-clauses are also regularly included in Mega-Regionals as a tool to limit the application of the treaty in denying protection to certain investors and their investments. Such clauses attempt to deny treaty protection to “shell” or “mailbox” corporations that are controlled by nationals of a non-contracting state. “Denial of benefits”-clauses appear in the practice of both the United States and Canada, including in NAFTA.

See, e.g., NAFTA, supra note 17, art. 1113; U.S. Model BITs 2004 and 2012, supra note 21, art. 17; Canada 2004 FIPA, supra note 38, art. 18.

Finally, Mega-Regionals often use “in accordance with host state law”-clauses to limit the protection of investments made in conformity with domestic law. The NAFTA and the U.S. Model BITs do not have “in accordance with host state law”-clauses, but nonetheless arguably require as a general principle of law that investments be made in accordance with the rules of the domestic legal order.

Stephan W. Schill, Illegal Investments in Investment Treaty Arbitration, 11 Law & Prac. Int’l Cts & Tribunals 281, 310-21 (2012).

All Mega-Regionals include a provision that prohibits states from expropriating or nationalizing an investment except for a public purpose, in a non-discriminatory manner, in accordance with due process of law, and against payment of prompt, adequate, and effective compensation.

See ASEAN-AUS-NZ FTA, supra note 7, ch. 11, art. 9(1)(a-d); ASEAN-Korea Investment Agreement, supra note 7, art. 12; ACIA, supra note 6, art. 14(1)(a-d); EU-Singapore FTA, supra note 9, art. 9.6(1)(a-d); TPP, supra note 3, art. 9.8 (1)(a-d); ceta, supra note 8, art. 8.12(1)(a-d); see also ASEAN-PRC Investment Agreement, supra note 7, art. 8(b) (instead of referring to due process of law, the agreement requires that the measure be “in accordance with applicable domestic laws, including legal procedures”).

A first way to ensure regulatory space and to reduce constraints on government conduct is to follow the U.S. approach

U.S. Model BITs 2004 and 2012, supra note 21, annex B. The decision to limit the scope of the expropriation provision to that which exists at customary international law is arguably in response to the expansive interpretations given by arbitral tribunals in the NAFTA context. See, e.g., S.D. Myers v. Canada, UNCITRAL Arbitration Rules, Partial Award on the Merits (Nov. 13, 2000) para. 282.

The third way is to limit specifically the scope of the concept of indirect expropriation. This is achieved in a variety of ways. CETA, for example, explicitly requires that an indirect expropriation occur only where a measure or series of measures exceeds a certain threshold by “substantially depriv[ing] the investor of the fundamental attributes of property in its investment.”

CETA, supra note 8, annex 8-A, para. 1.

The fourth way Mega-Regionals enhance the policy space of the host state under the expropriation provision is to include a specific exclusion from the expropriation provision for government regulation. The ACIA agreement includes the broadest regulation exclusion. It provides that “non-discriminatory measures of a Member State that are designed and applied to protect legitimate public welfare objectives … do not constitute expropriation.”

ACIA, supra note 6, annex 2, para. 4. See ASEAN-AUS-NZ FTA, supra note 7, Annex on Expropriation and Compensation, para. 4. See also EU TTIP Proposal, supra note 4, annex 1, para. 3.

Together with both the introduction of a clear threshold that has to be passed before a measure can even be considered an expropriation and the listing of factors that need to be taken into account when determining whether an indirect expropriation has occurred, the exception for regulations aims at ensuring that legitimate government action for the protection of public interests does not constitute a direct or indirect expropriation.

A further example for how Mega-Regionals limit substantive standards in order to reserve policy space and strengthen state control concerns changes to the fair and equitable treatment standard. Similar to the provisions on expropriation, there are different means to achieve the end of limiting the standard’s potency.

One way is to tie fair and equitable treatment to the standard offered by the domestic laws of the host state. ACIA can be seen, at last in the view of some, as adopting this approach.

See Diane Desierto, Regulatory Freedom and Control in the New ASEAN Regional Investment Treaties, 16 J. World Inv. & Trade 1018 (2015).

Another approach is to tie fair and equitable treatment to customary international law. This is the approach first adopted under NAFTA through an authoritative interpretation of the agreement by the NAFTA Free Trade Commission, which explicitly linked the fair and equitable treatment to the minimum standard of treatment under customary international law.

See NAFTA Free Trade Commission, Notes of Interpretation of Certain Chapter 11 Provisions (July 31, 2001).

A third approach is to provide a closed list of elements, inspired by current arbitral interpretations that concretize the meaning of fair and equitable treatment. CETA, Article 8.10, for example, states that the obligation of fair and equitable treatment prohibits the following:

Denial of justice in criminal, civil or administrative proceedings;

The fair and equitable treatment is a ubiquitous, pervasive standard that has seen variable interpretations. The unpredictability of the standard is likely reflected in the various fair and equitable treatment provisions mentioned above. Nonetheless, parties to Mega-Regionals have all seized the opportunity to refine the scope, nature and content of fair and equitable treatment, taking steps to move away from a purely autonomous understanding of the standard, while clearly aiming to ensure the preservation of their policy space.

A final example of a provision commonly found in Mega-Regionals that provides states with greater flexibility and control, as compared to classical BITs, relates to restrictions placed on free capital transfer provisions. Reacting to recent financial crises, these restrictions provide states with the ability to control inflow and outflows of capital more effectively.

Traditionally, BITs included “open-ended transfer rights.”

Andrew Newcombe & Lluis Paradell, Law and Practice of Investment Treaties 414 (2009).

Outside the ASEAN framework, safeguard provisions are also present.

Tpp, supra note 3, art. 29.3; CETA, supra note 8, art. 28.5. See also EU-Singapore FTA, supra note 9, art. 9.7(3).

Mega-Regionals, arguably influenced by NAFTA’s Article 2104, recognize that exceptional circumstances can exist in which a host state should maintain the flexibility to introduce measures that restrict transfers where the party experiences serious balance-of-payments difficulties, or threat thereof. Notwithstanding minor distinctions, restrictions on capital transfer provisions in Mega-Regionals have become important tools to reduce financial vulnerability in times of crisis, thereby ensuring that governments can act efficiently to protect public interests.

Compared to traditional BITs, contracting parties involved in Mega-Regionals are different in two main respects. First, the number of contracting parties has expanded from simple two-party bilateral arrangements to complex and intricate treaty negotiations between a wide range of parties. Mega-Regionals have been concluded, for instance, between countries from a particular region (e.g. ACIA), between countries from around the world (e.g. the TPP), and between individual countries and supra-national organizations (e.g. the EU) or regional trading blocs (e.g. RCEP). With an increase in numbers of contracting parties, Mega-Regionals must accommodate more interests. This reflects both in more, and more specific, exceptions, like the TPP tobacco carve-out,

See TPP, supra note 3, art. 29.5.

Second, the contracting parties involved in Mega-Regionals are different in character. Typically, traditional BITs were concluded principally between capital-exporting countries (i.e. countries in Europe and North America) and capital-importing, developing countries. The underlying rationale for most of these agreements was to protect investors from developed countries who invested in developing countries against illegitimate government conduct, such as expropriations without compensation or other types of illegitimate interferences with their investment. Although at a formal level these agreements were reciprocal in nature, as both parties undertook the same obligations, “in practice the obligations all fell on the developing country party.”

Kenneth J. Vandevelde, A Brief History of International Investment Agreements, 12 U.C. Davis J. Int’l L. & Pol’y 157, 171 (2005).

In contrast, Mega-Regionals reflect a changed environment in which investment flows are no longer unidirectional; instead they flow both ways. Treaties, in consequence, no longer solely accommodate the offensive interests of capital-exporting countries, but are negotiated from the start based on an overall assessment of offensive and defensive interests by every negotiating party, whether developed or developing. With investments flowing in two ways, Mega-Regionals have altered the matrix underlying the negotiation of investment disciplines, and for this reason come along with recalibrated substantive standards of treatment that not only contain rules on investment protection, but also emphasize host state policy space.

The second major structural difference between Mega-Regionals and traditional BITs, as mentioned above, is the combination of trade and investment in one agreement.

Seesupra Part IV, Sec. A.

First, with trade and investment rules now being negotiated side-by-side, there is an increase in the potential for cross-deals. In BIT negotiations, by contrast, where the sole focus is on the level of investment protection, cross-deals (more or less investment protection in exchange for concessions in other areas of negotiation) were practically non-existent. However, in Mega-Regionals, contracting parties may concede a certain level of substantive investment protections in exchange for a more favorable deal in another sector. In this way, negotiators may strategically use or demand concessions on investment protection and investor-state dispute settlement as bargaining chips to cut cross-issue deals. This may explain, to a certain extent, differences in the investment rules agreed to under Mega-Regionals.

Second, unlike with the negotiations of BITs, which usually involved one or two ministries of the contracting parties (depending on the internal organization, often the ministry for economic affairs and the foreign ministry), Mega-Regionals mandate greater involvement from multiple departments of government, including, for example, ministries for social affairs, environment, etc., with each of them having different interests, expertise, and new ideas. These actors already have been involved for a long time in the negotiation of trade agreements and now, with the reunion of investment and trade, also get involved in the negotiation of investment rules. The increased involvement at the domestic level is likely responsible for longer and more complicated negotiations that result in treaties containing more exceptions and more elaborate provisions, but that also exhibit more complete approaches to economic governance.

Finally, the combination of trade and investment rules in Mega-Regionals blends the trade and investment law communities. This also has repercussions on how the substantive rules of investment protection in Mega-Regionals are crafted and applied as compared to traditional BITs.

After all, the socialization of lawyers and the sociological composition of those who engage in the negotiation and application of investment rules influences their substance. Cf. Stephan W. Schill, W(h)ither Fragmentation? On the Literature and Sociology of International Investment Law, 22 Eur. J. Int’l L. 875 (2011).

All in all, the combination of trade and investment in one agreement is a game-changer that not only affects the general impact of Mega-Regionals as pillars of global economic governance, but also accounts for further developments of the investment provisions contained in the agreements.

The final structural difference with classical BITs consists in the greater public attention to the negotiation, ratification and implementation of Mega-Regionals. Traditionally, BITs were negotiated quietly and with little, if any, public attention. Mega-Regionals differ radically in this respect and attract public attention in all stages of treaty making. This is mainly due to the fact that Mega-Regionals have a broader coverage of interests, including environmental, human rights and labor issues, and involve more stakeholders. With the increase in potential impact of Mega-Regionals on those interests, more members of the public and more special interest groups, including non-governmental organizations, get involved in the political process surrounding the negotiation of Mega-Regionals. This not only indirectly affects the negotiations of Mega-Regionals; it may have concrete influence on the procedures through which negotiation positions in different constituencies are formed. In the EU, for example, the European Commission launched an online public consultation on investment protection and investor-state dispute settlement in TTIP to channel criticism and to improve communication between those who negotiate Mega-Regionals and the general public.

European Commission, European Commission Launches Public Online Consultation on Investor Protection in TTIP, Press Release, Mar. 27, 2014, available athttp://europa.eu/rapid/press-release_IP-14-292_en.htm. The European Commission received almost 150,000 responses to its online consultation. See European Commission, Report on the Online Public Consultation on Investment Protection and Investor-to-State Dispute Settlement (ISDS) in the TTIP, Brussels, Jan. 1, 2015, Commission Staff Working Document 2015 SWD (2015) 3 final, available athttp://trade.ec.europa.eu/doclib/docs/2015/january/tradoc_153044.pdf.

Examples, where the increase in public attention has had practical consequences for the content of Mega-Regionals are the inclusion of more exceptions, carve-outs, and clarifications that aim to protect host state policy space and interests the public is particularly concerned about. In addition, with an increase in public attention come corresponding demands for greater transparency, both as regards the negotiation of Mega-Regionals, but also their implementation, including through investor-state dispute settlement. This explains the inclusion of provisions on transparency that grant the public access to documents that are relevant for arbitral proceedings

See, e.g., TPP, supra note 3, art. 9.24(1) (Transparency of Arbitral Proceedings); EU-Singapore FTA, supra note 9, annex 9-C, art. 1 (Rules on Public Access to Documents, Hearings and the Possibility of Third Persons to Make Submissions); CETA, supra note 8, art. 8.36 (Transparency of Proceedings).

Mega-Regionals have important structural differences compared to traditional BITs in that they seek to balance the goals of investment liberalization and increasing state control. These structural changes were first witnessed with NAFTA, which already combined more than two contracting parties, including two developed and one developing country, fused trade and investment into one agreement, and started to attract public attention in the mid-1990s after claims were advanced by investors under NAFTA Chapter 11 and subsequently responded to greater demands for transparency.