In brief

  • For foreign investors, bilateral and multilateral trade agreements can be an important tool in managing sovereign risk. These agreements often provide an investor with substantive protections against the host government and a mechanism for resolving disputes with the host government in arbitration.
  • The Australian Government has, however, recently announced that it no longer intends to include provisions providing for arbitration between the host government and the investor in its trade agreements with developing countries.
  • If the Australian Government’s proposals are implemented, this is unlikely to prevent investors from deriving the benefits of trade agreements. However, investors will need seek to restructure their investments through intermediary countries which do have trade agreements providing for arbitration with the host country.  

Background and key issues

A key consideration for investors investing in developing countries, is how investments should be structured to best manage sovereign risk.

During the last 30 years, a complex network of bilateral and multilateral trade agreements designed to promote and protect foreign investment has emerged. Over the past decade, these agreements have proliferated, with the United Nations Conference on Trade and Development estimating that, by the end of 2009, almost 6000 of these agreements existed.1

For foreign investors, an understanding of this network of trade agreements is critical in order to ensuring that sovereign risk is effectively managed. This is because most of these agreements:

  1. confer substantive protections on the foreign investor and their investment, such as the right to have an investment treated fairly and equitably by the host country (the foreign country into which the investor is investing), and
  2. provide a mechanism for settlement of disputes by arbitration directly between the foreign investor and the host country (known as investor-state dispute settlement (ISDS)), often without the necessity for recourse to the host country’s domestic courts.  

Although a foreign investor may, even without the substantive protections conferred under a trade agreement, still be afforded certain rights in respect of their investment (whether under the law of the host country or as a matter of international law), it is often much more difficult to enforce those rights absent a trade agreement that provides for ISDS.

The Australian Government has however recently signalled a shift away from the above approach. In a Trade Policy Statement released on 12 April 2011 (Policy Statement), the Australian Government stated that it would no longer include provisions providing for ISDS in trade agreements with developing countries.2 If this policy is followed in respect of future trade agreements, this will limit the means by which Australian (and foreign) investors can protect themselves using bilateral treaties between Australia and other countries. However, with proper planning, investors will still be able to structure their investments through other countries which have entered into bilateral treaties and which provide for foreign investor protections. Ironically, then, the Australian Government’s approach may push Australian investors into offshore structures.

Policy Statement

In its Policy Statement, the Australian Government stated that it does not support ISDS provisions because they:

  1. confer greater rights on foreign businesses than those available to domestic businesses, and
  2. constrain the ability of Australian governments to make laws on social, environmental and economic matters in circumstances where those laws do not discriminate between domestic and foreign businesses. An example given in the Policy Statement is the ability to put health warnings or plain packaging requirements on tobacco products.

Accordingly, the Australian Government stated that if Australian businesses are concerned about sovereign risk in Australian trading partner countries, they will need to make their own assessments about whether they want to commit to investing in those countries.

The Australian Government has for some time been considering the merit of including ISDS provisions in its trade agreements. On 13 December 2010, the Productivity Commission released a report which weighed the benefits and risks of including ISDS provisions in trade agreements and concluded that ‘it seems doubtful that the inclusion of ISDS provisions … affords material benefits to Australia or partner countries.’3

For related commentary on the draft of the Productivity Commission’s report, please view our article ‘Developments in Australia’s investment landscape’.4

Importance of recent developments

Although the Policy Statement is said to adopt the recommendations of the Productivity Commission, the Australian Government’s position is surprising. It is at odds with the growing proliferation of trade agreements containing ISDS provisions which have been implemented around the world throughout the past decade, and which continue to be implemented. During this time, Australia has itself entered into many trade agreements, most of which (with the notable exception of the Australia-US Free Trade Agreement) contain ISDS provisions.

The Australian Government’s position is possibly reflective of a growing disquiet in the international legal community with respect to the number of arbitrations being brought under ISDS provisions and the ease with which informed investors are able to ‘treaty shop’. It potentially also reflects the Australian Government’s own concerns about actions being commenced against it in relation to its own recent activities such as the proposed resources tax.

The Australian Government’s policy announcement does not prevent Australian investors from obtaining protections for their foreign investments. Nor does it preclude foreign investors from obtaining protections for investments in Australia. However, it will require those investors to structure their investments through third countries which do provide for such protections so as to take advantage of ISDS provisions. For example:

  1. instead of investing directly into the host country, Australian investors seeking to invest abroad can invest through an intermediary country that has a trade agreement with the host country containing ISDS provisions, and
  2. instead of investing directly into Australia, foreign investors seeking to invest in Australia can direct their investments through an intermediary country that has a trade agreement with Australia containing ISDS provisions.  

As a result, somewhat ironically, the effect of the Australian Government’s proposals may be to:

  1. in the case of Australian investors investing abroad, move the investment vehicle offshore, which diverts tax revenue and returns away from Australia, and
  2. in the case of foreign investors investing in Australia, divert investment revenue away from Australia by deterring foreign investors from investing in a country which does not provide for the safeguard of ISDS.

At present, Australia is involved in a large number of trade negotiations, including with:

  • China (Australia’s largest trading partner)
  • Japan (Australia’s second largest trading partner)
  • Korea (Australia’s fourth largest trading partner)
  • Malaysia
  • Indonesia, and
  • the Gulf Cooperation Council.

It will be interesting to see how the Australian Government’s position affects the negotiation of these agreements. For Australian investors seeking to invest into these countries, and for investors from these countries seeking to invest into Australia, it will be important to closely monitor the progress of these negotiations.