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[Originally posted, with full hyperlinks, at http://eastasiaforum.org/author/lukenottage/]

Interesting responses by Andrew MacIntyre and others follow Peter McCawley’s recent posting on the East Asia Forumblog, throwing light on Indonesia’s electricity crisis. Further to my subsequent posting on burgeoning FDI into Japan, yet the recent blocking of an English fund’s bid to expand shareholdings in the J-Power wholesaler, I wonder what Indonesia’s overall experience has been in attracting foreign investment into power projects. From Wells and Ahmad, Making Foreign Investment Safe (OUP, 2007), I do know of three major investments that resulted in arbitrations after Indonesia suspended many projects following the Asian Financial Crisis a decade ago. These already involved some involvement from Australia and especially Japan. Hence the question: why and how should we provide for investment arbitration in the Australia-Japan FTA or in ASEAN+ agreements?

Two investment disputes directly or indirectly involved Japanese interests. Tomen, a major Japanese general trading company was a 9% partner in the Karaha Bodas power project consortium, led by two US companies, which was awarded US$261 million in arbitration. Sakura Bank helped finance the Dieng and Patuha power projects, where a consortium led by CalEnergy (in the US) obtained US$570 million out of $3 billion claimed against PLN (Indonesia’s utility company), from a first tribunal including an Australian arbitrator. This consortium then initiated a second arbitration against the Indonesian government itself, alleging sovereign performance guarantees. A third investment involved Enron’s withdrawal from the Pasuruan gas-fired power plant project. Wells and Ahmad are quite critical of these American companies’ limited experience or lack of long-term commitment to such overseas infrastructure developments.

Yet arbitration, often triggering payouts in political risks insurance provided by the home state (of the investor), now often provides significant relief not only against local firms partnering in the investment, but also against the “deeper pocket” of the partners’ host state. Foreign investors not only conclude arbitration agreements directly with the host state, allowing them to claim if the state expropriates or otherwise discriminates against the investment. More often nowadays, investors can invoke commitments to arbitrate made towards the investor’s home state by the host state, in Bilateral Investment Treaties (BITs, like the one between Indonesia and Australia) or in investment chapters of FTAs (like the just-negotiated Australia-Chile FTA). The main attraction is a procedure largely autonomous of the host state’s courts, but other benefits include the expertise of the arbitrators in the public international law and specialist procedures typically involved in such disputes.

Treaty-based Investor-State Arbitration (ISA) is clearly most attractive for the (actual or potential) net capital exporter, such as Australia vis-à-vis developing countries. Conversely, the Australian government was quick to agree to the US proposal to omit ISA from their 2004 FTA. This occurred after the US belatedly had found itself on the receiving end of adverse ISA rulings under NAFTA’s investment chapter; and later US FTAs have reinstated ISA with some adaptations.

Yet even a net capital importer, such as Australia vis-à-vis Japan, has some significant interests in including ISA in an FTA. Short-term, for example, there may be Australian firms investing in Japan, such as Macquarie in Haneda Airport. If the Japanese government discriminates against their investment, for example by invoking national security, Macquarie probably would prefer to bring a direct claim for compensation before a specialist arbitral tribunal rather than suing in local courts, or relying on a “diplomatic protection” claim brought on their behalf by the Australian government in the International Court of Justice. Long-term, for example, we can expect regional FTAs (rather like NAFTA) that combine net capital importers and exporters, as well as developing and developed countries. It should be easier to include ISA in such regional FTAs, like an ASEAN+ FTA involving both Australia and Japan, if countries like Australia and Japan already have committed to ISA in their respective bilateral treaties.

Still, developing countries that have mostly been on the receiving end of arbitration claims (especially in South America) are concerned about the Arbitration Rules provided in treaty-based ISA. Critics point out that ISA disputes involve a wider range of legitimate public interests than strictly commercial arbitration between private firms. Adapting the Rules at the multilateral level is difficult, for reasons unsurprising to those familiar with the WTO. An alternative is to make changes in bilateral treaties, such as the greater transparency obligations detailed in the Australia-Chile FTA.

But another possibility, which I favour at this stage, is to encourage institutions like the Australian Centre for International Commercial Arbitration to develop even more ambitious Arbitration Rules balancing private and public interests in ISA. They should then get the Australian government to include those ISA Rules in their FTAs, as another option for investors to select if proceeding to arbitration. Investors dedicated to Corporate Social Responsibility, or (more instrumentally) wanting to minimize hassles when seeking execution of any arbitral award, would then be advised to choose such Rules over the older ones that some countries remain wary about. This would represent another small but significant step towards PM Kevin Rudd’s East Asia community.

Further reading: Luke Nottage & Kate Miles “‘Back to the Future’ for Investor-State Arbitrations: Revising Rules in Australia and Japan to Meet Public Interests” Sydney Law School Research Paper No. 08/62

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Japanese Law in Asia-Pacific Socio-Economic Context