Peter Drysdale’s weekly editorial for the East Asia Forum, along with related postings to that blog and enormous media attention in Australia and elsewhere, focuses ‘on the continuing detention of Rio Tinto executive, Stern Hu, in Shanghai on allegations of espionage’. Drysdale signposts some future analysis of ‘the legal framework under which Hu’s detention has taken place’. He also emphasises that we need ‘a cooperative framework—bilaterally, regionally and globally‘ for ‘China’s authorities to avoid damage to the reliability of markets and for Australia to avoid the perception of investment protectionism’. The most pressing legal (and diplomatic) issues concern China’s criminal justice system, especially when ‘national security’ is allegedly involved. But we need already to consider some broader ramifications, including how we think about FDI legislation and (increasingly intertwined) investment treaty protections.
In short, most agree that the Chinese government got annoyed when Australia itself invoked national security interests to restrict Minmetals bid for OZ Minerals back in March 2009. Then it got really annoyed when Chinalco’s bid for Rio Tinto fell through, even though the Australian government wasn’t directly involved. And so, one story goes, Stern Hu has been arrested to send a message – in the hope that Australia (and other potential host states) will be think twice before invoking national security exceptions to restrict future FDI from China. The China-watchers are better placed to decide whether this is really the motivation behind his arrest. My point here is rather that we should not be surprised that host states may be increasingly tempted to invoke exceptions to limit FDI at the outset, which in turn generates risks of (over-)reactions by home states, as we may be witnessing in Hu’s case. And the initial temptation may arise due to proliferating investor-state arbitration provisions in investment treaties, because those later restrict their room to invoke national security or other limits once the FDI has been approved.
The starting point is that even today states retain considerable sovereignty when it comes to deciding what foreign investments are and are not permitted into their territories. Investment treaties – bilateral and now sometimes regional, either stand-alone or folded into broader Free Trade Agreements) – now often entrench substantive liberalisation. But these treaties still generally do not apply extensively to the pre-establishment phase, leaving that instead basically to national FDI legislation, and/or they maintain exceptions for national security or national interest. So even if Australia and China conclude their current FTA negotiations to make it broadly easier for firms from either country to invest in the other, that sort of exception is likely to be remain. We could therefore quite easily get another Minmetals – OZ Minerals situation.
Such overt up-front substantive restrictions on investments became less noticeable over the 1990s, especially in developed countries like Australia, as competition for FDI burgeoned world-wide. But now they may be on the rise again, with UNCTAD monitoring trends carefully. Concerns have grown about sovereign wealth funds, for example, as well as China’s push to secure resources directly (rather than through long-term contracts with smaller equity stakes, the longer-standing approach by Japanese companies active in Australia). And after an initial period where countries were desperate to attract funds after the GFC, those market collapses are perhaps forcing a rethink of (explicit or mostly implicit) models based on the merits of lightly regulated markets.
However, part of the recent shift may be due to the growing importance of investor-state arbitration provisions in investment treaties. Under these procedural rights, the investor can claim directly against the host state for breaching substantive protections (such as expropriations, ‘national treatment’ or transparent ‘fair and equitable treatment’) for investments that have been made. Thus, for example, the NZ-China FTA contains full investor-state arbitration provisions. It also has a narrow exception for certain ‘essential security interests’ (Art 201). However, more importantly, that FTA anyway does not extend full protections to the pre-establishment phase. For example, Art 138 on ‘national treatment’ - treating the foreign investors like national investors - does not extend to the initial ‘establishment’ of the investment (cf eg ASEAN-Australia-NZ FTA chapter 11 Art 4; or China-ASEAN FTA regarding services: Cai Congyan, ‘China-US BIT Negotiations and the Future of Investment Treaty Regime’, 12(2) JIEL 457 (2009) at 470). So NZ, for example, can maintain quite a broad national interest test for FDI, especially regarding ‘sensitive land’, under the Overseas Investment Act 2005. (That FDI legislation was recently subject to review, and some regulations were changed in July.)
Even without investor-state arbitration provisions in treaties, there may be somewhat more likelihood nowadays of the foreign investor being able to get their home state to bring a claim in public international law (say before the International Court of Justice) against the host state. This indirect means of protecting investors (‘diplomatic protection’) has been unpopular among investor and indeed prompted the development of investor-state arbitration, cemented particularly through investment treaties. The aversion to diplomatic protection was partly due to legal complications, such as the need first to exhaust remedies in the host state. But two major practical problems were that there was usually no obligation for the home state to pass on any compensation obtained from the host state to its investor, and the home state often hesitated to claim anyway in order to maintain a good broader relationship with the host state.
However, the experience of WTO dispute resolution shows how states often now sue each other over other economic issues, with interested industries or firms egging them on (think of Microsoft and the US enforcing TRIPS obligations) despite ‘compensation’ not flowing through directly to them. And investment disputes, thanks to burgeoning arbitrations that are brought directly by investors against hosts, are likewise increasingly seen as economic rather than political or diplomatic disputes. They too are seen to be appropriately capable of resolution through a much more ‘judicialised’ procedure, compared to even a decade ago. Thus, at least over the medium- to long-term, we may see some revival of diplomatic protection claims on behalf of foreign investors even where investment treaties lack investor-state arbitration provisions.
Either way, the indirect or increasingly direct threat of a claim about an investment that has been made provides an incentive for a host state to rely more on residual exceptions to allowing investments in the first place, such as the national security exception in national legislation or treaties. If so, we are likely to see more cases like that involving Stern Hu. That is, the (more broadly frustrated) home state of a frustrated investor reacts – even in a later context – against what it may have perceived as over-eager invocation of the national security exception. The irony in this case, perhaps intentional, is that China is now using its own national security law against a citizen of Australia. But it would be particularly unfair to make an example of an individual for the actions of his country, particularly when employed by a firm (Rio Tinto) not involved in Australia’s original invocation of the national security exception currently retained in its FDI legislation.
These sorts of issues are likely to become even more acute in light of some very recent developments in investment treaty arbitration practice (Investment Arbitration Reporter 2(11), 29 June 2009). In cases involving treaties with Russia and now China, tribunals have ruled that provisions that seemed to restrict arbitrations to quantification of compensation amounts should be read to extend arbitrability to the question of whether expropriation took place. Thus, even first- or second-generation investment treaties with China (including Australia’s dating back to 1988) may already apply far more extensively than almost everyone had thought (cf eg Gallagher and Shan, Chinese Investment Treaties, OUP 2009). In any event, China is renegotiating such treaties or concluding ones with new partners (like NZ) that clearly allow arbitrability of all issues. The backdrop is that China is now a major FDI-exporter, with Chinese investors already beginning to bring claims abroad – although so far no investor (or law firm wanting to do other business in China!) has risked claiming against China.
If these trends continue, namely direct investor-state arbitration provisions are concluded or reinterpreted to restrict the ability of home states to have second thoughts about foreign investments once they have been accepted, it seems to me that they will become more cautious when allowing in FDI in the first place. But if host states do impose restrictions, somewhere down the line they may experience a ‘Hu’ reaction from the frustrated home state. If so, then how Australia in turn reacts to China’s detention of Hu will be very important for the evolving field of investment treaty law and practice more broadly – the subject of a major conference at Sydney Law School over 19-20 February 2010.