Bilateral Investment Treaties: on the eve of a major reform?

20 June 2017

Last month, Ecuador's government announced the termination of all bilateral investment treaties the country had signed since 1968. The announcement is the latest instalment in the ongoing international controversy on the issue of the role and impact of bilateral investment treaties (BITs), and in particular of their standard clause entitling foreign investors to claim compensation from governments for measures that affect their expected profitability, the Investor-State Dispute Settlement system (ISDS).

On the occasion of the fiftieth anniversary of the United Nations Conference on Trade and Development and during the 15th Raul Prebisch Lecture, Rafael Correa Delgado, President of the Republic of Ecuador. 24 October 2014. UN Photo / Jean-Marc Ferré.

The ISDS system has frequently awarded compensation even for measures taken for legitimate regulatory purposes as long as they were deemed to contravene an undefined “Fair and Equitable Treatment” standard.

It was intensely debated in 2013-2015 in relation to the proposed Transatlantic Trade and Investment Partnership between the United States and the European Union and the Trans-Pacific Partnership among 12 Pacific Rim countries. See my previous blogs on international trade at a crossroads, the ISDS system and on the debate in the US on Trans Pacific Partnership,

Why Ecuador has chosen to terminate all its bilateral investment treaties?

The Ecuadoran decision implements the main recommendation of the Report of the Citizens' Commission on a Comprehensive Audit of Investment Protection Treaties and of the Investment Arbitration System set up by President Rafael Correa (above) in May 2013.

The Commission had been created in the aftermath of a ruling by an arbitral tribunal under the World Bank's International Centre for the Settlement of Investment Disputes (ICSID) in a case brought by Occidental Petroleum claiming compensation for the termination of its oil concession, decreed by the government on the grounds that the company had sold 40 percent of its production rights to another investor without the requisite government approval.

The arbitrators, while acknowledging that the company had violated the investment contract, found that cancellation was a disproportionate response and awarded Occidental a compensation of US$ 2.3 billion (PDF).

This is equivalent to 59% of Ecuador’s 2012 national budget provision for education and 135% of the provision for health. The amount of the compensation was strongly criticised in a dissenting opinion by the third arbitrator, Professor Brigitte Stern of the University of Paris (PDF).

To substantiate its recommendation of termination the Commission Report examines the relationship between the presence of BITs and the level of inward foreign direct investment in Ecuador and finds that there is no correlation: 60% of FDI originates in countries with which Ecuador has no BIT, including the two largest investors, Brazil and Mexico.

This finding coincides with those of econometric and survey research at the global level which have cast doubt about the effectiveness of BITs as a means to attract foreign direct foreign.

Do bilateral treaties work as mechanisms for attracting foreign direct investment?

A paper comprehensively reviewing studies carried out between 2005 and 2010  concludes that “much econometric evidence suggests that BITs are unlikely to have a substantial impact on investments” (PDF).

The paper also reports on a survey that asked 602 corporate executives to what extent BITs influence their decision to invest in a given country. Around one fourth of the survey respondents replied that investment agreements did not at all affect their decisions to invest, slightly less than half said to a limited extend, and less than a fifth said investment agreements were very important.

A similar response was found in a survey of political risk insurance providers. In the case of government-sponsored agencies, interviewed officials from the Netherlands, Denmark, Finland, Austria, Sweden, Italy and Japan tended to echo the summing-up of the official from the United Kingdom who stated that BITs “are not specifically taken into account when we are considering investment projects”.

As for private political risk insurers, interviews with representatives from large and medium sized firms, Lloyd’s Syndicates, and re-insurers indicated that “few of them find BITs of much relevance when determining the risk of investment projects”.

This is supported by a regression analysis of data from two prominent political risk rating agencies which concludes that there is “little evidence that BITs meaningfully influence political risk ratings” (PDF).

Ecuador is the fifth developing country deciding BITs not conducive to development

Ecuador is the fifth developing country to have decided in recent years that BITs as they are currently framed and especially their ISDS clause are not conducive to development.

Between 2011 and 2014, South Africa gave notice to terminate bilateral investment treaties with Germany, Switzerland and the Netherlands and has proceeded to end or renegotiate all others as they reach termination date (PDF).

Bolivia had withdrawn from ICSID in 2007 and terminated its BIT with the US in 2012.

For its part Indonesia announced in March 2014 that it would not renew its bilateral investment treaty with the Netherlands and that it would allow all 67 of its other bilateral investment treaties to lapse.

Will others adopt India's new Model Treaty, which will serve as its blueprint for future investment agreements?

A particularly relevant development is India's sending of notices in July 2016 to 58 countries announcing its intention to terminate or not renew their bilateral investment treaties while at the same time introducing a Model Bilateral Investment Treaty which will provide the blueprint for all new investment agreements (PDF).

The Model Treaty strengthens the protection of State interest in several important respects.

  • It reaffirms the regulatory authority of the State
  • it replaces the “fair and equitable treatment” standard of existing BITs with a specific enumeration of forbidden measures which furthermore to be actionable must involve violations of customary international law
  • and while retaining the ISDS system, it requires the foreign investor to spend at least five years exhausting domestic remedies before initiating ISDS proceedings.

It remains to be seen whether capital exporting countries will be keen to accept the Model Treaty as the basis for new investment agreements (India is currently engaged in negotiations with the US and Canada).

But there is no mistaking the thrust of the international effort to substantially change the much criticised BIT format.

A powerful indication is the December 2015 announcement by the European Commission to the effect that “the Commission will start work, together with other countries, on setting up a permanent International Investment Court.

The objective is that over time the International Investment Court would replace all investment dispute resolution mechanisms provided in EU agreements, EU Member States’ agreements with third countries and in trade and investment treaties concluded between non-EU countries.”

Image: Rafael Correa Delgado, former President of the Republic of Ecuador on the occasion of UNCTAD's the fiftieth anniversary, during the 15th Raul Prebisch Lecture.  24 October 2014. Credit: UN Photo / Jean-Marc Ferré

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