This Chapter reviews the inclusion and operation of investor-state dispute settlement (ISDS) provisions in trade agreements generally with some specific reference to the provisions in the Peru-Australia Free Trade Agreement (PAFTA).
The Committee has regularly reviewed this topic in recent years and much of the information in this Chapter is taken from previous reports of the Committee.
The Chapter explains the ISDS mechanism, considers both the criticism of and support for these provisions before reviewing some proposed improvements and alternative mechanisms.
ISDS an international arbitration procedure that is intended to be an impartial, law-based approach to resolving conflicts between countries and foreign investors. These mechanisms provide a means for foreign investors to settle disputes with host governments through a third party outside of either country’s formal judicial system. ISDS provisions are designed to protect foreign investors from direct or indirect expropriation of their investments. Originally established to protect foreign investors in developing countries, ISDS clauses are now included in the majority of FTAs.
From a country’s point of view, an ISDS scheme offers a number of advantages:
it provides a mechanism to resolve investment conflicts without creating country to country conflict;
it protects a country’s citizens who invest abroad; and
it provides foreign investors in a country with reassurance that the country will respect the rule of law in relation to their investments.
From a foreign investor’s point of view, ISDS is a more reliable mechanism for resolving disputes than the alternatives:
taking action in the legal system of the host country, which may not have laws to permit such an action, or may give certain institutions immunity; or
seeking the diplomatic assistance of the investor’s home country, which relies on the willingness of the home country to provide such assistance.
ISDS is now widespread and well established. The world’s first ISDS institution, the International Centre for Settlement of Investment Disputes (ICSID) was established in 1966. ICSID was established by an international convention to which Australia is a signatory, and operates under the auspices of the World Bank.
ISDS provisions vary across the range of agreements in which they are contained, but there is a constant framework at the core of all ISDS schemes. To bring an ISDS case, a foreign investor must believe that an arbitrary or capricious action of the host Government has caused them to lose their investment.
ISDS cases are heard by a tribunal of three: one appointed by the investor, one appointed by the country, and a third agreed by both parties. The cases can be either public or private.
As explained to the Committee at its inquiry into the original Trans-Pacific Partnership Agreement (TPP), the role of the tribunal is to review the host Government’s actions to determine if those actions were arbitrary or capricious:
They are essentially conducting what has rightly been described in some ways as global administrative law. They are reviewing the process that led to the law being passed. They are reviewing matters such as whether the reasoning that informed the passage of the law was sufficiently conveyed to the public and the affected investors, whether it was arbitrary, whether it was capricious and whether it was disguised expropriation. Those are the points they are considering.
An ISDS tribunal cannot overturn domestic laws and regulations. The tribunal can only require an investor be compensated for the loss of the investment.
The risks identified and reiterated to the Committee by witnesses during their inquiries into trade agreements include:
‘regulatory chill’: governments may be hesitant to introduce regulations, particularly in the areas of environmental legislation or taxation, because these could be challenged and leave the government open to compensation claims. This is perceived as impinging on sovereignty and undermining democracy;
rights of investors: foreign investors gain greater legal rights than domestic businesses by granting them access to third-party arbitration;
compensation payments: foreign investors have been awarded large compensation payments running into billions of dollars; and
international tribunals: the tribunals are made up of three corporate lawyers and usually hold closed hearings. The tribunal members are practicing advocates, not independent judges. There is no system of precedents and no appeal system.
These issues were again raised during the current inquiry. The Australian Council of Trade Unions (ACTU) focused on the perceived undue influence that ISDS clauses may place on a government’s ability to legislate in the public interest:
For us, this part of trade agreements is probably the most threatening and the most dangerous, because we do believe that it threatens democracy and our sovereignty … ISDS provides corporations with disproportionate rights and power with this avenue to threaten and lodge claims for actual or potential harm resulting from local, state and federal government policy regulation. This results in an unacceptable expansion of the rights of corporate investors at the expense of democratic governments, as ISDS can be used to frustrate or block the democratic right of government to develop laws and policies across all government portfolios. ISDS constitutes a gross imbalance between private rights and the public interest, because claims lodged and a threat to lodge a claim by foreign corporations can result in what we call a chilling effect, which means people fear making future domestic policy promises.
The Australian Fair Trade and Investment Network (AFTINET) restated its opposition to the inclusion of ISDS provisions in trade agreements generally and stressed that the United States (US) and the European Union (EU) are both currently retreating from the inclusion of ISDS clauses in their trade agreements:
There’s going to be no ISDS in the current Australia-EU free trade agreement which is being negotiated, because the European Court of Justice has found that ISDS is not compatible with EU law on national sovereignty, and we note that, in the recently revamped version of the of the American Free Trade Agreement, concluded between the US, Canada and Mexico, the US and Mexico have agreed to end ISDS provisions between themselves, and the provisions which will remain between the US and Mexico will only deal with the direct expropriation of assets; they will not enable companies to actually sue over domestic laws, which could include environmental, health or other public interest laws. We believe that both of those examples are evidence of concern about the impact of ISDS on the ability of governments to regulate in areas of public interest like health, the environment and even Indigenous land rights and others.
Support for ISDS
Despite these ongoing issues and growing community concerns, there is also considerable support for the inclusion of ISDS mechanisms in trade agreements. ITS Global summarised the perceived benefits of ISDS mechanisms for businesses:
ISDS allows businesses to protect their investments in an FTA country without having to rely on domestic legal remedies or require their government to take action against the other government party. There is substantial precedent for ISDS being used to protect investment and minimise unreasonable sovereign risk;
ISDS de-politicises the FTA dispute settlement process. An investor can have their claim determined by an independent arbitral tribunal. To action state-to-state dispute resolution measures under an FTA, the affected investor must first persuade its government to pursue a claim. This can be difficult for investors and investments which are politically less attractive to defend; and
ISDS gives businesses some degree of confidence that a host state will be held accountable for breaches of its investment obligations and commitments. Without effective enforcement mechanisms, the rights granted by the FTA are less likely to be effective in promoting investment.
ISDS mechanisms are seen as providing protection for Australian businesses operating abroad from ‘arbitrary, opaque or unfair decisions by foreign governments’. In Peru, this is particularly relevant in the mining industry. Rio Tinto notes its strong support for the inclusion of an ISDS mechanism:
This mechanism helps us reduce the sovereign and political risks and protects us against expropriation. Having the right to access an international tribunal to resolve investment disputes protects high capital investment industries such as mining, from discrimination and instability.
The Minerals Council of Australia (MCA) echoed these sentiments, stressing the need to provide certainty for Australian investors operating abroad:
… ISDS provisions provide investment certainty for international investments. This makes Australia a more attractive destination for investors, as well as provide [sic] greater certainty for investment overseas which in the case of the minerals sector can be significant. It is important to ensure that foreign investors are broadly treated the same as domestic investors, subject to specific exceptions and carve outs. From the MCA’s perspective, this is crucial in ensuring greater certainty and stability for Australian investors abroad. This will help reduce the risk of protectionist investment measures, such as discrimination and expropriation and ensuring a minimum standard of treatment.
Improvements and safeguards
Dr Luke Nottage told the Committee that, contrary to previous arguments against the inclusion of ISDS mechanisms in trade agreements, recent evidence suggests positive outcomes from these provisions, including that:
even qualified procedural rights for investors to bring direct action against host states for expropriation or other violation of substantive treaty commitments, in addition to the option of inter-state arbitration, has led historically to increased FDI on a world-wide basis;
Australian investors now make good use of ISDS protections to recoup losses incurred by alleged treaty violations, notably by developing states;
the risk of successful claims against Australia and hence supposed ‘regulatory chill’ should be minimal—as shown by the outcome of the Philip Morris claim (and the merits decision in its claim against Uruguay over tobacco regulation) even under some old treaties without CPTPP-like elaborations, as well as the ambit claims recently by some US investors.
The difference between older ISDS provisions and current examples was highlighted by other submitters:
Compared to older provisions, the modern ISDS provisions of agreements like PAFTA, TPP-11 and the updated Singapore-Australia Free Trade Agreement include extensive safeguards and protections for public policies.
The Committee can be satisfied that the PAFTA ISDS provisions are state-of-the-art in terms of safeguards to protect public policy, to ensure investment disputes are resolved in a transparent, accountable and fair manner and to address community concerns over ISDS.
The Department of Foreign Affairs and Trade (DFAT) explained that an ISDS mechanism has existed between Australia and Peru for over 20 years pursuant to the Agreement between Australia and the Republic of Peru on the Promotion and Protection of Investments, and Protocol (IPPA). Negotiating PAFTA and TPP-11 has provided an opportunity to update this older-style bilateral investment treaty. The IPPA will terminate upon entry into force of PAFTA, or upon entry into force of TPP-11, whichever happens first.
According to DFAT, although both agreements include improved safeguards, PAFTA contains additional safeguards to those available in TPP-11:
Both TPP-11 and PAFTA explicitly recognise that governments have an inherent right to regulate in the public interest, such as in relation to health and the environment. PAFTA also includes a broader safeguard on public health measures, as well as a general exceptions provision in relation to, amongst other things, animal or plant life or health, and the conservation of exhaustible natural resources. Like TPP-11, PAFTA also maintains Australia’s right to take measures for the protection of its essential security interests. Unlike the TPP-11, ISDS does not apply to the financial services chapter in PAFTA.
PAFTA also includes procedural safeguards to enhance the arbitration process, including:
a requirement that hearings will be open to the public;
a requirement that documents filed in the arbitration, as well as the tribunal’s decision, will be made public;
expedited review of claims that are baseless, or manifestly without legal merit; and
rules preventing a claimant pursuing a claim in parallel proceedings, such as before an Australian court or other dispute settlement procedures.
Further, under PAFTA arbitrators are required to comply with rules on independence and impartiality, including on conflicts of interest.
AFTINET welcomes the inclusion of these safeguards but remains concerned that the safeguards are not consistent between PAFTA and the TPP-11, are in places ambiguous and open to interpretation and still contain legal loopholes. In particular, AFTINET questions the discrepancy regarding the treatment of tobacco between the two Agreements:
PAFTA excludes ISDS cases against public health measures, specifically mentioning cases related to the PBS, Medicare, the Therapeutic Goods Administration and the Office of the Gene Technology Regulator. But there is no specific exclusion of tobacco regulation. This is a curious omission, given Australia’s experience of the Philip Morris case, and the fact that it is the only specific exclusion in the TPP-11. The more general safeguards for public health measures will not prevent tobacco companies from taking cases if a future government should decide on further changes to tobacco regulation.
Asked about this discrepancy, DFAT highlighted the difference between a bilateral and plurilateral agreement and assured the Committee that tobacco is covered by the broad public health carve-out in PAFTA:
The TPP-11 offers an excellent and very high standard of protection for the government in terms of the right to regulate. It contains safeguards that are not generally included in the earlier ISDS treaty … But in PAFTA we negotiated something that better reflected the views of Australia and Peru, whereas the TPP-11 better reflects the views of the 11 negotiating parties to that agreement. It was an opportunity to provide the safeguards you see in that particular agreement.
Support for the inclusion of ISDS mechanisms does not ignore the need for continuing improvement in implementation of the ISDS framework. Although Dr Nottage does not see any cause not to ratify PAFTA because of the inclusion of the ISDS provisions, he does suggest that those provisions could be further improved. He points out that there is already scope within PAFTA for these improvements to progress:
In particular, Australia can (and should) take an active role in developing a Code of Conduct for ISDS arbitrators, which must be done before the FTA comes into effect.
Under Article 8.24.1 Australia shall ‘consider’ adding an appellate review mechanism ‘if’ such an institutional mechanism is developed elsewhere (eg through UNCITRAL multi-laterally, or regionally perhaps alongside the CPTPP). It should already commence negotiations with Peru about adding such a mechanism, but this can be agreed separately even after ratification of this FTA.
Dr Nottage also suggests that Australia could follow the lead provided by New Zealand and ‘agree with Peru to make a separate joint declaration on how it views ISDS provisions. New Zealand has taken this action with two other states alongside the CPTPP.
AFTINET drew the Committee’s attention to new models being implemented by India and the EU. The Indian model strengthens the right of government to regulate in the public interest:
For example, the definition of expropriation in the draft India [Bilateral Investment Treaty] does not contain the loophole ‘except in rare circumstances’ …
The Committee understands that the EU model has been incorporated into the Transatlantic Trade and Investment Partnership between the EU and the US:
The EU model attempts to address the structural flaws of the lack of an independent judiciary and appeals system by establishing a panel of qualified judges to serve on tribunals (EU Commission 2015: Section 3 article 9 p.17). It also establishes an appeals tribunal consisting of more senior qualified judges (European Union 2015: Section 3 Article 10).
Submitters including AFTINET identified two alternatives to ISDS provisions being included in trade agreements. The first is the state-to-state dispute settlement mechanism included in these agreements which allow governments to act if they consider that an agreement has been breached:
All trade agreements have government-to-government dispute processes to deal with situations in which one government alleges that another government is taking actions which are contrary to the rules of the agreement.
The second is for investors to be responsible for their own risk management insurance:
The alternative for foreign investors are to take out risk insurance themselves—if they believe they’re investing into a risky environment, they can take out risk insurance and cover those risks in those ways. That form of insurance doesn’t expose the government of the country to cases which could claim compensation for health, environment or other public interest laws.