This Day in International Law – October 30

On October 30, 1947, the General Agreement on Tariffs and Trade (GATT) was signed by 23 nations in Geneva. The Agreement contained tariff concessions and a set of rules designed to prevent the parties from subverting the agreement. At the time of its signing, it was the sole international instrument governing world trade.

Ironically, the GATT came about as a by-product of the failure of a larger coalition of nations to agree on a charter for the International Trade Organization (ITO). The ITO represented the grand vision of the UN Economic and Social Council following the end of World War II. Its founding charter was signed by 53 nations, but never ratified, so it never came into effect. But while the larger group of nations failed to ratify the provisions of the ITO, a smaller group implemented the GATT among themselves as an interim measure.

The GATT ultimately proved to have much better longevity than the ITO and it remained in effect until 1994, when it was updated by the GATT 1994. Most notably this update included the agreement that created the World Trade Organization (WTO), which subsequently replaced the GATT in regulating international trade.

The Trans-Pacific Partnership and the Advancement of Investor-State Regimes

The Trans-Pacific Partnership and the Advancement of Investor-State Regimes

By: Jessica Rose

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Photo Credit: epSos .de

 

On October 5th of this year, the United States and eleven other nations in the Pacific Rim concluded negotiations on the largest regional trade agreement in history – the Trans-Pacific Partnership (the “TPP”). While the finalized version of the text has yet to be released, an outline of the agreement by the office of the United States Trade Representative includes an investment chapter that places the TPP squarely within the tradition of investor-state dispute settlement (ISDS) regimes. According to the outline, the TPP will include rules on expropriation and “provisions for expeditious, fair, and transparent investor-State dispute settlement subject to appropriate safeguards … [that] will protect the rights of the TPP countries to regulate in the public interest.”

The conclusion of TPP negotiations coincides with a significant but little-remarked event in the history of ISDS. A recent skirmish in August between foreign investors and the Polish Parliament suggests that foreign investors have found ways to use investor-state laws to influence governments even before those governments enact legislation, calling into question the right of TPP governments to “regulate in the public interest.”

The Background: Investor-State Dispute Settlement

ISDS treaties are designed to encourage the flow of investment, usually from developed to developing countries. One of the ways that these treaties try to attract foreign investment is by giving foreign investors, usually multinational corporations (“MNCs”), a mechanism to challenge the behavior of host states when that behavior negatively affects the value of their investment. MNCs can sue host governments through private arbitration – a system where ad hoc arbitrators, who are private citizens, act as judges. These arbitrators decide whether or not the host state’s behavior was sufficiently unfair to constitute expropriation– effectively taking the investor’s property. If so, the state must then compensate the MNC for its losses. In order to accommodate a range of claims against host governments, usually the ISDS regime will loosen the meaning of “expropriation” with words such as “tantamount to,” as in Chapter Eleven of North American Free Trade Agreement.

What does this look like in practice? In March of this year, an arbitration panel awarded Owens-Illinois Inc., an American MNC, $455 million because Venezuela, its host country, seized two of its glass-bottle plants back in 2010. This award is of the less-controversial variety, as Hugo Chavez spent much of his tenure nationalizing a significant portion of Venezuela’s economy. In cases like this, there are few concerns that a foreign investor was unfairly leveraging their powers under the ISDS regime to punish the host state for legitimate governing behaviour.

Why is ISDS controversial?

Objections to “interference” by foreign investors in the governance of host states are, however, common, because most ISDS regimes allow investors to object even if the action of a host state only indirectly affects the value of an MNC’s investment. Much discussion has focused on foreign investors’ ability to abuse that power.

For example, Elizabeth May, the leader of the Canadian Green Party, has repeatedly voiced objections to ISDS agreements Canada has entered into on this basis. She argues that governments are likely to avoid passing laws if they think a foreign investor will object on the basis that that law interferes with their investment. She says it is difficult to accurately assess the extent to which this “regulatory chill” is operating to shift the course of government action, since it probably comes up before proposed regulation even makes it into parliaments or congresses.

Quantitative research performed in 2014 analyzed empirical evidence to conclude that such regulatory chill is not, in fact, occurring. However, a political skirmish in Poland suggests that this conclusion may have been reached prematurely.

What Happened in Poland

On August 5th of this year, the lower chamber of the Polish parliament adopted a draft law on the restructuring of consumer mortgage loans denominated in foreign currency. The law mandated conversion of foreign currency mortgage loans into Polish zlotys at the exchange rate on the day of the granting of the loan. Banks were to bear 90% of the restructuring costs imposed by this law. Predictions about the net loss to the banking sector were estimated at five billion euro.

Before the higher chamber of parliament in Poland voted on the law, however, several foreign banks controlling the major Polish banks whose business would be affected by the law started a letter-writing campaign. Their message to Polish governmental authorities was that they would be bringing claims under the applicable ISDS treaty if the government voted the proposed bill into law. The Senate changed the loan restructuring terms by reducing the banks’ share of the costs to 50%. The law has since been sent back to the lower chamber of Parliament, where it may be completely retooled so as not to place any direct restructuring costs on banks.

While it would be unfair to presume that these changes were entirely a result of that intervention by the foreign banks, it would also be naïve to suggest that their actions played no role in the Polish Parliament’s change of heart. What this means, then, is that foreign actors managed to leverage the tools afforded them under an ISDS regime to influence the direction and shape of Polish legislation – instead of merely receiving compensation post-facto, when their investment had already been affected by those regulatory actions.

This example presents an interesting dilemma: the democratic process in Poland was arguably compromised by the intervention of foreign interests. However, the effects of a predicted 5 billion loss to the banking sector would likely have been so dire that it is easy to argue that the influence of those foreign interests, in this case at least, were a good thing.

Conclusion

The negotiations underpinning the biggest regional trade agreement in history have just concluded yet the landscape for ISDS regimes is still undergoing drastic shifts. The office of the United States Trade Representative assures that the TTP will include investor-State dispute settlement subject to appropriate safeguards that will protect the rights of the TPP countries to regulate in the public interest.

In this case, foreign corporations redirected the Polish State’s actions – but it is not clear whether it was at the expense of Poland’s sovereignty to regulate in the public interest. Regardless, clarity is necessary for an informed discussion to take place. The relationship between foreign investors and host states must be scrutinized to separate theory from practice, to ensure these agreements are entered into eyes-wide-open.

Jessica Rose is an LLM candidate at Berkeley Law. She is a student contributor for Travaux.

 

 

Promoting Responsible Investing: Rethinking International Frameworks for Sovereign Wealth Funds

By: Xenia Karametaxas |

Sovereign Wealth Funds (SWFs) are public investment vehicles owned and managed directly or indirectly by governments and set up to achieve a variety of macroeconomic objectives. SWFs typically seek to invest the funds from budget or trade surpluses deriving from national oil or mining revenues, for example. Although Kuwait established the first SWF in 1953 to invest excess oil revenues, the increased use of SWFs is a fairly new worldwide phenomenon. Indeed, their use has rapidly expanded over the past decade and SWFs control remarkable financial assets. In the aftermath of the 2007-2009 financial crisis, they played a major role in the bail-out of global banks such as UBS and Citigroup. With a combined total of over seven trillion dollars in assets as of 2014, SWFs have become key players in the international financial markets and in the global economy.

What Obligations Do SWFs Have to Invest Responsibly?

As institutional investors, SWFs have the fiduciary duty to act in the best long-term interests of their beneficiaries. Since the sovereign manages SWFs according to its territory’s objectives, the ultimate beneficiary is not a specific individual but rather the country’s present and future citizenry. In this context, therefore, socially responsible investment may enable a SWF to increase its financial profitability. Investing in companies with a positive ethical footprint has less negative impacts upon social, environmental and human rights factors. Companies that are involved in human rights violations or engage in severe environmental damage may get bad press coverage, become the target of campaigns by non-governmental organizations (NGOs), or even face lawsuits from employees, the community or other stakeholders. This has adverse business consequences, including lower share prices, high litigation costs, damaged corporate reputation, limited market access, and increased difficulties in recruiting the best employees. Conversely, a SWF that invests in companies with a positive ethical footprint may achieve better economic returns.

However, the fiduciary duties of SWFs towards their beneficiaries, the citizens, go beyond the economic maximization of returns on their investments.

First, SWFs operate as saving funds for future generations and consequently their management has the responsibility to respect and promote sustainable development and social justice through their investments in order to give future generations the opportunity to reap the rewards of the investment.

Second, the duty of SWFs to ensure responsible investment practices derives directly form the 1948 Universal Declaration of Human Rights (UDHR), under which “every individual and every organ of society” should respect and promote, to the extent of its capabilities, the rights set out in the UDHR. Thus, as societal actors under this agreement, investors have the obligation to respect and promote human rights.

Third, although SWFs do not formally become parties to international law treaties in the same way that states do and although such treaties do not impose obligations directly on corporations or investors, SWFs can use international treaties “as a moral compass for their responsible investment practices.” Moreover, as state organs, SWFs act as an extended arm of the state, which is often a formal treaty signatory with a clear mandate to protect human rights and the environment under these treaties.

Finally, as important capital providers and shareholders of large public companies, SWFs have the power to influence the behavior of the companies in which they invest. SWFs can be active owners through the exercise of shareholder rights at annual general meetings, by engaging in negotiations with the management of companies with poor corporate social responsibility records, or by putting pressure on such companies through disinvestment. Because SWFs have the ability to influence the management of large companies, they also have the responsibility to take action to correct negative consequences of the companies’ corporate activities.

SWFs’ Responsibilities Under International Normative Frameworks

The only international voluntary framework of investment and operational principles directed at SWFs are the Generally Agreed Practices and Principles (GAPP), commonly referred to as the Santiago Principles. Launched in 2008 by a working group composed of SWFs (the International Working Group of Sovereign Wealth Funds, or “IWG-SWF”) and the International Monetary Fund (IMF), the Santiago Principles aim to guarantee transparency, clarity, and equivalent treatment to SWFs and private funds. The underlying rationale behind the Santiago Principles is to avoid political interference exerted by or upon SWFs in recipient countries, and also to ease the concerns of recipient countries regarding SWFs’ investments.

Surprisingly, the Santiago Principles do not contain any provision addressing responsible investment practices in particular. Nevertheless, the Santiago Principles implicitly encourage responsible investment principles where avoidance of complicity in unethical conduct or social and environmental harm would protect the SWFs’ financial value. Moreover, responsible investment practices are inherently encouraged by the Santiago Principles’ requirement that SWFs identify, assess, and manage the risk of their operations. Thus, investing in a company that (allegedly) violates human rights or that causes environmental damage could risk the SWF’s reputation and bottom-line.

Of course, there are other existing regulatory frameworks that advocate for greater social responsibility that can also be applied to SWFs. The United Nations (UN) Principles for Responsible Investment, the UN Guiding Principles on Business and Human Rights, and the UN Global Compact all reflect the increasing relevance of environmental, social, and governance issues to investment practices of private and public actors. Nonetheless, given the corporate focus of these resources, they are unsuitable tools to apply to SWFs. Indeed, the small number of SWFs among the signatories of such codes reveals that SWFs may be unwilling or unable to meet the responsibilities outlined in these agreements.

Alternatively, given wide acceptance of the Santiago Principles and its focus on SWFs, the Santiago Principles would be a good starting point to reconcile the ethical and financial aspirations of SWFs. A first step towards greater implementation of responsible investment practices of SWFs should be provided by assessing the implementation of the Santiago Principles and encouraging the development of corporate responsibility provisions. In the long-term, the development of a code of conduct under the supervision of an international body such as the IMF, tailored to meet the specific needs of SWFs, should be considered.

SWFs as Promoters for Responsible Investment Practices

Because of their large size and potential market leverage, and due to their long-term investment horizons and their widespread public visibility, SWFs have the potential to catalyze change beyond their own portfolios.

With $ 863 billion in assets, the Norwegian SWF is not only the world’s largest SWF, but has also established itself as a leader and a model for responsible investment practices. Indeed, the Government Pension Fund Global (NGPF-G), as the Norwegian fund is officially known, has demonstrated how an SWF’s responsible conduct can shape best practices in the private sector and thereby set global standards of responsible investment. In fact, the internal investment policies of the NGPF-G have influenced the investment practices of several Norwegian private institutional investors such as pension funds and investment funds. In addition, the NGPF-F’s Council on Ethics draws up a yearly exclusion list in which companies that should be excluded from Norway’s investment universe are publicly listed. In doing so, the Norwegian SWF not only contributes to the professionalization of RI principles, but also exercises a form of normative pressure for RI on private investors.

To sum up, SWFs have not only a financial but also an ethical mandate towards their beneficiaries—the citizens. Through their leverage and impact, SWFs have the potential to contribute substantially to the improvement of the financial markets and the global economy. However, in the context of international frameworks, responsible investment obligations of SWFs have not received sufficient attention yet. In this respect, I advise that the Santiago Principles include a requirement that SWFs commit to ethically responsible investment behavior. Not only should SWFs avoid investing in companies that cause harm to the environment or that violate human rights, but SWFs should also serve as active promoters of sustainable development.