12 May 2017

Managing risks, protecting returns internationally - with treaties


Hussein Haeri
Partner | UK

Political risks associated with investing around the world are, or should be, familiar features of financial life. The means by which investors can protect themselves are relatively limited. As a result, any addition to investors’ safety toolkit is worth attention. In this article, Hussein Haeri and David Walker consider the issues.

Investing internationally, sometimes in unfamiliar jurisdictions, is integral to many investment portfolios. However, political risks in the host state are some of the biggest challenges for such investments, and these risks can take many forms. There are risks that you may be able to foresee and risks that may be less immediately apparent. There are risks of nationalization and discriminatory treatment, which may be obvious, but there are also more oblique but nonetheless very real risks such as unfair and arbitrary treatment and a lack of due process. There are also the risks that a new government could renege on your agreement with the previous government, or that different parts of the government may adopt inconsistent approaches to your investment.

Until relatively recently, investors had three limited means of protecting their foreign investments from political risk outside of their contractual rights. First, an investor could try to obtain political risk insurance. However, this can be very expensive and it often offers limited protection. Second, the investor could try to sue the host state in its own courts, though this is rarely the preferred option, not least because the judiciary is part of the host state apparatus. Finally, an investor could try to persuade its home state to commence negotiations and proceedings against the host state. Yet this leaves the investor beholden to an unpredictable political process. The home state may have many geopolitical reasons for not taking any action, regardless of the merits of the investor's claim. Moreover, the investor loses control over this process with respect to its position and rights.

Treaties and legal protection

Investment protection has changed dramatically as governments around the world have signed up to thousands of investment treaties. These treaties are agreements between sovereign states which aim to promote and encourage investments between them. Investment treaties can be part of multilateral agreements (such as the North American Free Trade Agreement), but bilateral investment treaties (BITs)
are the most common form. Alongside the increase in global trade and investment flows in recent decades, BITs have proliferated and there are now around 3,000 of them.

Under the terms of a BIT, two sovereign states agree to certain standards of treatment and protection for qualifying investors from one treaty party when they make investments in the territory of the other treaty party. The content of each BIT varies and each BIT is unique because it is the subject of negotiations and agreement between two sovereign states. However, some commonly included standards and protections
for investors in investment treaties are:

  • fair and equitable treatment;
  • protection from expropriation, whether direct or indirect (unless accompanied by compensation);
  • national treatment (i.e. that the host state will treat the foreign investment no less favorably than local competitors);
  • most-favoured-nation treatment (which means that the investor should be treated no less favorably than the investors of a third country);
  • freedom to transfer funds (e.g. the freedom to move profits and capital out of the country); and,
  • full protection and security (this concerns the protection given to an investor’s property from damage caused by the host state’s officials or others acting within the state’s jurisdiction).

These investment protections or standards are binding legal obligations on states under public international law, and most BITs give qualifying investors the right to bring international arbitration proceedings directly against the host state to enforce them. Qualifying investors can thus bring international arbitration proceedings for violations by the host state (including its organs and agencies for which it is responsible) of the treatment standards in the BIT. This applies even if the investor does not have a contract, let alone a contractual arbitration agreement, with the government of the host state.

In arbitration proceedings, an arbitral tribunal will provide a neutral and independent forum in which to judge the host state’s behavior. This should be compared with attempting to bring a claim in the host state's courts system, which, as mentioned above, may be influenced by the state's interests. If the state is found liable, the tribunal may award damages to the investor that can run to millions and even billions of dollars. Another notable advantage of arbitration is that awards are enforceable through international conventions such as the World Bank's ICSID convention, or the New York Convention.

Use of investment treaties

Investment treaties can provide a useful means for a qualifying investor to enforce its rights if a host state has breached protections and standards within a BIT. Indeed, investors have brought successful investment treaty arbitrations against states in all parts of the world in recent years. However, this will only aid investors and investments that qualify for protection under a relevant BIT.

Many investors remain unaware of how investment treaties can protect their investments and they ignore the issue until a dispute has arisen and it is too late. For an investor, knowing and securing rights can be the most effective way of ensuring that they do not need to be exercised. Thus, investors would be well advised to review their existing investment portfolios to fully understand the protections available and the areas where they are vulnerable to risk and to consider international investment protection when evaluating new investment opportunities abroad.

This article was first published in Wealth Briefing 12 May 2016

Category: Article